Morningstar DBRS Confirms Ontario Power Generation Inc. at A (low)/R-1 (low), Stable Trends

DBRS Limited (Morningstar DBRS) confirmed Ontario Power Generation Inc.’s (OPG or the Company) Issuer Rating and Unsecured Debt credit rating at A (low), and the Commercial Paper credit rating at R-1 (low). All trends are Stable.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings on OPG are based on its regulated generation business, which operates under a reasonable regulatory regime under the Ontario Energy Board. The Stable trends reflect the Company's key credit metrics, which remain reasonable given the complex and substantial capital expenditures (capex) program.

Morningstar DBRS notes OPG has a number of large capital projects ongoing. Work has continued on the Darlington Refurbishment project (total capex of $12.8 billion). OPG continues to assess and seek ways to manage the impact of the COVID-19 pandemic on the project’s total cost, which otherwise remains on budget and on schedule. In July 2023, the Province of Ontario (the Province; 100% owner of OPG; rated AA (low) with a Positive trend by Morningstar DBRS) announced that the Company will begin planning and licensing three additional Small Modular Reactors (SMRs) at Darlington. Public hearings with the Canadian Nuclear Safety Commission on the first SMR at Darlington began in January 2024. That same month, the Province announced its support for OPG proceeding with certain pre-executive phase activities, which include preliminary engineering work and securing long-lead components, with a budget of approximately $2 billion, for the refurbishment of Units 5-8 of the Pickering Nuclear Generating Station (GS), which is anticipated to be returned to service by the mid-2030s. Additionally, wholly-owned subsidiary Atura Power, as part of OPG's nonregulated segment, is constructing a large-scale hydrogen production facility and a 250-megawatt battery energy storage system. With the electrification of the economy and the expected increase in electricity demand in the Province, the Company also intends to pursue opportunities to increase generation capacity such as through the Independent Electricity System Operator request for proposals or the development of hydro sites throughout the Province.

CREDIT RATING DRIVERS
Morningstar DBRS believes a positive credit rating action is unlikely over the medium term given the business profile and the ongoing significant and complex capex program. A negative credit rating action is also considered unlikely given the reasonable key credit metrics, but may occur should there be cost overruns that result in significant stranded costs.

EARNINGS OUTLOOK
OPG expects earnings in 2024 to be lower than in 2023 because of higher planned outage days for maintenance for the Darlington GS, the planned shutdown of Unit 1 of the Pickering GS in September 2024, and lower regulated nuclear prices for the year. Overall, Morningstar DBRS expects earnings volatility going forward will come from (1) forecast risk as part of the regulatory process; (2) macro factors such as weather, unexpected outages, and the Province’s economic conditions; and (3) variability in water flows and wholesale electricity prices for uncontracted facilities.

FINANCIAL OUTLOOK
Given these ongoing projects, OPG has forecast capex to almost double in 2024 from $2.9 billion in 2023. Morningstar DBRS expects capex to remain at this level for at least the near term, and will likely result in substantial net free cash flow deficits that will require debt financing. Morningstar DBRS notes that the Company is exploring additional funding sources, such as investment tax credits or partnerships with government and Indigenous communities, which would reduce its debt needs. While most of OPG's projects are regulated and will be added to the Company's rate base when completed, there is significant execution risk because of the complexity and scale of the projects. Morningstar DBRS has factored into OPG's current credit ratings that its key credit metrics will weaken moderately over the medium term, but, given the complexity of the projects, remain reasonable for the A (low) credit rating. Morningstar DBRS will continue to monitor progress on the Darlington Refurbishment, the Pickering Refurbishment, and the SMR project, and expects that the Company will not undertake any major capex without having financing and a cost-recovery mechanism in place to minimize financial risks.

CREDIT RATING RATIONALE
OPG’s credit ratings are supported by the reasonable regulatory framework that provides stable cash flow, support of the Province, and limited nuclear waste management liabilities. This is offset by nuclear generation risk, risk of political intervention, significant capex program, and a high cost base that has historically resulted in reductions in allowable costs through regulated rate setting.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
There were no Environmental factors that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factors that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of OPG, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of OPG, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of OPG, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Regulated Utility and Independent Power Producer Industries (January 30, 2024), https://dbrs.morningstar.com/research/427244

The following methodologies have also been applied:
-- DBRS Morningstar Global Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (February 24, 2023), https://dbrs.morningstar.com/research/410196
-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (March 28, 2023),
https://dbrs.morningstar.com/research/411694

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info-DBRS@morningstar.com.

The credit ratings were initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for these credit rating actions.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with these credit rating actions.

These are solicited credit ratings.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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