-- We are revising our outlook on Ontario Power Generation Inc. (OPG) to
negative from stable.
-- At the same time, we are affirming our ratings, including our 'A-'
long-term corporate credit rating, on the company.
-- The outlook revision reflects the revision of our stand-alone credit
profile on OPG to 'bbb-' from 'bbb'.
-- The ratings reflect our opinion of the company's strong business risk
profile and significant financial risk profile.
On Nov. 27, 2012, Standard & Poor's Ratings Services revised its outlook on
Ontario Power Generation Inc. (OPG) to negative from stable. At the same time,
Standard & Poor's affirmed its ratings, including its 'A-' long-term corporate
credit rating, on the company.
The outlook revision reflects the revision of our stand-alone credit profile
(SACP) to 'bbb-' from 'bbb'. Based on our criteria for government-related
entities, based on a 'bbb-' standalone credit profile and a "high" probability
of extraordinary government support, the negative outlook reflects the
negative outlook on the utility's shareholder, the Province of Ontario
(AA-/Negative/A-1+). A further lowering of the SACP or a downgrade on the
province would lead to a negative rating action on OPG.
The SACP revision reflects our view that OPG's credit metrics could weaken in
the near-to-medium term. The company is continuing with a number of projects
that require a significant amount of capital expenditure in the next two
years. In particular we forecast that the Darlington nuclear facility
refurbishment together with the Lower Mattagami project will require
approximately C$1 billion in capital expenditures in each of the next two
years. This is in addition to the other projects that OPG is working on along
with sustaining capital expenditure.
We view this capital expenditure in a regulatory context, which provides
limited cash flow relief during construction for multiyear projects and a
balanced-but measured-perspective on yearly rate applications. Accordingly,
the timing difference between the regulatory asset's development (with the
consequential debt) and the start of cash flow in the regulatory environment
(which has allowed moderate rate increases) could stress financial metrics.
The ratings on OPG, which Ontario owns, reflect Standard & Poor's opinion of
the regulatory oversight of the utility's baseload nuclear and hydroelectric
assets; a diverse generation portfolio; and dominant market position in
Ontario. Weak cash flow metrics and exposure to regulatory delay and cost
overruns related to new construction and refurbishment of existing facilities
offset the company's credit strengths, in our view. Exposure to merchant
electricity prices and volume related to OPG's unregulated business further
constrain the SACP. We rate management as "fair" under our management and
governance criteria. The company borrows about 80% of its C$4.9 billion
reported consolidated debt as of Sept. 30, 2012, from the government
shareholder, through Ontario Electricity Financial Corp. (OEFC).
We base the 'A-' rating on OPG's SACP, which we assess at 'bbb-', and our
opinion that the ratings on OPG and Ontario are linked. We assess that there
is a "high" likelihood that the government shareholder would provide timely
and sufficient extraordinary support in the event of financial distress. This
reflects our views that OPG's role is "important" to Ontario, that the utility
plays a major role in the government's energy policy; and that the link
between the utility and the province is "very strong", reflecting ownership
relationship, ongoing financial support from OEFC, and the province's strong
influence in the company's investment decisions.
In our view, OPG's business risk profile benefits from having about 77% of its
EBITDA in 2011 supported by regulated sources. These sources include nuclear
and baseload hydroelectric assets that the Ontario Energy Board (OEB)
regulates as well as regulated nuclear waste management. Assurance of cost
recovery and a predictable, albeit moderate, return for these assets is a
positive credit factor. Historically, although the OEB decisions have led to
more moderate returns for OPG, given the discretion that the company has with
respect to its capital expenditure and the resultant level of debt it was able
to mitigate the impact of lower revenues. However, the company has reached an
inflection point in its capital plans where significant expenditures for such
things as the Darlington facility refurbishment and the Lower Mattagami
project are required. We believe that these projects will put significant
strain on credit metrics for the next two years.
The fuel diversity and large number of generating units in OPG's generation
portfolio mitigate the risk of operational disruptions and enhance its
business position, in our opinion. As of Sept. 30, 2012, the portfolio of
assets that the company owns and operates includes:
-- 6,606 megawatts (MW) of baseload regulated nuclear generation;
-- 6,996 MW of predominantly run-of-the-river hydroelectric generation,
of which 3,312 MW is regulated; and
-- 5,447 MW of intermediate unregulated thermal generation (projected to
shut down by 2014).
We believe OPG has a strong competitive position. The company dominates the
Ontario electricity market, producing 85 terawatt-hours (TWh; most of it
baseload) of the 142 TWh of electricity consumption in the province in 2011.
Its unregulated hydro assets typically enjoy a competitive advantage compared
with higher marginal cost gas-fired alternatives.
Constraining OPG's unregulated cash flows, in our view, are the company's
exposure to the wholesale electricity price and volume risk due to
fluctuations in Ontario demand, the inherent uncertainty of available water
flows, and competitively priced imports from neighboring markets. Wholesale
electricity prices have struggled in 2012, with the weighted average Hourly
Ontario Electricity Price at C$24 per MW-hour (MWh) for the nine months ended
Sept. 30, 2012, compared with the C$32 per MWh in 2011.
Technical challenges associated with key components of nuclear facilities have
the potential to expose the units to lengthy outages, hurting cash flow
performance and increasing capital demands. OPG's nuclear liability
risk-sharing agreement with Ontario limits the company's used nuclear fuel
liabilities and partially mitigates the operating challenges.
In implementing its energy policy favoring renewable energy generation to
replace the less eco-friendly coal-fired generation facilities, the province
has directed OPG toward investments in projects on various occasions. It also
required the utility to shut down the remaining coal-fired plants by 2014.
Along with these directives, the government has provided ongoing support to
OPG through loans from OEFC and long-term power purchase agreements with the
Ontario Power Authority to support the company's other projects. It also
provides OPG with a contingency support agreement to cover operating costs and
a modest return on investments of the coal-fired facilities until complete
closure in 2014. We regard these ongoing supports as important mitigating
factors to the company's business risk profile.
We believe OPG's stand-alone financial risk profile is significant. We believe
stand-alone cash flow metrics are generally weak, partially as a result of the
material postretirement benefit adjustments and modest return on investments.
Adjusted funds from operations (AFFO) interest coverage was 2.7x and
FFO-to-total debt was 9.1% for the 12 months ended Sept. 30, 2012. AFFO, in
our definition, deducts the contribution to nuclear waste and decommissioning
funds, which we regard as a cost of ongoing operations. We expect any
improving trend that might emerge in the next three years to be gradual. We
forecast that AFFO for the next two years will be approximately C$800 million
in each of the next two years. Based on the significant capital expenditure
required, we believe that AFFO-to-debt could fall below 9% in each of the next
OPG's liquidity is adequate under our criteria, and should be sufficient to
cover cash uses in the next 12 months. Standard & Poor's bases its liquidity
assessment on the following factors and assumptions:
-- We expect that the company's liquidity sources of about C$2.9 billion
in the next 12-18 months will exceed its uses by about 1.6x.
-- Available cash resources include our expectation of annual cash flow
from operations of about C$900 million, and available credit facilities of
C$1.9 billion as of Sept. 30, 2012. The committed and available credit
facilities comprise a C$1 billion maturing May 2017, a C$700 million bank
credit facility to support initial construction of the Lower Mattagami
project, and a C$700 million OEFC facility for Lower Mattagami.
-- Projected uses of cash in the next 12 months include a sizable capital
expenditure of about C$1.7 billion.
We expect that the utility will not pay out dividends in the foreseeable
future and future debt maturities do not present a material concern, given the
shareholder's practice of refinancing notes payable at their due dates.
The negative outlook reflects our view of the 'bbb-' SACP, the high likelihood
of provincial support, and the negative outlook on the province. Although we
recognize that OPG's cash flow adequacy will be weaker in the next two years
due to substantial capital expenditure on regulated and contracted projects,
we believe that the SACP could be lowered if we expect OPG's adjusted
FFO-to-total debt to stay below 8%-10% or adjusted FFO interest coverage
weakens to below 3.0x. This could result from unfavorable rate decisions,
operational issues resulting in unexpected outages in its generation
facilities, or a move toward a more aggressive financial policy (including
extended significant debt financed capital expenditure). A decline in the SACP
to 'bb+' would result in a downgrade on OPG.
For the SACP to move a notch higher, we believe OPG would need to improve
significantly the level and stability of is overall cash flow strength
comfortably above 10%-12%. This could result from an equity injection from
the province which we consider to be highly unlikely. It could also result
from some form of additional regulatory cash flow support during the upcoming
period of high capital spending on large projects that we have seen for other
Canadian utilities in a similar position.
We link the ratings on the utility and those on the province through our
enhanced government-related entity methodology. All else being equal, a
one-notch downgrade to Ontario would result in a one-notch downgrade in OPG.
An outlook revision to stable on the province could result in a similar
outlook revision on OPG. A change in the relationship with the government
shareholder, which includes changes in ownership, could move the ratings in
Related Criteria And Research
-- Methodology: Management and Governance Credit Factors for Corporate
Entities and Insurers, Nov. 13, 2012
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Rating Government-Related Entities: Methodology And Assumptions, Dec.
-- Key Credit Factors: Business And Financial Risks In The Investor-Owned
Utilities Industry, Nov. 26, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ontario Power Generation Inc.
Outlook Revised To Negative
Corporate credit rating A-/Negative/-- A-/Stable/--
Canada scale A-1(Low)