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Fixed Income Quarterly—Gas & Electric Utilities
Recent Regulatory Developments –
• The Alberta Utilities Commission (AUC) is expected to commence an oral hearing on May 26, 2014, for the 2013 and 2014 Generic Cost of Capital proceeding, which will include a full review of capital structure and return on equity (currently set at 8.75%).
• On March 25, 2014, the British Columbia Utilities Commission (BCUC) issued a decision on Stage 2 of its Generic Cost of Capital proceeding. Stage 1 established the allowed ROE and capital structure for FortisBC Energy at 8.75% and 38.5%, respectively, effective January 1, 2013, to December 31, 2015. Stage 2 effectively establishes cost of capital and deemed equity for:
• FortisBC Electric – capital structure of 40% and an equity risk premium of 40 bps for an ROE of 9.15%;
• Fortis BC (Vancouver Island) – capital structure of 41.5% and an equity risk premium of 50 bps for an ROE of 9.25%; and,
• FortisBCEnergy(Whistler)–capitalstructureof41.5% and an equity risk premium of 75 bps for an ROE of 9.50%.
• On March 6, 2014, Emera announced that it had finalized the Federal Loan Guarantee for the $1.5 billion Maritime Link Project (subsea cable between Newfoundland and Nova Scotia). The company expects to put the project financing in place (up to $1.3 billion) during Q2/14.
• On February 27, 2014, FortisBC Energy Inc. announced that it had received approval from the BCUC to amalgamate FortisBC Energy Inc., FortisBC Energy (Vancouver Island) Inc. (Moody’s: A3), FortisBC Energy (Whistler) Inc., and Terasen Gas Holdings Inc. (DBRS: BBB (high), Moody’s: Baa2). The BCUC determined that the amalgamation is “beneficial and in the public interest.” The regulated natural gas utilities will amalgamate under one legal name, FortisBC Energy Inc., following consent from the Lieutenant Governor in Council and the receipt of all other necessary approvals.
• On January 17, 2014, the Alberta Electric System Operator (AESO) announced the five companies selected to compete for the opportunity to build, finance, own and operate the proposed $1.6 billion Fort McMurray West Transmission Project. Canadian Utilities Ltd., AltaLink, EPCOR, TransAlta and TransCanada were among the five proponent partnerships selected to bid. The project consists of a 500-kv transmission line from Edmonton to Fort McMurray designed to support increasing growth in northeastern Alberta. The AESO is expected to select the winning bid for the project, which will be determined based on the company that can undertake the lowest life-cycle cost, in December 2014.
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On January 17, 2014, ATCO Pipelines received approval from the AUC for its $600 million Urban Pipeline Replacement (UPR) application. Construction of the UPR project, which is designed to replace and relocate high-pressure natural gas pipelines in the Calgary and Edmonton areas into the surrounding transportation utility corridors, will be completed over the next five years.
On December 19, 2013, Toronto Hydro received approval from the Ontario Energy Board for Phase II of its 2014 work program under the Incentive Regulation Mechanism/ Incremental Capital Module. Total approved capital expenditures in 2014, in addition to expenditures relating to the $194.9 million Copeland Transformer Station, amount to $398.8 million.
Curve Steepness – During the quarter, the Utility 2s-5s credit curve flattened by 2 bps to 22 bps, the 5s-10s curve flattened by 2 bps to 36 bps, and the 10s-30s curve flattened by 1 bps to 32 bps (Table 5). In light of the relative steepness, we see better value in the middle part of the credit curve.
Credit Ratings – On March 31, 2014, S&P revised its outlook on Brookfield Renewable Energy Partners L.P. to Positive from Stable and affirmed the rating at BBB. The Positive outlook reflects the agency’s view of the partnership’s improving level of parent-only cash flow (POCF) and modest amounts of debt at the holding company. An upgrade could occur if POCF-to- debt remains at or about 30% on a sustained basis.
On February 24, 2014, Moody’s revised its outlook on TransAlta to Negative from Stable and affirmed the rating at Baa3. The Negative outlook was attributed to FY2013 results that failed to meet the agency’s expectations: (1) FY2013 CFO pre-WC/debt came in at 13.9%, which was below the 19% CFO pre-WC/debt level Moody’s associates with the Baa3 rating – Moody’s 2014 forecasted range of 16–18% is still below this minimum level; and (2) FY2013 cash flow of approximately $700 million came in below the expectation of $800 million – TransAlta management is currently forecasting 2014 FFO guidance of $743–793 million. The agency views the recent initiatives to strengthen the balance sheet, including the 38% dividend cut and the sale of a non-core asset (CE Generation) for US$193.5 million, as positive; however, this may not be able to offset expected weakness embedded into cash flow generation forecasts. Moody’s has indicated that it will resolve the Negative outlook in the next 12–18 months and has assigned a 1-in-3 probability of a one-notch downgrade. Conversely, the outlook could revert to Stable if the company achieves CFO pre-WC/ debt of about 19% on a sustainable basis.
On February 24, 2014, DBRS changed the trend on FortisAl- berta Inc. to Positive from Stable and confirmed the rating at A (low). The Positive outlook is a result of DBRS’s assess- ment that FortisAlberta’s business and financial risk profile is reflective of an “A” rating based on the following factors: