Calgary — Standard & Poor's is looking at cutting the credit ratings of 15 Canadian utilities, saying their historically favourable regulatory environment may no longer be a sufficient counterbalance to comparatively high levels of debt.
The sweeping review will take three months and may see some credit ratings of some companies downgraded two notches, while others may be unchanged, S&P said Thursday in a conference call with analysts and reporters. The companies under review include some of Canada's largest utilities, such as Atco Ltd. and TransCanada PipeLines Ltd., although utilities whose debts are backed by governments are not subject to the review.
The ratings agency did not point to any one factor for its decision during the conference call, and said turmoil in the U.S. utilities sector — including the implosion of Enron Corp. — was unrelated to its review. (Enron had investment-grade ratings until only days before its collapse.)
The head of S&P's Canadian operations said later in an interview that a major consideration was some recent regulatory decisions in Canada that have given utilities lower rates of return than requested because they believed it would not affect credit ratings.
"In a way, we've stepped out of that cycle," said Thomas Connell, managing director and head of S&P's Toronto office. "We've said, if that's all they're going to get, we're now slightly less willing to reaffirm the rating at the previous levels and we'll tell the companies that; we'll tell the investors that and we'll tell the regulators that."
He suggested that utilities that do not reduce their debt leverage may need to pay higher risk premiums on bonds.
S&P's report announcing the review suggested that the rate-of-return approach is less desirable than "performance-based" regulation, which allows utilities to boost profits through cost-cutting.
The head of Alberta's utilities regulator said Thursday that provincial consumers have expressed concern about abandoning the rate-of-return approach, and that other options are potentially more risky. "It may provide an incentive for more efficiencies, but we'll have to wait until that concept is developed in a little more explicit way," said Neil McCrank, chairman of the Alberta Energy and Utilities Board.
Beyond specific regulatory decisions, the environment in which utilities operate is becoming more volatile, Mr. Connell said. Weather patterns are becoming less predictable, and other factors such as the Kyoto Protocol further cloud the picture, he said. "The world is becoming more complicated."
One equity analyst said S&P's decision was likely prompted by turmoil in the sector outside Canada. "It's definitely coming out as a reaction to what's gone on not just in the United States, but in Europe as well," said Maureen Howe, a managing director of institutional equity research at RBC Capital Markets.
S&P put five companies on credit watch, with a negative outlook, including: Atco, Emera Inc., Fortis Inc., Trans Quebec & Maritimes Pipeline Inc. and Foothills Pipe Lines Ltd. Another 10 firms, already on credit watch with a negative outlook, are also part of the review: BC Gas Inc., Borealis Infrastructure Trust, Electricity Distributors Finance Corp., Hamilton Utilities Corp., Hydro Ottawa Holdings Inc., London Hydro Inc., Oakville Hydro Corp., Toronto Hydro Corp., TransCanada and Veridian Corp.
Neither of S&P's rival agencies, Dominion Bond Rating Services and Moody's Investors Services Inc., plan a similar wide-ranging review. Analysts at both firms said they have continually updated their ratings for utilities, noting that the regulatory environment has traditionally been considered one of the key risk factors for the sector.
Matthew Kolodzie, an analyst at DBRS, said his ratings on several utilities are already slightly lower than those of S&P.
© The Globe and Mail
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