DBRS Confirms Lower Mattagami Energy Limited Partnership at A (high) and R-1 (low)

DBRS has today confirmed both the Issuer Rating of A (high) and the Senior Secured Bonds rating of A (high) for Lower Mattagami Energy Limited Partnership (LMELP) – the Commercial Paper rating has also been confirmed at R-1 (low). The trend is Stable for each rating. The ratings reflect robust project economics, highly rated counterparties and the financial and structural flexibility to manage primary risks and withstand potential downside scenarios during both construction and operating periods.

DBRS views LMELP as a hybrid entity having some of the characteristics of both a traditional power project and a corporate utility. Sponsor Ontario Power Generation Inc. (OPG, rated A (low) and R-1 (low)) formed LMELP and LMLP (Lower Mattagami Limited Partnership; collectively, the Lower Mattagami River Project, or LMRP) to redevelop existing OPG hydroelectric generating assets on the lower Mattagami River in northern Ontario. OPG has contributed the existing generating assets (434 megawatts (MW)) to LMELP, while LMLP will hold the incremental 490 MW of new construction generating assets. Construction began in June 2010, and as of March 31, 2012, according to OPG, work was proceeding consistent with the approved budget and schedule. OPG is a significant and experienced power producer and hydro operator with about 19,000 MW of generating capacity and $5.1 billion in annual revenues for the year ending December 31, 2011. The Province of Ontario (the Province, rated AA (low)) has been closely involved in the LMRP redevelopment.

Post-construction risks are considered modest and manageable for the rating category based on LMRP’s favourable cost-of-service type treatment under the 50-year Hydroelectric Energy Supply Agreement (HESA) with the Ontario Power Authority (OPA, rated A (high)). The 50-year HESA is unlike a traditional power purchase agreement and provides a utility-like cost-of-service revenue requirement rather than a specific $ per megawatt hour (MWh) payment for energy produced. While the HESA can generate revenue upside above the revenue requirement floor level, DBRS assumes a more conservative case that excludes market upside. All prudently incurred construction and operating costs are flowed through the HESA, which provides significant downside protection below the floor levels and is the primary driver for the ratings.

Risk during construction is considered reasonably low based on modest complexity, proximity to established sites, experienced contractors and Design Build (DB) Agreement/HESA protections against construction delays and cost overruns. Additional credit protection is provided by OPG’s guarantee of LMELP debt through the construction period and until the Recourse Release Date (after which recourse will be limited only to LMRP). Expected debt service coverage ratios (DSCR) are consistent with the rating category and the HESA revenues have limited downside, transferring hydrology and market price risk to a highly rated counterparty. The HESA is a contract for differences under which LMRP will sell its production to the Independent Electricity System Operator (IESO) with OPA making “true-up” payments on a monthly basis as needed.

The estimated $3 billion LMRP complex will be funded to achieve a post-completion capital structure of 65% debt and 35% equity in order to match the capital structure required under the HESA. OPG’s
$1 billion equity investment includes a $400 million contribution of existing assets (estimated 2015 value) and a future, back-ended $600 million cash injection. The $1.9 billion debt component is expected to be funded on an ongoing basis throughout construction through the $700 million commercial paper (CP) program (and/or the $700 million four-year bank facility) with short-term debt balances periodically termed out with longer-term secured bond issues. The first such term-out was in May 2011 and DBRS assigned a rating of A (high) for LMELP’s $475 million in senior secured bonds ($225 million of 4.331% Series 2011-3 bonds due May 18, 2021, and $250 million of 5.139% Series 2011-4 bonds due May 18, 2041). A new bond issue is currently underway and expected to close by the end of April 2012.

The senior bonds and the bank facility are secured by the physical assets and material contracts of LMRP, while the CP program is unsecured but fully backstopped by the secured bank line. With only the $700 million bank line and CP program, and reliance upon periodic secured bond offerings, LMRP does not have its full debt requirements committed through construction. This risk is considered manageable and DBRS expects OPG to time bond issues so that liquidity is maintained to handle any potential short-term market disruptions. Additionally, OPG would have the ability to accelerate the timing of its cash equity injection in order to bolster LMRP liquidity, if needed. Funding risk is further mitigated by the OPG’s guarantee of LMRP debt (bonds, bank lines and CP) until the Recourse Release Date (when construction is complete and certain other conditions are met).

DBRS notes that the ratings incorporate its review of certain financial information, contractual arrangements and other relevant details that are not disclosed in this rating report due to the private nature of LMRP.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Project Finance, which can be found on our website under Methodologies.