EX-99.1 2 d79721dex991.htm EX-99.1 EX-99.1
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Exhibit 99.1

A copy of this preliminary prospectus has been filed with the securities regulatory authorities in each of the provinces and territories of Canada but has not yet become final for the purpose of the sale of securities. Information contained in this preliminary prospectus may not be complete and may have to be amended. The securities may not be sold until a receipt for the prospectus is obtained from the securities regulatory authorities.

No securities regulatory authority has expressed an opinion about these securities and it is an offence to claim otherwise. This prospectus constitutes a public offering of these securities only in those jurisdictions where they may be lawfully offered for sale and therein only by persons permitted to sell such securities.

These securities have not been, and will not be, registered under the United States Securities Act of 1933, as amended (the “1933 Act”), or any state securities laws, and accordingly will not be offered, sold or delivered, directly or indirectly within the United States of America, its possessions and other areas subject to its jurisdiction, except in limited circumstances. See “Plan of Distribution”.

This prospectus has been filed under procedures in each of the provinces and territories of Canada that permit certain information about these securities to be determined after the prospectus has become final and that permit the omission of that information from this prospectus. The procedures require the delivery to purchasers of a supplemented PREP prospectus containing the omitted information within a specified period of time after agreeing to purchase any of the securities.

PRELIMINARY BASE PREP PROSPECTUS

Initial Public Offering

by way of Secondary Offering

  September 17, 2015

LOGO

HYDRO ONE LIMITED

$        

         Common Shares

This prospectus qualifies the distribution of     ●     common shares of Hydro One Limited (“common shares”) being offered by the Province of Ontario (the “Province” or the “Selling Shareholder”) at a price of $    ●     per common share. It is currently estimated that the offering price for Hydro One Limited’s common shares offered under this prospectus will be between $    ●     and $    ●     per share. Hydro One Limited will not receive any proceeds from this offering. See “Principal and Selling Shareholder”.

Following the completion of this offering, the Province will hold approximately     ●    % of Hydro One Limited’s total issued and outstanding common shares (approximately     ●    % if the Over-Allotment Option is exercised in full). As a result, the Province will have a significant influence over Hydro One Limited and its affairs. See “Governance and Relationship with Principal Shareholder” and “Risk Factors”.

Prior to the closing of this offering, Hydro One Limited will acquire all of the issued and outstanding shares of Hydro One Inc. Hydro One is the largest electricity transmission and distribution company in Ontario. Hydro One owns and operates substantially all of Ontario’s electricity transmission network, and is the largest electricity distributor in Ontario by number of customers.

On August 31, 2015, at the direction of the Province, as sole shareholder of Hydro One Inc., Hydro One Inc. declared a dividend in-kind on its common shares payable in all of the issued and outstanding shares of Hydro One Brampton Networks Inc. The dividend was paid to the Province, at its direction, by transferring all of the issued and outstanding shares of Hydro One Brampton Networks Inc. to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning this dividend and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc.

There is currently no market through which Hydro One Limited’s common shares may be sold, and purchasers may not be able to resell common shares purchased under this prospectus. This may affect the pricing of the common shares in the secondary market, the transparency and availability of trading prices, the liquidity of the common shares, and the extent of issuer regulation. See “Risk Factors”. Closing of this offering is conditional on the common shares being approved for listing on the Toronto Stock Exchange (“TSX”).

 

 

Price: $        per Common Share

 

 

     Price to the
Public(1)
    Underwriters’
Fee(2)
    Net Proceeds
to the Selling
Shareholder(3)
 

Per common share

   $      ●        $      ●        $      ●     

Total offering(4)

   $      ●        $      ●        $      ●     

 

Notes:

 

(1) The offering price for the common shares will be determined by negotiations between the Province and the Underwriters (as defined below).

(continued on next page)


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(2) The Province has agreed to pay the Underwriters a fee of $    ●     for each common share sold to institutional investors and $    ●     for each common share sold to other investors (the “UnderwritersFee”). The Underwriters’ Fee shown in the table above and in note (4) below assumes that 70% of the Hydro One Limited common shares offered hereunder are sold to institutional investors. See “Plan of Distribution”.

 

(3) After deducting the Underwriters’ Fee but before deducting expenses of this offering, estimated to be $    ●    , which will be paid by the Province. The Province has also agreed to reimburse the Underwriters for their reasonable expenses in connection with this offering.

 

(4) The Province has granted to the Underwriters an over-allotment option (the “Over-Allotment Option”), exercisable, in whole or in part, at any time for a period of 30 days after the closing date of this offering, to purchase from the Province up to an additional    ●     common shares, on the same terms as set out above solely to cover over-allotments, if any. If the Over-Allotment Option is exercised in full, the total “Price to the Public”, “Underwriters’ Fee” and “Net Proceeds to the Selling Shareholder” will be $    ●    , $    ●     and $    ●    , respectively. This prospectus also qualifies the grant of the Over-Allotment Option and the distribution of up to     ●     common shares sold by the Province if the Over-Allotment Option is exercised. A purchaser who acquires common shares forming part of the Underwriters’ over-allocation position acquires those common shares under this prospectus, regardless of whether the Underwriters’ over-allocation position is ultimately filled through the exercise of the Over-Allotment Option or secondary market purchases. See “Plan of Distribution”.

The following table sets out the number of common shares that may be sold by the Province to the Underwriters pursuant to the exercise of the Over-Allotment Option:

 

     Maximum Size or Number of
Shares Available
   Exercise Period    Exercise Price

Over-Allotment Option

       ●    common shares    For a period of 30 days
after the closing date of
this offering
   $    ●     per common
share

The underwriters for this offering are RBC Dominion Securities Inc., Scotia Capital Inc., BMO Nesbitt Burns Inc., CIBC World Markets Inc., TD Securities Inc., National Bank Financial Inc., Barclays Capital Canada Inc., Credit Suisse Securities (Canada), Inc., Goldman Sachs Canada Inc., Canaccord Genuity Corp., Desjardins Securities Inc., GMP Securities L.P., Raymond James Ltd., Dundee Securities Ltd., Industrial Alliance Securities Inc. and Manulife Securities Incorporated (collectively, the “Underwriters”). The Underwriters, as principals, conditionally offer the common shares, subject to prior sale, if, as and when sold by the Province and accepted by the Underwriters in accordance with the conditions contained in the underwriting agreement referred to under “Plan of Distribution” and subject to the approval of certain legal matters on behalf of Hydro One Limited by Osler, Hoskin & Harcourt LLP, on behalf of the Province by Torys LLP and on behalf of the Underwriters by Blake, Cassels & Graydon LLP.

In connection with this offering, the Underwriters may over-allot or effect transactions that stabilize or maintain the market price of the common shares at levels other than those which otherwise might prevail on the open market. The Underwriters may offer the common shares at a lower price than stated above. See “Plan of Distribution”.

RBC Dominion Securities Inc., Scotia Capital Inc., BMO Nesbitt Burns Inc., CIBC World Markets Inc., TD Securities Inc., National Bank Financial Inc. and Desjardins Securities Inc. are subsidiaries or affiliates of lenders that have made certain existing credit facilities available to Hydro One Inc., which will become a wholly-owned subsidiary of Hydro One Limited prior to the closing of this offering. In addition, RBC Dominion Securities Inc. and Scotia Capital Inc. are subsidiaries or affiliates of lenders that are anticipated to make certain new credit facilities available to both Hydro One Limited and Hydro One Inc. Although Hydro One Limited is not offering common shares pursuant to this offering, it may be considered a connected issuer of the Underwriters who are affiliates of such lenders for purposes of securities laws in Canada. See “Plan of Distribution” and “Pre-Closing Transactions”.

Subscriptions will be received subject to rejection or allotment in whole or in part and the Underwriters reserve the right to close the subscription books at any time without notice. Closing of this offering is expected to occur on or about     ●    , 2015 or such later date as Hydro One Limited, the Selling Shareholder and the Underwriters may agree, but in any event not later than     ●    , 2015 (the “Closing Date”). The common shares offered under this prospectus will be deposited with CDS Clearing and Depository Services Inc. in electronic form on the Closing Date. A purchaser of common shares pursuant to this offering will not receive a share certificate on closing.

An investment in Hydro One Limited’s common shares is subject to a number of risks that should be considered by a prospective purchaser. Under securities laws in certain jurisdictions, the statutory remedies of rescission or damages where this prospectus contains a misrepresentation are not available against the Province, as selling shareholder. The commencement of actions and enforcement of remedies against the Province may also be subject to limitations. The Province will not provide any guarantee in respect of the common shares. Prospective purchasers should carefully consider the risk factors described under “Risk Factors” before purchasing common shares.

All of the information contained in the supplemented PREP prospectus that is not contained in this base PREP prospectus will be incorporated by reference into this base PREP prospectus as of the date of the supplemented PREP prospectus.

Hydro One Limited’s registered office and head office is located at 483 Bay Street, 8th Floor, South Tower, Toronto, Ontario, M5G 2P5.


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TABLE OF CONTENTS

 

    Page  

Meaning of Certain References

    1   

About this Prospectus

    1   

Non-GAAP Measures

    2   

Forward-Looking Information

    3   

Market and Industry Data

    4   

Trade-Marks and Trade-Names

    5   

Marketing Materials

    5   

Prospectus Summary

    6   

The Offering

    15   

Summary Consolidated Financial Information

    17   

Electricity Industry

    20   

Rate-Regulated Utilities

    29   

Business of Hydro One

    34   

Use of Proceeds

    50   

Selected Consolidated Financial Information

    51   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

    54   

Pre-Closing Transactions

    98   

Corporate Structure

    101   

Dividends

    102   

Description of Share Capital

    102   

Principal and Selling Shareholder

    104   

Departure Tax

    106   

Consolidated Capitalization

    107   

Credit Ratings of Securities

    107   

Governance and Relationship with Principal Shareholder

    108   

Directors and Management of the Company

    121   
    Page  

Executive Compensation

    134   

Directors’ Compensation

    151   

Share Grant Plans

    151   

Plan of Distribution

    152   

Options to Purchase Securities

    154   

Prior Sales

    155   

Eligibility for Investment

    155   

Certain Canadian Federal Income Tax Considerations

    155   

Risk Factors

    157   

Promoter

    169   

Legal Proceedings and Regulatory Matters

    170   

Legal Matters

    170   

Interests of Management and Others in Material Transactions

    170   

Auditors, Transfer Agent and Registrar

    171   

Material Contracts

    172   

Purchasers’ Statutory Rights of Withdrawal and Rescission

    172   

Exemptions

    172   

Agent for Service of Process in Canada

    173   

Glossary

    174   

Index to Financial Statements

    F-1   

Appendix A Board Mandate

    A-1   

Appendix B Audit Committee Mandate

    B-1   

Certificate of Hydro One Limited and Hydro One Inc.

    C-1   

Certificate of the Underwriters

    C-2   

Certificate of the Selling Shareholder

    C-3   
 

 

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MEANING OF CERTAIN REFERENCES

Capitalized terms used in this prospectus are defined under “Glossary”. Words importing the singular number include the plural, and vice versa, and words importing any gender include all genders.

Unless otherwise noted or the context otherwise requires, references to “Hydro One” or the “Company” refer to Hydro One Limited, Hydro One Inc. and their subsidiaries taken together as a whole as they will exist immediately following the closing of this offering and the related pre-closing steps described under “Pre-Closing Transactions”. References to “Hydro One Inc.” refer only to Hydro One Inc. and references to “Hydro One Limited” refer only to Hydro One Limited.

In addition, “Province” refers to the Province of Ontario as a provincial government entity, and “Ontario” or the “province” in lower case type refers to the Province of Ontario as a geographical area.

References to “management” in this prospectus mean the persons who are identified in this prospectus as executive officers of Hydro One Limited and who will be the executive officers of Hydro One Limited and its operating subsidiaries, as the case may be, following the closing of this offering. Any statements in this prospectus made by or on behalf of management are made in such persons’ respective capacities as executive officers of Hydro One Limited and its operating subsidiaries, as applicable, and not in their personal capacities. See “Directors and Management of the Company”.

This prospectus refers to certain terms commonly used in the electricity industry, such as “rate-regulated”, “rate base” and “return on equity”. For a description of these terms, see “Rate-Regulated Utilities”. The terms rate base and return on equity are not considered non-GAAP measures. Rate base is an amount that a utility is required to calculate for regulatory purposes, and refers to the net book value of the utility’s assets for regulatory purposes. Return on equity is a percentage that is set or approved by a utility’s regulator and represents the rate of return that a regulator allows the utility to earn on the equity component of the utility’s rate base. Hydro One refers to the rate base and return on equity of its transmission and distribution businesses because it believes that such terms assist in understanding Hydro One’s business and are commonly used by investors and research analysts to help evaluate the performance of rate-regulated utilities.

In this prospectus, all dollar amounts are expressed in Canadian dollars unless otherwise indicated. All references to “$” or “dollars” are to Canadian dollars, and all references to “U.S.$” are to U.S. dollars.

ABOUT THIS PROSPECTUS

A prospective purchaser should rely only on the information contained in this prospectus and is not entitled to rely on parts of the information contained in this prospectus to the exclusion of others. Hydro One, the Selling Shareholder and the Underwriters have not authorized anyone to provide prospective purchasers with additional or different information. The Selling Shareholder and the Underwriters are not offering to sell the common shares in any jurisdiction where the offer or sale of such securities is not permitted. The information contained in this prospectus is accurate only as of the date of this prospectus or the date indicated, regardless of the time of delivery of this prospectus or of any sale of the common shares.

Unless otherwise indicated or the context otherwise requires, the disclosure contained in this prospectus assumes that: (i) the Over-Allotment Option has not been exercised; and (ii) the transactions referred to under the heading “Pre-Closing Transactions” have been completed, following which Hydro One Inc. will be a wholly-owned subsidiary of Hydro One Limited. See “Pre-Closing Transactions”.

On August 31, 2015, at the direction of the Province, as sole shareholder of Hydro One Inc., Hydro One Inc. declared a dividend in-kind on its common shares payable in all of the issued and outstanding shares of Hydro One Brampton Networks Inc. The dividend was paid to the Province, at its direction, by transferring all of the issued and outstanding shares of Hydro One Brampton Networks Inc. to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning this dividend and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc.

 

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Because this dividend occurred after the dates of, and periods covered by, the consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, those financial statements and the consolidated financial information derived from those financial statements include the assets, liabilities and results of operations of Hydro One Brampton Networks Inc.

To see the impact of certain transactions related to this offering on the financial statements of Hydro One Inc., including the transfer of all of the issued and outstanding shares of Hydro One Brampton Networks Inc. to a company wholly-owned by the Province, see the unaudited pro forma condensed consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, together with “Summary Consolidated Financial Information” and “Selected Consolidated Financial Information”.

For prospective purchasers outside Canada, none of Hydro One, the Selling Shareholder or any of the Underwriters has done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in Canada. Prospective purchasers are required to inform themselves about, and to observe any restrictions relating to, this offering and the possession or distribution of this prospectus.

This prospectus includes a summary description of certain material agreements relating to Hydro One. See “Material Contracts”. The summary description is not complete and is qualified by reference to the terms of the material agreements, which will be filed with the Canadian securities regulatory authorities and available on SEDAR at www.sedar.com. Prospective purchasers are encouraged to read the full text of such material agreements.

Any graphs, tables or other information demonstrating the historical performance of Hydro One Inc. or any other entity contained in this prospectus are intended only to illustrate past performance of such entities and are not necessarily indicative of future performance of Hydro One Limited, Hydro One Inc. or such entities.

NON-GAAP MEASURES

Hydro One Limited and Hydro One Inc. prepare and present their financial statements in accordance with U.S. GAAP.

Hydro One Limited intends to report certain non-GAAP measures in its future continuous disclosure documents after it becomes a publicly-listed company. It currently intends to report “Adjusted Net Income” and “FFO” (funds from operations), both of which are referred to (for Hydro One Inc.) in “Summary Consolidated Financial Information” and “Selected Consolidated Financial Information”. These measures are not recognized measures under U.S. GAAP and do not have a standardized meaning prescribed by U.S. GAAP. They are therefore unlikely to be comparable to similar measures presented by other companies. They should not be considered in isolation nor as a substitute for analysis of the Company’s financial information reported under U.S. GAAP.

To the extent that “Adjusted Net Income” is used in future continuous disclosure documents of Hydro One Limited, it will be defined as net income, adjusted for certain items, including non-recurring items and other items that management does not consider reflect the operating performance of the Company. No adjustments to net income are presented in this prospectus. Management believes that this measure, as the Company will define it, will be helpful in assessing the Company’s financial and operating performance.

FFO” is defined as net cash from operating activities, adjusted for the following: (i) changes in non-cash balances related to operations, (ii) dividends paid on preferred shares, and (iii) noncontrolling interest distributions. Management believes that this measure will be helpful as a supplemental measure of the Company’s operating cash flows.

 

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FORWARD-LOOKING INFORMATION

This prospectus contains “forward-looking information” within the meaning of applicable Canadian securities laws. Forward-looking information in this prospectus is based on current expectations, estimates, forecasts and projections about Hydro One’s business and the industry in which Hydro One operates and includes beliefs of and assumptions made by management. Such statements include, but are not limited to: expectations regarding the ability to generate stable and growing net cash from operating activities to fund the Company’s ongoing sustaining capital investments and to support a strong and growing dividend; the Company’s intention to use a portion of its net cash from operating activities in combination with additional debt to fund future development capital investments; anticipated future capital expenditures and projected rate bases; estimates with respect to the amount of investment required to connect the East-West Tie Line to Hydro One’s transmission system; the fact that the Company may consider larger-scale acquisition opportunities or other strategic initiatives outside of Ontario and that these acquisition opportunities may include other providers of electrical transmission, distribution and other similar services in Canada or in the United States; anticipated annual adjustments to the Company’s revenue requirements; expectations regarding the ability of the Company to recover expenditures in future rates; Hydro One’s expectations for industry growth and demand for electricity in Canada and the United States and new sources of electricity generation, including renewable energy; expectations regarding Hydro One’s current and anticipated plans for sustaining and development capital expenditures for its distribution and transmission systems; expectations regarding anticipated levels of funds from operations and ability to draw down on the Company’s existing and new credit facilities; expectations regarding Hydro One’s expected load growth and the impact of Hydro One’s conservation and demand management requirements and targets; expectations regarding the ability to negotiate collective agreements consistent with rate orders and to maintain stable outsourcing arrangements; Hydro One’s relationship with the Province and the Province’s investment in Hydro One; the estimated impact of changes in the forecasted long-term Government of Canada bond yield (used in determining Hydro One’s regulated rate of return) on Hydro One’s net income; expectations regarding the amount of the departure tax payable by Hydro One under the Electricity Act; future pension contributions and anticipated changes to Hydro One’s pension plan arrangements; expectations regarding future executive compensation levels; expectations regarding the Governance Agreement and other agreements with the Province and the implementation of corporate governance practices and appointment of directors and officers; expectations regarding Hydro One’s dividend policy and the Company’s intention to declare and pay dividends, including the anticipated annual dividend amount of $500 million in the aggregate initially, based on a target payout ratio of 70% to 80% of net income; the Company’s intention to implement a dividend reinvestment plan and to operate the plan on a non-dilutive basis to holders of the common shares; and legal proceedings in which Hydro One is currently involved.

Words such as “aim”, “could”, “would”, “expect”, “anticipate”, “intend”, “attempt”, “may”, “plan”, “will”, “believe”, “seek”, “estimate”, “goal”, “target”, and variations of such words and similar expressions are intended to identify such forward-looking information. These statements are not guarantees of future performance and involve assumptions and risks and uncertainties that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, implied or forecasted in such forward-looking information. Hydro One does not intend, and it disclaims any obligation to update any forward-looking information, except as required by law.

The forward-looking information in this prospectus is based on a variety of factors and assumptions including, but not limited to: no unforeseen changes in the legislative and operating framework for Ontario’s electricity market; favourable decisions from the Ontario Energy Board and other regulatory bodies concerning outstanding and future rate and other applications; no unexpected delays in obtaining the required approvals; no unforeseen changes in rate orders or rate setting methodologies for Hydro One’s distribution and transmission businesses; no unfavourable changes in environmental regulation; continuing exemptive relief being granted by the Canadian securities regulatory authorities for Hydro One Limited’s preparation of its financial statements in accordance with U.S. GAAP or Hydro One Limited otherwise being eligible under Canadian securities laws to prepare its financial statements in accordance with U.S. GAAP; a stable regulatory environment; and no significant event occurring outside the ordinary course of business of Hydro One. These assumptions are based on information currently available to Hydro One, including information obtained by Hydro One from third-party sources. Actual results may differ materially from those predicted by such forward-looking information. While Hydro One does not know what impact any of these differences may have, Hydro One’s business, results of operations and financial condition may be materially adversely affected if any such differences occur. Factors that could cause actual results or outcomes to differ materially from the results expressed or implied by forward-looking information include, among other things:

 

    regulatory risks and risks relating to Hydro One’s revenues, including risks relating to rate orders, actual performance against forecasts and capital expenditures,

 

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    the risk of claims by First Nations and Métis communities related to sovereignty and jurisdiction over reserve and traditional territories, or a perceived failure by the Crown to sufficiently consult a First Nations or Métis community,

 

    the risk that the Company may be unable to comply with regulatory and legislative requirements or that the Company may incur additional costs for compliance that are not recoverable through rates,

 

    the risk of exposure by the Company’s facilities to the effects of severe weather conditions, natural disasters or other unexpected occurrences for which the Company is uninsured or to which the Company could be subject to claims for damage,

 

    the risk of labour disputes and inability to negotiate appropriate collective agreements on acceptable terms consistent with the Company’s rate decisions,

 

    risks that the Company is not able to arrange sufficient cost-effective financing to repay maturing debt and to fund capital expenditures,

 

    risks associated with fluctuations in interest rates and failure to manage exposure to credit risk,

 

    the risk that the Company may not be able to execute plans for capital projects necessary to maintain the performance of the Company’s assets or to carry out projects in a timely manner,

 

    the risk of non-compliance with environmental regulations or failure to mitigate significant health and safety risks and inability to recover environmental expenditures in rate applications,

 

    the risk of not being able to recover the Company’s pension expenditures in future rates and uncertainty regarding the future regulatory treatment of pension, other post-employment and post-retirement benefits costs,

 

    risks associated with the Province’s significant share ownership and other relationships with the Province, including potential conflicts of interest that may arise between the Company, the Province and related parties,

 

    the risk of future sales of common shares by the Province or issuance of additional common shares by Hydro One Limited which may adversely affect the market prices for the common shares,

 

    the risk that Hydro One Inc.’s liability for payment-in-lieu of tax under the Electricity Act may be impacted by the valuation of the shares and debt of Hydro One Brampton Networks Inc. and risks associated with changes to Hydro One’s tax status as a result of this offering, and

 

    assumptions and estimates required for the preparation of pro forma financial statements may be materially different from the Company’s actual results and experience in the future.

Hydro One cautions you that the above list of factors is not exclusive. Some of these and other factors are discussed in more detail under “Risk Factors”. You should review such section in detail.

In addition, Hydro One cautions the reader that information provided in this prospectus regarding Hydro One’s outlook on certain matters, including potential future expenditures, is provided in order to give context to the nature of some of Hydro One’s future plans and may not be appropriate for other purposes.

MARKET AND INDUSTRY DATA

This prospectus includes market and industry data obtained from third party sources, industry publications, and publicly available information, including Natural Resources Canada’s About Electricity, the National Energy Board’s Canada’s Energy Future 2013: Energy Supply and Demand Projections to 2035, the Ontario Energy Board’s Yearbook of Distributors (2014), the Edison Electric Institute’s 2014 Financial Review: Annual Report of the U.S. Investor-Owned Electric Utility Industry, the U.S. Energy Information Administration’s Annual Energy Outlook 2015 with projections to 2014 and market data sourced from Bloomberg, as well as industry and other data prepared by Hydro One on the basis of its knowledge of the Canadian market and economy (including its estimates and assumptions relating to the Canadian market and economy based on that knowledge). Hydro One believes that this market and economic data is accurate and that its estimates and assumptions are reasonable, but there can be no assurance as to the accuracy or completeness thereof. The accuracy and completeness of the market and economic data used throughout this prospectus are not guaranteed and none of Hydro One, the Selling Shareholder or any of the Underwriters make any representation as to the accuracy of such information. Although Hydro One believes it to be

 

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reliable, none of Hydro One, the Selling Shareholder or any of the Underwriters has independently verified any of the data from third party sources referred to in this prospectus, nor analyzed or verified the underlying studies or surveys relied upon or referred to by such sources, or ascertained the underlying economic and other assumptions relied upon by such sources.

TRADE-MARKS AND TRADE-NAMES

This prospectus includes trademarks which are protected under applicable intellectual property laws and are the property of Hydro One Inc. or its subsidiaries. Solely for convenience, the trade-marks and trade-names referred to in this prospectus may appear without the ® or ™ symbols, but such references are not intended to indicate, in any way, that Hydro One will not assert, to the fullest extent under applicable law, its rights or the right of the applicable licensor to these trade-marks and trade-names. All other trademarks used in this prospectus are the property of their respective owners.

MARKETING MATERIALS

A “template version” of the following “marketing materials” (each such term as defined in National Instrument 41-101 – General Prospectus Requirements) for this offering filed with the securities commission or similar regulatory authority in each of the provinces or territories of Canada is specifically incorporated by reference into this prospectus:

 

  1. the term sheet dated     ●    , 2015 and filed on SEDAR on     ●    , 2015; and

 

  2. the investor presentation dated     ●    , 2015 and filed on SEDAR on     ●    , 2015.

The term sheet and investor presentation referred to above will be available under Hydro One Limited’s profile on SEDAR at www.sedar.com.

In addition, any template version of any other marketing materials filed with the securities commission or similar regulatory authority in each of the provinces and territories of Canada in connection with this offering, after the date hereof, but prior to the termination of the distribution of the common shares under this prospectus (including any amendments to, or an amended version of, any template version of any marketing materials), is deemed to be incorporated by reference herein. Any template version of any marketing materials utilized in connection with this offering are not part of this prospectus to the extent that the contents of the template version of the marketing materials have been modified or superseded by a statement contained in this prospectus.

 

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PROSPECTUS SUMMARY

The following is a summary of the principal features of this offering and should be read together with the more detailed information and financial data and statements contained elsewhere in this prospectus. This summary does not contain all of the information prospective investors should consider before investing in Hydro One Limited’s common shares. Please refer to the “Glossary” for a list of defined terms used herein.

ELECTRICITY INDUSTRY

Overview

The electricity industry is made up of businesses that generate, transmit, distribute and sell electricity. Hydro One’s business is focused on the transmission and distribution of electricity.

 

    Transmission refers to the delivery of electricity over high voltage lines, typically over long distances, from generating stations to local areas and large industrial customers.

 

    Distribution refers to the delivery of electricity over low voltage power lines to end users such as homes, businesses and institutions.

Overview of an Electricity System

The basic configuration of a typical electricity system showing electricity generation, transmission and distribution is illustrated in the following diagram:

 

LOGO

Transmission of Electricity in Ontario

Transmission companies own and operate transmission systems that deliver electricity over high voltage lines. Hydro One’s transmission system accounts for 96% of Ontario’s electricity transmission network. Investments in transmission infrastructure are required to ensure the safe and reliable delivery of electricity. These investments are made to maintain the function and reliability of transmission systems, accommodate increased demand for electricity and respond to developments affecting the electricity industry. Developments with respect to electricity generation often have a direct impact on transmission companies, since significant investments in transmission systems may be required to accommodate new generation sources (such as renewable energy) or the retirement of existing generation facilities (such as coal-fired facilities). Major changes affecting the generation of electricity must be closely coordinated with transmission considerations in mind. Recent discussions and initiatives by provincial governments to examine opportunities for Ontario to import additional electricity from Québec and Newfoundland and Labrador may also require new transmission infrastructure. These types of investments are in addition to the investments that transmission companies must undertake to sustain their existing assets, maintain reliability and provide connections to the transmission system.

Distribution of Electricity in Ontario

Distributors own and operate distribution systems that deliver electricity over low voltage power lines to end users. Distributors in Ontario are also known as “local distribution companies”. In Ontario, 72 local distribution

 



 

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companies currently provide electricity to approximately five million customers. The distribution industry in Ontario is fragmented, with the 15 largest local distribution companies accounting for approximately 78% of the province’s five million customers. Hydro One owns the largest local distribution company in Ontario, Hydro One Networks Inc., with approximately 1.2 million customers, or approximately 24% of the total number of customers in Ontario.

15 Largest Distributors in Ontario(1)

(Thousands of Customers)

 

LOGO

 

 

Notes:

 

(1) Source: Ontario Energy Board Yearbook of Distributors (2014). For Hydro One Networks Inc., this figure excludes certain classes of customers which are included in the total number of customers reported elsewhere in this prospectus.

 

(2) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc.

Most of the local distribution companies in Ontario are owned or jointly owned by municipalities. A local distribution company is responsible for distributing electricity to customers in its service territory, which may cover large portions or all of a particular municipality, or an otherwise-defined geographic area.

To create more efficiencies in the distribution sector, the Premier’s Advisory Council on Government Assets has endorsed the need for faster consolidation among local distribution companies in Ontario. The Province has responded by announcing tax incentives in the 2015 Ontario Budget which are intended to promote consolidation.

For more information, see “Electricity Industry”.

 



 

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RATE-REGULATED UTILITIES

Overview

The rates charged for electricity transmission and distribution services are regulated in Canada and many other jurisdictions. The term “rate-regulated” is used to refer to an electricity business whose rates for transmission, distribution or other services are subject to approval by a regulator. The Ontario Energy Board is the regulator responsible for approving electricity transmission and distribution rates in Ontario.

In Canada, regulators generally use two different models for approving the rates charged by rate-regulated utilities: (i) a “cost of service” model, and (ii) a “performance-based” model (sometimes also referred to as an “incentive-based” model).

In a cost of service model, a utility charges rates for its services that allow it to recover the costs of providing its services and earn an allowed return on equity. The costs of providing its services must be prudently-incurred.

In a performance-based model, a utility also charges rates for its services that allow it to recover the costs of providing its services and earn an allowed return on equity. However, the rates charged by the utility in a performance-based model assume that the utility becomes increasingly efficient over time, resulting in lower costs to provide the same service. If a utility achieves cost savings in excess of those established by the regulator, the utility may retain some or all of the benefits of those cost savings, which may permit the utility to earn more than its allowed return on equity.

Value Drivers for a Rate-Regulated Utility

Management believes that the key drivers of value for a rate-regulated utility are:

 

    the utility’s rate base,

 

    capital expenditures that ultimately add to the utility’s rate base,

 

    the utility’s deemed capital structure, as set by the regulator,

 

    the utility’s allowed return on equity, as set by the regulator,

 

    the ability to generate efficiencies and cost savings in the operations of the utility, and

 

    the ability to maintain a constructive relationship with its regulator.

For a description of these drivers, see “Rate-Regulated Utilities”.

 



 

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BUSINESS OF HYDRO ONE

Overview

Upon completion of this offering, Hydro One Limited will be one of Canada’s largest publicly-listed electricity companies, measured by assets. With a stable regulated business, strong “A” category credit ratings and projected increases in its rate base, Hydro One expects to continue generating stable and growing net cash from operating activities to fund its ongoing sustaining capital investments and to support a strong and growing dividend. The Company will operate independently of the Province and will be overseen by an experienced and independent board of directors.

Investment Highlights

Stable Regulated Cash Flows and Strong Balance Sheet

The transmission and distribution of electricity are essential infrastructure services. Hydro One’s transmission and distribution businesses are fully rate-regulated and represent 99% of its overall business, measured by revenues. These businesses generate stable and growing net cash from operating activities and net income. Hydro One’s net cash from operating activities grew to $1,256 million in 2014 from $892 million in 2009 and $911 million in 2004, representing a compound annual growth rate of 7.1% and 3.3% on a five and ten year basis, respectively. Hydro One’s net income grew to $747 million in 2014 from $470 million in 2009 and $498 million in 2004, representing a compound annual growth rate of 9.7% and 4.1% on a five-and ten-year basis, respectively.

Hydro One Inc. has been a reporting issuer in Canada for over 15 years and has been an active participant in the public debt markets. Hydro One Inc. has one of the strongest credit profiles of any public regulated electricity utility in Canada, with its debt currently rated A (stable) by Standard & Poor’s, A1 (negative) by Moody’s, and A (high) (stable) by DBRS. Hydro One Inc. has a strong track record of raising capital in the public debt markets, and has raised over $3.2 billion in gross proceeds through the sale of debt in the past three and a half years alone. Management expects that maintaining a strong credit profile and a low cost of borrowing will be a key element of Hydro One’s business and regulatory strategy following this offering, and that Hydro One will have significant debt capacity to fund future investments.

Driven by a stable regulated business, strong “A” category credit ratings and projected increases in its rate base, Hydro One expects to continue generating stable and growing net cash from operating activities to fund its ongoing sustaining capital investments and to support a strong and growing dividend. Additionally, the Company intends to use a portion of its net cash from operating activities in combination with additional debt to fund future development capital investments.

Robust and Predictable Growth Profile

Additions to Rate Base through Approved Capital Expenditures

Hydro One must continually invest in its transmission and distribution businesses in order to provide safe and reliable electricity service and meet its obligations as a regulated utility. A significant number of Hydro One’s transmission and distribution assets were built in the 1960s and 1970s or earlier and are reaching the end of their service lives. The Company therefore expects that it will be required to make significant investments in its existing infrastructure over the long term. Over the past five fiscal years, the Company has spent an average of $1.5 billion per year on capital expenditures. When placed into service, these investments add to Hydro One’s rate base, which grew during that period from $11.6 billion to $16.3 billion, representing a compound annual growth rate of 7.1%.

The Company incurs capital expenditures to maintain safety, reliability and integrity of its transmission and distribution assets and to allow for prudent growth necessary to continue to meet the evolving needs of its customers and the electricity market. This is achieved through a combination of sustaining capital expenditures, which are required to support the continued operation of Hydro One’s existing assets, and development capital expenditures, which involve both additions to existing assets and large scale projects such as new transmission lines and transmission stations. Sustaining capital expenditures are recurring in nature and involve less regulatory and completion risk compared to large scale development projects.

 



 

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Hydro One anticipates that it will spend an average of $1.5 billion per year over the next five years on total capital expenditures, with sustaining capital expenditures representing an average of approximately 60% of total capital expenditures in each year. The Company anticipates that these investments will contribute to improved reliability, customer service and operating efficiencies, as well as increased net cash from operating activities and net income from a growing rate base.

 

Projected Capital Expenditures for Transmission and Distribution Businesses

   2015      2016      2017      2018      2019  
     (millions)  

Transmission

   $ 899       $ 866       $ 848       $ 839       $ 832   

Distribution

   $ 665       $ 669       $ 674       $ 678       $ 682   

Total

   $ 1,564       $ 1,535       $ 1,522       $ 1,517       $ 1,514   

 

Projected Capital Expenditures by Category

   2015      2016      2017      2018      2019  
     (millions)  

Sustaining

   $ 905       $ 891       $ 955       $ 1,022       $ 978   

Development

   $ 470       $ 444       $ 381       $ 321       $ 379   

Other

   $ 189       $ 200       $ 186       $ 174       $ 157   

Total

   $ 1,564       $ 1,535       $ 1,522       $ 1,517       $ 1,514   

 

Notes:

 

(1) Projected capital expenditures may be considered forward-looking information, and reflect the Company’s current expectations and assumptions relating to projects contemplated in the Company’s capital expenditure programs and Ontario Energy Board approvals received to date. Transmission capital expenditures for 2015 and 2016 were previously approved by the board of directors of Hydro One Inc. and are consistent with the capital expenditures information presented in the most recent transmission rates application filed with the Ontario Energy Board, which led to the Ontario Energy Board’s approval of Hydro One’s 2015 rate order for transmission services. Distribution capital expenditures for 2015, 2016 and 2017 were previously approved by the board of directors of Hydro One Inc. and are consistent with the capital expenditures information presented in the most recent distribution rate application filed with the Ontario Energy Board, which led to the Ontario Energy Board’s distribution rates decision for Hydro One’s 2015, 2016 and 2017 years. Actual capital expenditures for any of the years referred to above may be greater or less than projected capital expenditures. See “Forward-Looking Information”. See “Risk Factors” for a discussion of material factors that could cause actual capital expenditures to differ from projected capital expenditures.

 

(2) “Other” capital expenditures consist of special projects, such as those relating to information technology.

 



 

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The impact of Hydro One’s capital expenditures on its rate base is illustrated in the following graph, which shows both the historical rate base of Hydro One for the past five fiscal years and its projected rate base over the next five fiscal years through the addition of assets that are anticipated to be placed into service.

Rate Base

($ millions)

 

LOGO

 

Notes:

 

(1) “CAGR” means compound annual growth rate.

 

(2) Projected rate base may be considered forward-looking information. The rate base in each year represents the combined rate base for Hydro One’s transmission and distribution businesses. The transmission rate bases of Hydro One Networks Inc. for 2015 and 2016 have been approved by the Ontario Energy Board, subject to certain conditions in respect of in-service additions. The distribution rate bases of Hydro One Networks Inc. for 2015, 2016 and 2017, have been approved by the Ontario Energy Board. Transmission rate bases for 2017, 2018 and 2019, and distribution rate bases for 2018 and 2019, are projected based on Hydro One’s current expectations and assumptions regarding investments in its transmission and distribution infrastructure and the timing of assets being included in Hydro One’s rate base, and will be subject to Ontario Energy Board approval in connection with Hydro One’s rate applications for those years. Transmission rate bases for 2017, 2018 and 2019, and distribution rate bases for 2018 and 2019, as approved by the Ontario Energy Board, may be higher or lower than the rate bases shown. See “Forward-Looking Information”.

Development Capital Projects

Hydro One anticipates spending an average of approximately $400 million per year over the next five years on development capital projects for its transmission and distribution businesses. These capital projects typically involve longer development timelines. Hydro One has significant development experience, having designed and built substantially all of Ontario’s transmission system and a large portion of its distribution system. This includes the Bruce-to-Milton transmission project, which was completed in 2012 on budget and six months ahead of schedule. This was the largest transmission infrastructure project in Ontario in 20 years and involved the construction of approximately 700 transmission towers and approximately 180 kilometres of double circuit lines. More recently, Hydro One was selected to develop the Northwest Bulk Transmission Line, another large scale transmission project that, if approved by the Ontario Energy Board, would reinforce the connection between Thunder Bay and Dryden.

As the Company owns substantially all of Ontario’s transmission network, the Company believes that additional development opportunities for Hydro One may arise as a result of the requirement to connect new transmission lines to Hydro One’s transmission system, even where Hydro One may not be the developer of the new line. For instance, in the case of the East-West Tie Line, which is being developed by NextBridge Infrastructure, management estimates that Hydro One may need to invest over $100 million in station upgrades in order to connect the new line to Hydro One’s transmission system if the project is approved by the Ontario Energy Board.

 



 

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Acquisition Opportunities

As the largest distributor in Ontario, Hydro One has been an active consolidator of local distribution companies. In the late 1990s and early 2000s, when significant changes were made to the electricity sector in Ontario, Hydro One acquired 88 individual local distribution companies, which were subsequently integrated into Hydro One’s distribution business (with the exception of Hydro One Brampton Networks Inc., which was operated as a stand-alone entity). More recently, the Company acquired Haldimand Hydro in June 2015 and Norfolk Power in August 2014, adding approximately 40,000 customers to its distribution network. A third Hydro One acquisition, of Woodstock Hydro, received Ontario Energy Board approval on September 11, 2015 and is expected to close later in 2015. Through these recent acquisitions, the Company will have increased its customer base by approximately 5%. Hydro One will continue to evaluate local distribution company consolidation opportunities in Ontario in the future and intends to pursue those acquisitions which deliver value to the Company and its shareholders.

Over time, the Company may also consider larger-scale acquisition opportunities or other strategic initiatives outside of Ontario to diversify its asset base and leverage its strong operational expertise. These acquisition opportunities may include other providers of electrical transmission, distribution and other similar services in Canada or in the United States.

Significant Scale and Leadership Position in Ontario

Hydro One plays an essential role in the electricity system of Canada’s most populous province. Hydro One owns and operates substantially all of Ontario’s transmission system, and is also the largest electricity distributor in Ontario. Management believes that Hydro One’s significant scale and leading position in the electricity industry in Ontario provide it with several key competitive advantages that may not be available to smaller utilities, including:

 

    a lower cost of borrowing and access to the public debt markets in order to fund its development and growth initiatives,

 

    the ability to draw on a large and highly experienced in-house team of experts covering all key aspects of Hydro One’s business, including asset management, operations, post-outage recovery, project design, engineering, procurement, project management and construction,

 

    the resources and commitment to prudently invest in innovation and continuous improvement initiatives to enhance customer service, improve the reliability and performance of Hydro One’s transmission and distribution systems and reduce operations, maintenance and administration costs,

 

    a refined and comprehensive stakeholder engagement process that covers Hydro One’s customers, municipalities, remote communities and other parties,

 

    extensive experience building and maintaining effective relationships with First Nations and Métis communities, and

 

    a leading role in working with regulatory authorities on developments with respect to energy policy, regulatory changes, new transmission and distribution investments, regional planning and new technologies.

Management believes that these strengths have increased Hydro One’s operational effectiveness, helped it maintain a positive and constructive relationship with its regulators, customers and stakeholders and ultimately contributed to achieving successful outcomes in its applications for the approval of transmission and distribution rates, new development projects and the acquisition of local distribution companies.

Consistent and Stable, Rate-Regulated Environment

Hydro One’s transmission and distribution businesses operate in a stable, rate-regulated environment. Hydro One does not set the price of electricity and has nominal direct exposure to the cost of electricity because this cost is passed on directly to consumers. The rates approved by the Ontario Energy Board for transmission and distribution services are intended to allow utilities to recover their cost of providing services and earn an allowed return on equity, while achieving productivity gains for the mutual benefit of utilities and their customers.

 



 

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Over the past six years, the Company’s allowed return on equity approved by the Ontario Energy Board has ranged from 8.39% to 9.66% for its transmission business and 9.30% to 9.85% for its distribution business.

 

Allowed Return on Equity

 
     2010      2011      2012      2013      2014      2015  

Transmission

     8.39%         9.66%         9.42%         8.93%         9.36%         9.30%   

Distribution

     9.85%         9.66%         9.66%         9.66%         9.66%         9.30%   

 

Notes:

 

(1) Management anticipates that the return on equity set by the Ontario Energy Board will be lower in 2016 compared to 2015 due to decreases in interest rates.

Historically, Hydro One has earned or exceeded its allowed return on equity on a consolidated basis.

Proven Senior Management Team and Experienced, Independent Board of Directors

Following this offering, Hydro One Limited will operate as an independent, commercially-oriented public company, with an experienced board of directors and senior leadership team. Hydro One’s current leadership has demonstrated the capability to execute Hydro One’s strategic plan and drive performance improvements and shareholder returns. As a shareholder of Hydro One Limited, the Province will engage in the business and affairs of Hydro One as an investor and not as a manager, as contemplated by the Governance Agreement. To support Hydro One’s new direction, a new board of directors and senior leadership team were appointed in connection with this offering. Members of the new board of directors meet high standards of independence, commercial experience and director expertise and will oversee the Company’s strategy, operations and growth as a publicly-listed company. The group includes Canadian business leaders, electricity sector experts, corporate directors and a former provincial Ombudsman.

Hydro One will be led by a highly experienced management team that together has extensive industry, operating and public company experience. Mayo Schmidt, the Company’s new President and Chief Executive Officer, was formerly the Chief Executive Officer of Viterra Inc. and its predecessor, Saskatchewan Wheat Pool. Mr. Schmidt has a track record of leading large scale business transformation and growth while generating value and benefits for investors, employees and customers. At Viterra, Mr. Schmidt transformed a relatively small regional co-operative into a publicly-held, multi-billion dollar corporation with nearly 7,000 employees and operations around the world. In recognition of his accomplishments at Viterra, Mr. Schmidt was named “Chief Executive of the Year in 2009” by Canadian Business Magazine. Michael Vels, the Company’s new Chief Financial Officer, was formerly the Chief Financial Officer of Maple Leaf Foods Inc. Mr. Vels brings to Hydro One considerable executive level experience in public company governance, debt and equity capital raising, mergers and acquisitions, business transformation and information technology. Mr. Schmidt and Mr. Vels join an established management team at Hydro One that has extensive experience with the Company’s operations, assets and regulators.

GOVERNANCE AGREEMENT

Concurrently with the closing of this offering, Hydro One Limited will enter into the Governance Agreement with the Province. The purpose of the Governance Agreement is to prescribe the role of the Province, as a holder of Voting Securities, in the governance of Hydro One Limited. Although the Governance Agreement does not address all aspects of the governance of Hydro One Limited, it comprehensively deals with, and limits, the role of the Province in that governance. It describes the principles that govern how Hydro One Limited will be managed and operated, including that the Province, in its capacity as a holder of Voting Securities, will engage in the business and affairs of Hydro One Limited as an investor and not as a manager. It also contains commitments by the Province restricting the exercise of its rights as a holder of Voting Securities.

 



 

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The Governance Agreement specifically addresses the following matters: (i) the governance principles under which Hydro One Limited and its subsidiaries will be managed and operated; (ii) the nomination of directors, which includes: (a) the requirement for a fully independent board of directors (other than the Chief Executive Officer), and (b) the maximum number of directors that may be nominated by the Province; (iii) the election and replacement of directors; (iv) approvals requiring a special resolution of the directors; (v) restrictions on the right of the Province to initiate fundamental changes; (vi) pre-emptive rights provided to the Province with respect to future issuances of Voting Securities by Hydro One Limited; and (vii) limits with respect to the Province’s acquisition of outstanding Voting Securities. See “Governance and Relationship with Principal Shareholder.” For a description of the governance of Hydro One Limited more generally, see “Directors and Management of the Company”.

 



 

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THE OFFERING

 

Issuer:

Hydro One Limited.

 

Selling Shareholder:

The Province.

 

Offering:

    ●     common shares of Hydro One Limited to be sold by the Province (    ●     common shares if the Over-Allotment Option is exercised in full). See “Plan of Distribution”.

 

Offering Price:

$    ●     per common share.

 

Offering Size:

$    ●     ($    ●     if the Over-Allotment Option is exercised in full).

 

Over-Allotment Option:

The Province has granted to the Underwriters the Over-Allotment Option, exercisable, in whole or in part, at any time for a period of 30 days after the Closing Date, to purchase from the Province up to an additional     ●     common shares, on the same terms as set out above solely to cover over-allotments, if any.

 

Common Shares Outstanding Following Closing:

Immediately following the closing of this offering and the other transactions contemplated by this prospectus,     ●     common shares will be issued and outstanding. See “Principal and Selling Shareholder”.

 

Common Shares Held by the Selling Shareholder Following Closing:

Immediately following the closing of this offering and the other transactions contemplated by this prospectus, the Province will hold approximately     ●    % of Hydro One Limited’s total issued and outstanding common shares (approximately     ●    % if the Over-Allotment Option is exercised in full). See “Principal and Selling Shareholder”.

Proceeds to the Selling Shareholder:

The net proceeds to the Selling Shareholder from this offering will be approximately $    ●     after deducting the Underwriters’ Fee referred to on the cover page of this prospectus but before deducting the expenses of this offering. If the Over-Allotment Option is exercised in full, the net proceeds to the Selling Shareholder from this offering will be approximately $    ●     after deducting the Underwriters’ Fee referred to on the cover page of this prospectus but before deducting the expenses of this offering.
  Hydro One Limited will not receive any proceeds from this offering. See “Use of Proceeds”.

 

Dividend Policy:

The Board is expected to establish a dividend policy pursuant to which Hydro One Limited will pay a quarterly dividend, initially in the amount of $    ●     per common share. The annual amount of the dividend is anticipated to be approximately $500 million in the aggregate initially, based on a target payout ratio of 70% to 80% of net income. Assuming the closing of this offering occurs on     ●    , 2015, the first dividend for the period from the closing of this offering to     ●    , 2016 is expected to be paid on or about     ●    , 2016 in the amount of $    ●     per common share. The payment of dividends is not guaranteed and the amount and timing of any dividends payable will be at the discretion of the Board. See “Dividends – Dividend Policy”.

 

Dividend Reinvestment Plan:

Following the closing of this offering and subject to the receipt of any required regulatory approvals, Hydro One Limited intends to adopt a dividend reinvestment plan pursuant to which resident Canadian holders of common shares will be entitled to elect to have all of the cash dividends of Hydro One Limited payable to them automatically reinvested in additional common shares, which will be either purchased on the open market or issued from treasury. The dividend reinvestment plan is currently intended to operate on a basis that does not result in significant dilution to holders of common shares. See “Dividends – Dividend Reinvestment Plan”.

 



 

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Lock-Up:

During the period beginning on the closing date of this offering and ending on the date that is 180 days following the closing date of this offering, each of Hydro One Limited and the Selling Shareholder will not, directly or indirectly, without the prior written consent of RBC Dominion Securities Inc. and Scotia Capital Inc., on behalf of the Underwriters, issue, sell, offer or grant any option, warrant or other right to purchase or agree to issue or sell, or otherwise lend, transfer, assign, pledge or dispose of any common shares or other securities of Hydro One Limited or other securities convertible into, exchangeable for, or otherwise exercisable into the common shares or other equity securities of Hydro One Limited or agree to do any of the foregoing or publicly announce any intention to do any of the foregoing, subject to certain exceptions. See “Plan of Distribution”.

 

Pre-Closing Transactions:

Certain pre-closing transactions will occur prior to the closing date of this offering. This will include steps taken to complete the acquisition of Hydro One Inc. by Hydro One Limited, recapitalize Hydro One Inc.’s subsidiary, Hydro One Networks Inc., and pay a dividend or make a return of capital to the Province in the amount of $1 billion. See “Pre-Closing Transactions”.

 

Risk Factors:

Investors should read the “Risk Factors” section of this prospectus for a discussion of factors to consider carefully before deciding to invest in Hydro One Limited’s common shares. These risks include, without limitation:

 

  Risks Relating to Hydro One’s Business

 

    Regulatory Risks and Risks Relating to Hydro One’s Revenues

 

    First Nations and Métis Claims Risk

 

    Risk of Natural and Other Unexpected Occurrences

 

    Risks Associated with Information Technology Infrastructure and Data Security

 

    Work Force Demographic Risk and Labour Relations Risk

 

  Risks Relating to the Company’s Relationship with the Province

 

    Ownership by the Province and Voting Power

 

    Continued Influence by the Province

 

    Nomination of Directors and Confirmation of Chief Executive Officer and Chair

 

    Board Removal Rights

 

    10% Ownership Restriction

 

    Potential Difficulties in Enforcing Civil Liabilities Against the Province, Hydro One Limited and Other Persons

 

  Risks Relating to this Offering

 

    Absence of a Prior Public Market

 

    Potentially Volatile Market Price for Common Shares

 

    Payment of Dividends

 

    Tax Risks Relating to this Offering

 

    Pro Forma Financial Information

 

    First Nations and Métis Proceedings

 

  The above list of risk factors is not exclusive. These and other risk factors are discussed in more detail under “Risk Factors”.

 



 

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SUMMARY CONSOLIDATED FINANCIAL INFORMATION

The following presents historical and pro forma summary consolidated financial information of Hydro One Inc., in each case, for the periods ended and as at the dates indicated below. The selected consolidated financial information has been derived from the unaudited interim financial statements of Hydro One Inc. as at and for the three and six month periods ended June 30, 2015 and June 30, 2014 and the audited consolidated financial statements of Hydro One Inc. as at and for the years ended December 31, 2014, December 31, 2013 and December 31, 2012 appearing elsewhere in this prospectus. Hydro One’s historical results for any prior period are not necessarily indicative of its results to be expected in any future period. The selected pro forma condensed financial information as at and for the six months ended June 30, 2015 and for the year ended December 31, 2014 has been derived from the unaudited pro forma condensed consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, and give effect to the transactions described in the notes to those statements as if they had occurred on January 1, 2014 for the unaudited pro forma condensed consolidated statements of operations and June 30, 2015 for the unaudited pro forma condensed consolidated balance sheet. Those transactions relate to the following events:

 

    the payment by Hydro One Inc. and certain of its subsidiaries of the “departure tax”, as described in “Departure Tax”,

 

    the recognition by Hydro One Inc. of a deferred tax asset as a consequence of leaving the payments in lieu of corporate income taxes (“PILs”) regime and entering the corporate tax regime (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Factors Affecting Results of Operations – Payments in Lieu of Corporate Income Taxes”),

 

    the recapitalization of Hydro One Networks Inc., as described in “Pre-Closing Transactions”, and

 

    the transfer of all of the issued and outstanding shares of Hydro One Brampton Networks Inc. to a company wholly-owned by the Province, as described in “Pre-Closing Transactions”.

The selected pro forma condensed financial information is unaudited, for informational purposes only, and not necessarily indicative of what Hydro One Inc.’s financial position or results of operations would have been had such transactions been completed as at the dates indicated and does not purport to represent what the financial position or results of operations might be for any future period.

The following information should be read in conjunction with “Risk Factors”, “Consolidated Capitalization”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the consolidated financial statements of Hydro One Inc., and the unaudited pro forma condensed consolidated financial statements of Hydro One Inc. and the related notes included elsewhere in this prospectus. The financial statements of Hydro One Inc. included in this prospectus have been prepared in accordance with U.S. GAAP.

 

     Six Months Ended June 30  

Statement of Operations Data(1)

   2015      2015      2014  
     (pro forma)                
     ($, in millions)  

Revenues

        

Distribution

     2,320         2,574         2,497   

Transmission

     770         770         804   

Other

     27         27         29   
  

 

 

    

 

 

    

 

 

 

Total revenues

     3,117         3,371         3,330   
  

 

 

    

 

 

    

 

 

 

Costs

        

Purchased power

     1,590         1,808         1,746   

Operation, maintenance and administration

     546         560         645   

Depreciation and amortization

     368         377         348   
  

 

 

    

 

 

    

 

 

 

Total costs

     2,504         2,745         2,739   
  

 

 

    

 

 

    

 

 

 

Income before financing charges and provisions for payments in lieu of corporate income taxes

     613         626         591   

Financing charges

     193         187         185   

Provision for payments in lieu of corporate income taxes

     64         68         51   

Net income

     356         371         355   
  

 

 

    

 

 

    

 

 

 

 



 

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    Year ended December 31  

Statement of Operations Data(1)

  2014      2014      2013      2012  
    (pro forma)                       
    ($, in millions)  

Revenues

       

Distribution

    4,408         4,903         4,484         4,184   

Transmission

    1,588         1,588         1,529         1,482   

Other

    57         57         61         62   
 

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

    6,053         6,548         6,074         5,728   
 

 

 

    

 

 

    

 

 

    

 

 

 

Costs

       

Purchased power

    2,993         3,419         3,020         2,774   

Operation, maintenance and administration

    1,165         1,192         1,106         1,071   

Depreciation and amortization

    708         722         676         659   
 

 

 

    

 

 

    

 

 

    

 

 

 

Total costs

    4,866         5,333         4,802         4,504   
 

 

 

    

 

 

    

 

 

    

 

 

 

Income before financing charges and provisions for payments in lieu of corporate income taxes

    1,187         1,215         1,272         1,224   

Financing charges

    392         379         360         358   

Provision for payments in lieu of corporate income taxes

    87         89         109         121   

Net income

    708         747         803         745   

 

     As at June 30      As at December 31  

Selected Balance Sheet Data(1)

   2015      2015      2014      2013      2012  
     (pro forma)                              
     ($, in millions)  

Total assets

     23,671         23,167         22,550         21,625         20,811   

Long-term debt (including current portion)

     10,090         9,290         8,925         9,057         8,479   

 

Notes:

 

(1) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc. Because this transfer occurred after the dates of, and periods covered by, the historical consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, those financial statements and the historical summary data appearing in the table above include the assets, liabilities and results of operations of Hydro One Brampton Networks Inc. during the periods and as at the dates indicated, except in the columns marked as “pro forma”.

 

     Six months ended June 30     Year ended December 31  

Other Financial Measures(1)

   2015     2014     2014     2013     2012  
     ($, in millions)  

Reconciliation of net income to adjusted net income

          

Net income

     371        355        747        803        745   

Adjustments

                                   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income(2)

     371        355        747        803        745   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation of net cash from operating activities to FFO

          

Net cash from operating activities

     713        334        1,256        1,404        1,294   

Change in non-cash operating working capital

     59        304        55        (11     31   

Preferred dividends

     (9     (9     (18     (18     (18

Noncontrolling interest distributions(3)

     (2                            
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

FFO(2)

     761        629        1,293        1,375        1,307   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Notes:

 

(1) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc. Because this transfer occurred after the dates of, and periods covered by, the historical consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, those financial statements and the other financial measures appearing in the table above include amounts contributed by Hydro One Brampton Networks Inc. during the periods indicated.

 



 

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(2) Adjusted net income and FFO are non-GAAP measures. See “Non-GAAP Measures”.

 

(3) In 2014, there was a $72 million noncontrolling interest contribution. This was a one-time item, and has been excluded from the calculation of FFO in 2014.

 

Operating Statistics and Other Information (Including

Hydro One Brampton Networks Inc. except where noted)(1)

   Year Ended December 31  
   2014      2013      2012  

Transmission

        

Electricity transmitted (TWh)

     139.8         140.7         141.3   

Total transmission lines spanning the province (circuit-kilometres)

     29,344         29,344         29,327   

Rate base(2) ($ millions)

     9,934         9,353         8,774   

Capital expenditures ($ millions)

     845         714         776   

Distribution

        

Electricity distributed to Hydro One customers (TWh)

     29.8         29.8         29.2   

Electricity distributed through Hydro One lines (TWh)

     42.4         42.5         42.4   

Total distribution lines spanning the province (circuit kilometres)

     123,657         122,853         121,525   

Distribution customers (Hydro One Networks Inc.)(4)

     1,268,745         1,270,817         1,236,526   

Distribution customers (Hydro One Brampton Networks Inc.)

     149,681         146,039         141,860   

Rate base(2) ($ millions)

     6,315         5,925         5,550   

Capital expenditures ($ millions)

     680         673         671   

Certain Operating Statistics for Hydro One Brampton Networks Inc.(3)

        

Total distribution lines (circuit kilometres)

     3,242         3,104         2,952   

Distribution customers

     149,681         146,039         141,860   

 

Notes:

 

(1) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc. Because this transfer occurred after the dates of, and periods covered by, the historical consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, those financial statements and the summary operating statistics appearing in the table above include amounts contributed by Hydro One Brampton Networks Inc. during the periods indicated.

 

(2) Rate base in each year refers to the rate base of Hydro One’s transmission business or distribution business, as the case may be, approved by the Ontario Energy Board for that year. See “Meaning of Certain References”.

 

(3) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions.

 

(4) Includes certain classes of customers which are excluded in the Ontario Energy Board Yearbook of Distributors (2014).

 



 

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ELECTRICITY INDUSTRY

Overview

The electricity industry is made up of businesses that generate, transmit, distribute and sell electricity. Hydro One’s business is focused on the transmission and distribution of electricity.

Generation

Generation refers to the production of electricity by a generator. Generators include generating stations (commonly known as power plants) that produce electricity on a large scale, as well as generating equipment that produces electricity on a small scale, such as rooftop solar panels. Small-scale generators installed at or near the end-user’s location are sometimes referred to as “distributed generation” sources, which distinguish them from centralized generation sources, which tend to be large scale generators that produce electricity for transportation to other locations. Electricity may be generated using non-renewable fuel sources such as natural gas, coal or nuclear material, or using renewable resources such as water, wind, biomass, solar energy or geothermal heat.

Transmission

Transmission refers to the delivery of electricity over high voltage lines, typically over long distances, from generating stations to local areas and large industrial customers. Transmission customers include distributors of electricity, as well as industrial companies who are directly connected to transmission networks. Transmission also involves the delivery of electricity between different jurisdictions, such as provinces, states or countries. This is accomplished through the use of “interties”, which are transmission facilities that physically connect adjacent transmission systems in different jurisdictions. Transmitters own and operate transmission assets such as transmission lines, transformer stations and communications and control facilities.

Distribution

Distribution refers to the delivery of electricity over low voltage power lines to end users such as homes, businesses and institutions. Distributors usually deliver electricity to customers in a particular municipality or geographic area. Distributors may also distribute electricity to other distributors. Distributors own and operate distribution assets such as distribution stations, poles, distribution lines, switches and meters.

Retailing

Retailing refers to the sale of electricity to consumers. In Ontario, retailing of electricity is normally conducted by businesses that do not own the infrastructure or equipment necessary to distribute electricity. Retailers sell electricity to homes and small businesses but rely on distributors to deliver the electricity sold by the retailers. Retailers sometimes also rely on distributors to prepare and deliver electricity bills on behalf of the retailers. Retailers generally offer differentiated products as compared with distributors, such as fixed rate electricity contracts or electricity produced from renewable energy sources. Retailers do not exist in all markets.

Overview of an Electricity System

The basic configuration of a typical electricity system showing electricity generation, transmission and distribution is illustrated in the following diagram:

 

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Transmission and distribution networks are sometimes referred to as the “electricity grid” or simply “the grid”. For simplicity, the diagram above does not show customers directly connected to the transmission system or distributed generation sources or other distributors that may be connected to the distribution system.

Canada’s Electricity Industry

In Canada, the generation, transmission and distribution of electricity has historically been carried out by government-owned, vertically-integrated utilities. This is still the case in many provinces and territories. However, consistent with general trends in the North American electricity industry, some jurisdictions in Canada, including Ontario, have moved away from this model towards more competitive market structures. In these jurisdictions, vertically-integrated utilities have been reorganized into separate generation, transmission and distribution companies. This separation is intended to promote competition among generators and to facilitate non-discriminatory or “open” access to transmission and distribution systems in order to increase competition in the supply of electricity. As a result, there are some electricity companies in Canada that engage solely in electricity generation, while others engage in either transmission or distribution, or both. Electricity companies in Canada may be investor-owned with shares listed on a stock exchange, or they may be owned by provincial governments, municipal governments or private investors.

The market structure and regulation of the electricity industry has evolved further in some jurisdictions, such as Ontario and Alberta. For instance, in Alberta, generation has been de-regulated, resulting in a competitive market for the generation and sale of electricity. However, all provinces and territories in Canada continue to regulate transmission and distribution rates. This function is carried out by a regulator, which is typically an independent board or commission that oversees and regulates certain aspects of the electricity industry in each province and territory.

The demand for electricity in Canada is affected by many factors, including population growth, economic growth and the electricity needs of households and businesses. The demand for electricity varies continuously. Electricity demand is typically seasonal, rising with the increased use of air conditioning in the summer or electric heating in the winter. Increased electricity usage over the medium to long term generally results in additional investments that are required to be made by generation, transmission and distribution businesses.

The provinces of Ontario, Québec, British Columbia and Alberta are the largest consumers of electricity in Canada. According to the National Energy Board, electricity demand in Canada is expected to grow at an annual rate of 1% from 2013 until 2035, with most of the demand originating from the industrial sector. In recent years, Canada has been a net exporter of electricity to the United States.

Electricity is generated in Canada using a variety of non-renewable and renewable sources. Hydroelectric generation accounts for most of the electricity produced in Canada on an overall basis. Fossil fuels, such as coal, natural gas and oil, are the second most common source of electricity generation, followed by nuclear power. The actual mix of generation varies in each province and territory based on the type of generation sources available. For instance, hydroelectric power is common in provinces such as Québec, Ontario, Manitoba and British Columbia because of the availability of water resources suitable for electricity production, while coal-fired generation is common in Alberta and Saskatchewan in part because of the large coal deposits that exist in those provinces. Nuclear power is a significant source of generation in Ontario. Electricity generation from renewable sources has increased in recent years and is expected to increase further in Canada over the long term, while generation from coal and oil are expected to decrease.

The transmission system in Canada includes more than 160,000 kilometres of transmission lines. Generators, transmitters, distributors and system operators must work to ensure that enough electricity and transmission and distribution capacity is available to meet demand at any given time and avoid power outages. Adequate transmission capacity and well-maintained transmission and distribution networks are key elements of a reliable electricity grid.

Ontario’s Electricity Industry

Evolution

The structure of Ontario’s electricity industry underwent significant change in the late 1990s and early 2000s. Prior to April 1, 1999, Ontario Hydro, a Crown corporation owned by the Province, supplied most of Ontario’s needs with respect to electricity generation, transmission and distribution. Consistent with initiatives taken in other electricity

 

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markets in North America at the time, the Province initiated a restructuring of the electricity industry in Ontario in order to encourage greater competition. The adoption of the Electricity Act, 1998 (Ontario) (the “Electricity Act”) resulted in the reorganization of Ontario Hydro into five separate entities, including Hydro One Inc., as the successor to its transmission and distribution business, and Ontario Power Generation Inc., as the successor to its generation business. Each of Hydro One Inc. and Ontario Power Generation Inc. is currently 100% owned by the Province.

The Electricity Act also established the requirement of transmitters and distributors to provide non-discriminatory or “open” access to their transmission and distribution systems in order to facilitate greater competition in the supply of electricity.

As part of the restructuring of Ontario’s electricity industry, the province’s municipally-owned electricity distributors were reorganized into separate business corporations. These distributors are typically referred to in Ontario as local distribution companies, or “LDCs”. Many of these distributors were sold by their municipal owners, who benefitted from limited exemptions from the transfer tax that applies to certain transfers that they would otherwise have had to pay on the fair market value of the utility. This led initially to a significant reduction in the number of local distribution companies in Ontario, with Hydro One Inc. as the primary consolidator. Consolidation activity involving local distribution companies has since slowed.

Other major regulatory developments affecting Ontario’s electricity industry that have occurred since the 1990s include:

 

    the expansion of the mandate of the Ontario Energy Board to regulate the electricity industry, in addition to the natural gas industry, in Ontario,

 

    the creation of the Independent Electricity System Operator (“IESO”) to manage the operation and reliability of Ontario’s bulk power system and administer the wholesale electricity market;

 

    the creation of the Ontario Power Authority in 2004 (recently merged with the IESO in 2015) to engage in conservation initiatives, generation development and power system planning,

 

    the promotion of renewable energy production in Ontario, including through Ontario’s Feed-in Tariff programs which followed the adoption of the Green Energy and Green Economy Act, 2009 (Ontario),

 

    since 2010, the issuance by the Province every three years of a Long-Term Energy Plan (most recently in 2013) to serve as a planning document to guide future energy decisions in Ontario,

 

    the promotion of energy conservation measures, including through mandatory conservation and demand management requirements that must be followed by distributors, and

 

    the retirement of coal-fired generation in Ontario, which was completed in 2014.

Premier’s Advisory Council on Government Assets

In April 2014, the Province formed the Premier’s Advisory Council on Government Assets (the “Council”). The mandate of the Council was to review certain provincially-owned assets, including Ontario Power Generation Inc. and Hydro One Inc., and to recommend ways to maximize their value to the people of Ontario. In its final electricity sector report released in April 2015, the Council recommended, among other things, that the Province should proceed with a partial sale of its interest in Hydro One Inc. to create a growth-oriented company centred in Ontario. The Council recommended that the partial sale occur by way of a public offering, with approximately 15% of the shares of Hydro One Inc. to be offered to the market initially. The Council recommended that the Province indicate its intention to retain its remaining shares after selling down to 40% ownership, and that the balance should be widely held with no other individual shareholder having more than a 10% holding. The Council separately recommended proceeding with a sale or merger of the Province’s interest in Hydro One Brampton Networks Inc. to or with other local distribution companies in Ontario in order to act as a catalyst for consolidation and to strengthen competition in the electricity distribution sector.

In response to the Council’s recommendations, the Province is proceeding with this offering to broaden the ownership of Hydro One Inc. indirectly through its sale of shares in Hydro One Limited. The Province also announced that it would proceed with the sale or merger of Hydro One Brampton Networks Inc. In anticipation of that transaction, on August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions.

 

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Regulation of Transmission and Distribution

General

The Electricity Act and the Ontario Energy Board Act, 1998 (the “Ontario Energy Board Act”) together establish the general legislative framework for Ontario’s electricity market. The activities of transmitters and distributors in Ontario are overseen by three main regulatory authorities: (i) the Ontario Energy Board, (ii) the IESO, and (iii) the National Energy Board.

Ontario Energy Board

The Ontario Energy Board was established in 1960 and is the regulator of natural gas and electric utilities in Ontario. The Ontario Energy Board is an independent and impartial public regulatory agency. Its mandate changed significantly with the restructuring of the electricity market in Ontario in the late 1990s, when it became responsible for regulating local electricity distribution companies and for ensuring that distributors fulfill their obligations to connect and serve their customers. The Ontario Energy Board also became responsible for licensing certain participants in the electricity market, including transmitters and distributors. The Ontario Energy Board Act provides the Ontario Energy Board with the authority to regulate Ontario’s electricity market, including the activities of transmitters and distributors.

The Ontario Energy Board has the following objectives in relation to the electricity industry:

 

    to protect the interests of consumers with respect to prices and the adequacy, reliability and quality of electricity service,

 

    to promote economic efficiency and cost effectiveness in the generation, transmission, distribution, sale and demand management of electricity and to facilitate the maintenance of a financially viable electricity industry,

 

    to promote electricity conservation and demand management in a manner consistent with the policies of the Province, including having regard to the consumer’s economic circumstances,

 

    to facilitate the implementation of a smart grid in Ontario, and

 

    to promote the use and generation of electricity from renewable energy sources in a manner consistent with the policies of the Province, including the timely expansion or reinforcement of transmission systems and distribution systems to accommodate the connection of renewable energy generation facilities.

The Ontario Energy Board is responsible for, among other things, approving transmission and distribution rates in Ontario. It also approves the construction, expansion, or reinforcement of transmission lines greater than two kilometres in length, as well as mergers, acquisitions, amalgamations and divestitures involving distributors and other entities which it licenses. The activities of transmitters and distributors are subject to the conditions of their licenses and a number of industry codes issued by the Ontario Energy Board. These codes and other requirements prescribe minimum standards of conduct and service for licensed participants in the electricity market.

Bill 112 was introduced in the Legislative Assembly of Ontario in June, 2015. The Bill, as proposed, would amend the Ontario Energy Board Act to enhance the Ontario Energy Board’s authority to continue to protect electricity ratepayers with respect to retailer contracts, as well as enhance consumer protection and reliability. These changes, if enacted, would provide the Ontario Energy Board with: stronger compliance and enforcement powers by increasing penalties for companies that are not complying with its rules and directions; enhanced ability to ensure reliability and continuity of service if distribution or transmission companies are unable to fulfil their license obligations; enhanced oversight for ensuring best practices regarding utility consolidation activities; and stricter oversight of retailers as well as more protection for consumers who sign energy retail contracts.

IESO

The IESO is a not-for-profit corporation established in 1998 under the Electricity Act. It was created to manage the operation and reliability of Ontario’s bulk power system and administer the wholesale electricity market that was created with the restructuring of Ontario’s electricity industry in the late 1990s. It is governed by an independent board whose chair and directors are appointed by the Province. Today, the IESO oversees the wholesale electricity market and directs the real time operation of the power system by balancing the supply and demand of electricity in Ontario and directing the flow of electricity across transmission lines.

 

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Transmitters and other wholesale market participants, which include many distributors, must comply with the Market Rules issued by the IESO. The Market Rules establish a number of requirements that affect transmitters, including the requirement to comply with mandatory North American reliability standards for transmission issued by the North American Electric Reliability Corporation (“NERC”) and the Northeast Power Coordinating Council, Inc. (“NPCC”). These reliability standards became mandatory as a result of regulatory changes following the Northeast blackout that occurred in 2003. The IESO enforces these reliability standards through its Market Assessment and Compliance Division and also coordinates with system operators and reliability agencies in other jurisdictions to ensure energy adequacy and security across the interconnected bulk electricity system in North America.

In 2015, the IESO merged with the Ontario Power Authority and assumed responsibility for integrated medium and long-term power system planning in Ontario, including the planning of electricity needs and the procurement of clean sources of electricity supply. These activities include identifying the need for new transmission capacity. The IESO also coordinates province-wide conservation efforts, including approval of mandatory conservation and demand management programs for distributors.

National Energy Board

The National Energy Board is an independent federal regulatory agency that was established in 1959 with the mandate to regulate aspects of the Canadian energy industry under federal jurisdiction, and to inform the government and public about energy matters. The National Energy Board is governed by the National Energy Board Act (Canada) and has jurisdiction over the construction and operation of international power lines, as well as interprovincial lines that are designated as being under federal jurisdiction (of which there are currently none). As Hydro One owns and operates 11 active international power lines connecting Ontario’s transmission system with transmission systems in Michigan, Minnesota and New York, Hydro One is required to hold several certificates and permits issued by the National Energy Board, and is subject to its mandatory electricity reliability standards and reporting requirements.

Generation

In Ontario, electricity generation is supplied by a number of providers, with Ontario Power Generation Inc. producing approximately half of the electricity produced in Ontario. Its generation is largely rate-regulated, with rates approved by the Ontario Energy Board. The remainder of Ontario’s electricity is produced by non-government-owned producers. These producers generally sell their electricity pursuant to long-term power purchase agreements entered into with the IESO.

According to the IESO, the total installed generation capacity in Ontario was 34,780 MW as of June 22, 2015, of which 37% was supplied by nuclear facilities, 29% by gas or oil-fired facilities, 24% by hydroelectric facilities, 8% by wind-powered facilities and 1% by biofuel facilities. In its most recent Long-Term Energy Plan issued in 2013, the Province indicated that it is targeting to have a total of 20,000 MW of renewable generation on-line by 2025, which is forecast to represent approximately half of Ontario’s generation capacity.

Transmission

Transmission companies own and operate transmission systems that deliver electricity over high voltage lines. Hydro One’s transmission system accounts for 96% of Ontario’s electricity transmission network. The Company’s transmission system is interconnected to systems in Manitoba, Michigan, Minnesota, New York and Québec and is part of the larger North American system known as the Eastern Interconnection. The Eastern Interconnection is a contiguous electricity transmission system that extends from Manitoba to Florida and from east of the Rocky Mountains to the North American east coast. Being part of the Eastern Interconnection provides benefits to Ontario, such as greater security and stability for Ontario’s transmission system, emergency support when there are generation constraints or shortages in Ontario, and the ability to exchange electricity with other jurisdictions, which facilitates a more competitive marketplace.

Investments in transmission infrastructure are required to ensure the safe and reliable delivery of electricity. These investments are made to maintain the function and reliability of transmission systems, accommodate increased demand for electricity and respond to developments affecting the electricity industry. Developments with respect to electricity generation often have a direct impact on transmitters, since significant investments in transmission systems may be required to accommodate new generation sources (such as renewable energy) or the retirement of existing generation

 

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facilities (such as coal-fired facilities). For instance, as coal-fired generation in Ontario was retired, significant transmission investments were required to accommodate the subsequent changes in electricity flows across the transmission system. Similarly, Hydro One is currently constructing a major transformer station (the Clarington transformer station) in order to accommodate changes to the transmission system arising from the eventual retirement of the Pickering nuclear generation facility. Major changes affecting the generation of electricity must be closely coordinated with transmission considerations in mind. Recent discussions and initiatives by provincial governments to examine opportunities for Ontario to import additional electricity from Québec and Newfoundland and Labrador may also require new transmission infrastructure. These types of investments are in addition to the investments that transmission companies must undertake to sustain their existing assets, maintain reliability, and provide connections to the transmission system.

Distribution

Distributors own and operate distribution systems that deliver electricity over low voltage power lines to end users. In Ontario, 72 local distribution companies currently provide electricity to approximately five million customers. The distribution industry in Ontario is fragmented, with the 15 largest local distribution companies accounting for approximately 78% of the province’s five million customers. Hydro One owns the largest local distribution company in Ontario, Hydro One Networks Inc., with approximately 1.2 million customers, or approximately 24% of the total number of customers in Ontario.

15 Largest Distributors in Ontario(1)

(Thousands of Customers)

 

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Notes:

 

(1) Source: Ontario Energy Board Yearbook of Distributors (2014). For Hydro One Networks Inc., this figure excludes certain classes of customers which are included in the total number of customers reported elsewhere in this prospectus.

 

(2) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc.

Most of the local distribution companies in Ontario are owned or jointly owned by municipalities. A local distribution company is responsible for distributing electricity to customers in its Ontario Energy Board-licensed service territory, and in some cases to other distributors. A service territory may cover large portions or all of a particular municipality, or an otherwise-defined geographic area. Some municipalities in Ontario are served by more than one local distribution company, each covering a particular area of the municipality. Distribution customers include homes, businesses and institutions such as governments, schools and hospitals.

 

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To create more efficiency in the distribution sector, the Council has endorsed the need for faster consolidation among local distribution companies in Ontario. The Council also noted that the system needs private sector capital and a level of competition that will encourage innovation among companies that can adjust nimbly to the changing energy world. In addition, the Council has recommended time-limited tax incentives to promote consolidation. These tax incentives were included in the 2015 Ontario Budget, which announced a reduction in the transfer tax rate from 33% to 22%, an exemption from transfer tax for distributors with fewer than 30,000 customers and an exemption from the capital gains portion of the departure tax. These changes, which are intended to promote consolidation, would apply for the period beginning January 1, 2016 and ending December 31, 2018.

Electricity Industry in the United States

The general structure of the electricity industry in the United States is similar to that in Canada, particularly with respect to the regulation of transmission and distribution. Although the regulatory framework varies on a state-by-state basis, electricity transmitters and distributors generally operate under a regulated cost of service model.

In the United States, electric utilities range from fully integrated utilities to pure-play utilities which focus solely on transmission or distribution. There is a wide range of utility owners in the United States, including strategic and financial investors, both domestic and international, as well as governments and municipalities. The term “investor owned utility” is used in the United States to refer to electric and other utilities that are not government owned. The number of investor owned utilities has declined significantly as a result of consolidation – from 98 in 1995 to 47 in 2014. In recent years, investor owned utilities have followed a trend of migrating back toward a traditional regulated structure which has occurred as a result of a combination of organic growth in rate base, the acquisitions of regulated businesses and divestiture of non-regulated businesses. According to Bloomberg, mergers and acquisition activity in the North American power and utilities sector has been active in recent years, with 351 transactions announced since 2014. The total value of transactions with a disclosed acquisition price was $132.5 billion.

The U.S. electric transmission grid consists of more than 320,000 kilometres of high-voltage lines. The transmission system is regulated by the Federal Energy Regulatory Commission, which governs the planning and investment of transmission infrastructure, including setting a utility’s return on equity. Reliability standards for transmission are issued by the NERC and regional reliability councils such as the NPCC.

Recent years have seen significant transmission investment. According to the Edison Electric Institute, investor-owned electric utilities made transmission investments of approximately U.S.$16.9 billion in 2013. An additional U.S.$60.6 billion in transmission investments are expected to be necessary to modernize the transmission system through 2024. Investment in transmission is currently significantly higher than in previous years, with the largest component related to transmission expansion or new line development to ease congestion, interconnection of new sources of generation, including renewables, and support for production of shale gas. Investment is also required for improved system reliability and resiliency as well as replacement of existing lines.

The electricity distribution industry in the United States is generally subject to regulation by the state public utility commission in the jurisdiction in which the utility operates, which leads to significant variations in the allowable return on equity and other components of the rate setting process. Investment in electric distribution infrastructure by investor owned utilities in 2013 totaled U.S.$20.8 billion. Investment in the electricity distribution sector is primarily driven by the ongoing need to replace assets that have outlived their life cycle, to serve new loads or demand, to preserve reliability, to improve system security, resiliency and restoration capabilities, and increasingly in recent years, to accommodate growth in distributed generation.

Certain Trends in the Electricity Industry

Opportunities for Sector Consolidation

A number of regulated utilities have pursued acquisitions outside of their home jurisdictions to seek growth and diversification opportunities. The rationale for this strategy is to increase their scale and scope and diversify their asset base. Many electric utilities have also acquired regulated utilities outside of the electricity sector, such as gas distribution or water distribution. In addition to the potential for increased scale, scope and diversification, this strategy offers the potential to create synergies within given service territories from a regulatory and operations perspective.

 

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Consolidation trends have been evident in Europe and in the United States, but have not been prevalent in Canada given its limited number of privately-owned utilities. Pension and infrastructure funds have also been active participants in acquisitions in the utilities sector.

Impact of Green Energy Initiatives

Environmental regulations are being adopted in many jurisdictions in order to facilitate the development of cleaner forms of energy. Many governments and regulators are setting targets with specified compliance dates to meet green energy standards. These may take the form of targets for the reduction of carbon dioxide emissions or the procurement of renewable generation. These initiatives may result in changes to the electricity generation mix in those jurisdictions, potentially creating the need for upgrades to transmission infrastructure in order to preserve the reliability of the electricity grid. For example, as coal-fired generation was retired in Ontario, significant investments were required to accommodate the subsequent changes in power flows across the transmission system.

In August 2015, the Environmental Protection Agency in the United States announced the final version of what is commonly known as the Clean Power Plan, a series of regulatory changes that would, among other things, impose significant emissions restrictions on electric generation facilities. The final version of the plan sets a goal of reducing emissions from power plants by 32% by the year 2030, as compared with 2005 levels. These emissions restrictions are particularly aimed at coal-fired generation facilities. In a preliminary assessment of the reliability impacts in meeting this plan in North America, the NERC noted the potential opportunity for coordinated cross-border transmission flows, including the increased potential for Canadian companies to export up to three times more power to the United States. This may provide additional opportunities for renewable generation development in Ontario. Regulators, system planners and other parties are in the process of assessing the impact of the Clean Power Plan and increased intertie capacity to the United States.

Developments with Respect to Distributed Generation, Microgrids and Energy Storage

Alternatives to the traditional model of “centralized” generation are continually being developed. For instance, distributed generation sources, such as rooftop solar panels or natural gas generators integrated into industrial facilities, are becoming increasingly common. Where distributed generation sources are connected to the electricity grid, they may act as a source of supply to the grid, or reduce the amount of power supplied from the grid, while still making use of the grid as a stand-by source of power. Related to distributed generation are microgrids, which are small scale electricity grids with their own sources of generation that can operate independently of the electricity grid.

Energy storage technologies seek to store energy for use at a later time. Historically, there have been technical limitations on the ability to store large amounts of electricity. For this reason, electricity systems are designed to generate more electricity than is required in order to meet anticipated peak demand, which creates inefficiencies. The development of larger and more effective energy storage technologies could provide an additional means to facilitate the reliability of the electricity grid by acting as a source of back-up power, which would allow generators to produce less electricity in order to meet anticipated peak demand. Energy storage technologies may also facilitate improvements to power quality by smoothing fluctuations in power demand and enhance reliability by easing points of congestion in transmission and distribution networks.

These developments represent an opportunity to employ new technologies to improve reliability and power quality, or provide an alternative to constructing or maintaining traditional “wires” infrastructure. For instance, microgrids could be used in remote or other locations where it is not cost-effective to build transmission and distribution networks to serve customers in those locations.

Smart Meter and Smart Grid Technologies

The increasing adoption of energy conservation measures together with initiatives to reduce emissions from the generation of electricity has led to the development of technologies such as smart meters, which, unlike traditional electricity meters, provide customers with information about their electricity usage to enable them to change their consumption patterns and reduce their costs. Smart grids are an extension of this concept, and generally refer to a combination of technologies, such as computer systems, two-way communications technologies and monitoring systems aimed at improving the reliability and performance of the electricity grid and at expanding opportunities to

 

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provide demand response, price information and ability to control usage to electricity customers. For example, in the event of a power interruption, smart grid technology can be used to more quickly detect and locate the source of the interruption and restore service by re-routing electricity to alternative supply lines and generation sources. Smart grids are at varying stages of development and usage. One of the objectives of the Ontario Energy Board is to facilitate the implementation of a smart grid in Ontario.

Competitive Processes for Developing Transmission Infrastructure

Consistent with the general trend seen in government procurement programs for infrastructure investments, governments and electricity sector regulators are increasingly using competitive bidding processes to select the applicant to develop new large transmission projects. For instance, in Ontario, the Ontario Energy Board used a competitive process to select the designated transmitter for the development phase of the proposed East-West Tie Line, which would be a transmission line running between Thunder Bay and Wawa, Ontario. In Alberta, the Alberta Electric System Operator conducted a similar process to award the agreement for the Fort-McMurray West Transmission Project.

Incumbent transmission companies may experience increased competition from other utilities, construction companies and private investors in the competitive bidding processes for new transmission projects and are using a greater range of strategies to bid for the development and construction of new transmission infrastructure. These include forming consortiums, alliances and joint ventures, such as those with First Nations and Métis communities, and adopting cost and revenue sharing arrangements to share project risk. Larger and more established electric utilities may be well-positioned to enter into these arrangements due to their experience, expertise and effectiveness in engaging with stakeholders, and their existing infrastructure and transmission corridors.

 

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RATE-REGULATED UTILITIES

Overview

The rates charged for electricity transmission and distribution services are regulated in Canada and many other jurisdictions. The term “rate-regulated” is used to refer to an electricity business whose rates for transmission, distribution or other services are subject to approval by a regulator. The Ontario Energy Board is the regulator responsible for approving electricity transmission and distribution rates in Ontario.

In Canada, regulators generally use two different models for approving the rates charged by rate-regulated utilities: (i) a “cost of service” model, and (ii) a “performance-based” model (sometimes also referred to as an “incentive-based” model).

In a cost of service model, a utility charges rates for its services that allow it to recover the costs of providing its services and earn an allowed return on equity. The costs of providing its services must be prudently-incurred. Cost savings are typically passed on to customers in the form of lower rates reflected in future rate decisions. In a cost of service model, the utility has the potential to retain cost savings that are achieved in the intervening years between rate decisions.

In a performance-based model, a utility also charges rates for its services that allow it to recover the costs of providing its services and earn an allowed return on equity. However, the rates charged by the utility in a performance-based model assume that the utility becomes increasingly efficient over time, resulting in lower costs to provide the same service. If a utility achieves cost savings in excess of those established by the regulator, the utility may retain some or all of the benefits of those cost savings, which may permit the utility to earn more than its allowed return on equity.

Value Drivers for a Rate-Regulated Utility

Management believes that the key drivers of value for a rate-regulated utility are:

 

    the utility’s rate base,

 

    capital expenditures that ultimately add to the utility’s rate base,

 

    the utility’s deemed capital structure, as set by the regulator,

 

    the utility’s allowed return on equity, as set by the regulator,

 

    the ability to generate efficiencies and cost savings in the operations of the utility, and

 

    the ability to maintain a constructive relationship with its regulator.

Rate Base

The rate base of a rate-regulated utility refers to the net book value of the utility’s assets for regulatory purposes. Rate base is an important regulatory term because a utility is permitted to earn a return on the equity portion of its rate base. An increase in a utility’s rate base will generally result in an increase in the utility’s net income, all other things being equal.

Rate base differs from a utility’s total assets for accounting purposes, primarily because it only includes the regulated assets of a utility. If a utility also owns and operates non-rate-regulated businesses, the assets of those businesses are not included in the utility’s rate base. A utility’s rate base must be calculated in accordance with the requirements of the utility’s regulator and must be approved by the regulator as part of the utility’s application for transmission or distribution rates. In Ontario, the rate base for a transmission or distribution company generally includes the gross value of the company’s regulated assets (such as transmission lines and transformers or distribution lines and poles), less accumulated depreciation, and adding an allowance for working capital. The rate base of a utility is reduced by ongoing depreciation of the utility’s regulated assets.

Capital Expenditures

Transmission and distribution companies incur capital expenditures to allow them to meet their obligations to deliver electricity safely and reliably, at a reasonable cost to customers. Utilities incur both sustaining capital expenditures, which maintain the performance of existing assets, and development capital expenditures, which add to or expand existing

 

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assets. Development capital expenditures include those investments required to develop and build large-scale projects such as new transmission lines and stations as well as smaller projects such as transmission line or station reinforcements, extensions or additions. Capital expenditures tend to increase a utility’s rate base after the assets produced by the capital expenditures become operational (sometimes referred to as “in-service”) and are approved by the regulator for inclusion in the utility’s rate base. Capital expenditures are therefore a key driver of value for a rate-regulated utility.

Capital Structure

Rate-regulated utilities have a “deemed” or approved capital structure that is set by the regulator. This is typically expressed as ratio of debt-to-equity. In Ontario, the deemed capital structure for electricity transmitters and distributors set by the Ontario Energy Board is 60/40. This means that a utility is considered to have a capital structure consisting of 60% debt and 40% equity. This capital structure is applied to the utility’s rate base. For instance, if a utility has a rate base of $100 million and a 60/40 capital structure, this means that the regulated assets of the utility are deemed to be capitalized with $60 million of debt and $40 million of equity. The deemed capital structure is important to a utility because it is used to calculate the dollar amount of a utility’s return on equity that the utility is entitled to be paid through rates. See “– Return on Equity” below. A utility’s deemed capital structure also reflects the regulator’s view of the amount of debt that a utility should have in order to operate prudently.

Return on Equity

A utility’s return on equity or “ROE” is the rate of return that a regulator allows the utility to earn on the equity portion of the utility’s rate base. Return on equity is expressed as a percentage. For instance, over the past six years, Hydro One’s allowed return on equity approved by the Ontario Energy Board has ranged from 8.39% to 9.66% for its transmission business and 9.30% to 9.85% for its distribution business.

A utility’s return on equity represents the amount, over and above a utility’s costs associated with providing services, that a utility is permitted to earn as its net income after tax. A utility’s allowed return on equity is therefore a significant factor that affects the financial performance of rate-regulated utilities.

In order to calculate its allowed return on equity as a dollar amount, the utility applies the allowable return on equity percentage set by the regulator to the equity portion of its rate base. The equity portion of its rate base is, in turn, determined by multiplying the utility’s rate base by the percentage of equity reflected in its deemed capital structure (i.e., 40% in Ontario).

Regulators use different methods to set a utility’s allowed return on equity, and these methods vary from jurisdiction to jurisdiction. In Ontario, the Ontario Energy Board sets the allowed return on equity for transmission and distribution companies. In doing so, it sets a percentage, and adjusts this percentage by applying a formula that takes into account the interest rates on certain government debt securities and a risk premium based on utility bond spreads. The allowed return on equity is reviewed and changed by the Ontario Energy Board annually.

Operational Cost Savings and Efficiencies

Utilities seek greater efficiency and cost savings, including from economies of scale, productivity improvements or the use of new technology and systems. These cost savings are typically passed on to customers in the form of lower rates. In a cost of service model for rates, this means that the lower costs may be reflected in a lower revenue requirement approved by the regulator in the utility’s next rate application, while the utility has the potential to retain cost savings that are achieved in the intervening years between rate decisions. In other words, in a cost of service model, cost savings, if any, are generally only retained by the utility until new rates are approved by the regulator. In a performance-based model for rates, the utility has the potential to retain some or all of the benefit of cost savings achieved in excess of those established by the regulator, thereby increasing its return on equity. The ability to demonstrate greater efficiency and cost savings in the operations of a utility is a key factor in a regulator’s decision to approve rates. This, together with the utility’s desire to increase profitability while keeping rates low, provides incentives for utilities to continue to seek more efficient ways to deliver their service to customers.

 

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Relationship with Regulator

The ability of a utility to maintain a constructive relationship with its regulator is a key driver of value. This relationship lays the foundation for all decisions made by the regulator in respect of the utility’s business, including with respect to revenue requirements. The term “revenue requirement” refers to the amount that a utility is entitled to charge through rates that covers its cost of providing services plus the dollar amount of its allowed return on equity. A utility must justify and provide supporting evidence for its performance and forecasted cost of service. A rate-regulated utility seeks to obtain approval from its regulator for its revenue requirement in a manner that covers the actual costs of providing services and generates an adequate return on equity. To the extent that the utility earns any ancillary revenues from its regulated assets or personnel, these are subtracted from the revenue requirement.

Rate Applications in Ontario

Framework

The Ontario Energy Board is the regulator that approves electricity transmission and distribution rates in Ontario. Transmission rates are currently determined based on a cost of service model, while distribution rates are generally determined using a performance-based model. These models are reviewed and modified by the Ontario Energy Board from time to time. The Ontario Energy Board has indicated that it will provide guidance regarding how the policies in its performance-based framework for distribution rates may be applied to transmitters in the future.

Transmission Rates (Cost of Service Model)

In the current model for determining transmission rates in Ontario, a transmitter applies to the Ontario Energy Board for approval of its revenue requirement for each year covered by its rate application (typically two years in total). The revenue requirement for each year covers the anticipated costs of providing the service for that year and an amount that represents the allowable return on equity approved by the Ontario Energy Board.

 

     

    Cost of Service ($)    

 

      +      

    Return on Equity ($)    

 

      =      

    Revenue Requirement ($)    

 

For example, if a utility is applying for the approval of rates for 2017 and 2018, it may request a revenue requirement of $1,000 million for 2017 and $1,050 million for 2018. The cost of service would generally consist of: (i) income taxes (or payments in lieu of taxes), (ii) the utility’s cost of debt, (iii) depreciation on the utility’s assets, and (iv) operation, maintenance and administration costs.

The following diagram illustrates the components of a hypothetical transmitter’s revenue requirement of $1,000 million for a particular year.

 

     
Return on Equity    $200 million    Calculated by multiplying the allowed return on equity set by the regulator by the equity component of the utility’s rate base
     
Income Taxes    $50 million    Taxes or payments in lieu of taxes
     
Cost of Debt    $150 million    The approved cost of debt for the utility at the deemed capital structure
     
Depreciation    $300 million    Depreciation and amortization on transmission assets such as towers, stations and components
     
Operation, Maintenance and Administration Costs    $300 million    Labour, materials, equipment and other costs to operate and maintain the utility’s transmission system
     
Revenue Requirement    $1,000 million   

In the example above, $800 million of the transmitter’s revenue requirement is to cover the transmitter’s anticipated cost of service for that year. The $200 million amount represents the allowed net after tax return on equity over and above the transmitter’s cost of service.

 

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Distribution Rates (Performance-Based Model)

In the current model for determining distribution rates in Ontario, a utility applies to the Ontario Energy Board to have its cost of service reviewed as part of its application for distribution rates. However, the process for applying for distribution revenue requirements differs from the process for applying for transmission revenue requirements in the following ways:

 

    the period covered by a distribution rate application is typically at least five years, which is longer than the typical period covered by a transmission rate application,

 

    the utility applies for the approval of its revenue requirement only for the first year covered by the rate decision,

 

    the revenue requirement for each of the subsequent years is determined based on a formula that accounts for inflation and certain productivity factors set by the regulator. The revenue requirement in these subsequent years is set on the assumption that the utility is lowering its cost of service over the period covered by the rate decision due to efficiency or productivity improvements,

 

    the utility is permitted to retain all or a portion of the cost savings achieved in excess of those established by the regulator during the period covered by the rate decision, thereby allowing the utility to earn more than its allowed return on equity, and

 

    the utility and the Ontario Energy Board must, as part of the application process, agree on a set of performance measures that the utility must meet and on which it must report on an ongoing basis to the Ontario Energy Board. These are intended to reduce the incentive of utilities to allow service or performance levels to deteriorate as the utilities lower their cost of service.

Under a performance-based model, the utility must effectively manage its business to earn its allowed return on equity over the period covered by the rate decision. Under this model, revenues earned from rates may not correspond to the utility’s actual costs.

Application Process

Transmitters and distributors must file a rate application with the Ontario Energy Board to seek approval of their revenue requirement, which forms the basis for the rates to be charged for the approved period. Hydro One typically files a rate application every two years for transmission rates, which are applicable for the prospective two year period. The period between its applications for distribution rates tends to be more variable, and depends on the type of application selected by Hydro One for distribution rates.

A rate application is supported by pre-filed evidence, which contains details on the various categories of expenses proposed to be incurred by the transmitter or distributor, including operations, maintenance and administration costs, depreciation and amortization, costs of debt and income taxes (or payments in lieu of taxes). A rate application will also include details on the capital expenditures proposed to be made.

Intervenors, such as consumer groups and other electricity industry participants, and staff of the Ontario Energy Board, may also participate in the applicant’s stakeholder activities, in technical conferences, and in the tribunal process itself, and they may also file questions and their own evidence. The parties may attempt to negotiate a full or partial settlement of the issues raised by the application. Unsettled issues are referred to a hearing, in which the applicant is required to defend its rate application through a written or oral hearing. After the completion of the hearing, the Ontario Energy Board issues a decision with reasons. In the case of rate proceedings, the applicant must submit a draft rate order reflecting the decision of the Ontario Energy Board. The Ontario Energy Board will approve the final rate order or request revisions to better reflect its decision.

Transmitters and distributors such as Hydro One must forecast and make assumptions regarding their expected costs and the demand for electricity during the periods covered by the rate application, and they must support their applications with information about prior or historical years and the current year. In Ontario, rate applications use “forward test years”, rather than historical test years, which means that rates are set based on forecasts and projections of electricity demand and costs of service in the years covered by the rate decision, rather than based on historical electricity demand and cost information, which may not accurately reflect actual future electricity demand and costs.

 

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A transmitter or distributor may apply to the Ontario Energy Board during the period between rate decisions for the approval of “deferral accounts” or “variance accounts”, which are accounts used by the utility to track, among other items, unforeseen capital expenditures or particular operation, maintenance and administration costs incurred during that period that were not included in the utility’s last application for rates. The Ontario Energy Board will determine in connection with a subsequent rate application whether to allow a utility to include the assets produced from these capital expenditures in the utility’s rate base or to recover such costs in rates.

Once distribution rates are approved, the Ontario Energy Board has the right to revisit distribution rates in cases where the utility’s actual earnings are above or below 300 basis points of its allowed return on equity or if performance erodes to unacceptable levels.

 

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BUSINESS OF HYDRO ONE

Business Segments

Hydro One is the largest electricity transmission and distribution company in Ontario. Hydro One owns and operates substantially all of Ontario’s electricity transmission network, and is the largest electricity distributor in Ontario by number of customers.

Hydro One has three business segments: (i) transmission; (ii) distribution; and (iii) other business (telecommunications).

Hydro One’s transmission business consists of owning, operating and maintaining Hydro One’s transmission system, which accounts for 96% of Ontario’s transmission network. This includes the Company’s 66% interest in B2M Limited Partnership, a limited partnership between Hydro One and the Saugeen Ojibway Nation in respect of the Bruce-to-Milton transmission line. The Company’s transmission business is a rate-regulated business that earns revenues mainly from charging transmission rates that must be approved by the Ontario Energy Board. Hydro One’s transmission business represented approximately 56% of its total assets as at June 30, 2015, and accounted for approximately 72% of its total net income in 2014. All of the Company’s transmission business is carried out by its wholly-owned subsidiary, Hydro One Networks Inc., except for the portion of its business held through B2M Limited Partnership, which the Company controls.

Hydro One’s distribution business consists of owning, operating and maintaining Hydro One’s distribution system, which it owns primarily through its wholly-owned subsidiary, Hydro One Networks Inc., the largest local distribution company in Ontario. The Company’s distribution system is also the largest in Ontario, and principally serves rural communities. The Company’s distribution business is a rate-regulated business that earns revenues mainly by charging distribution rates that must be approved by the Ontario Energy Board. Hydro One’s distribution business represented approximately 42% of its total assets as at June 30, 2015, and accounted for approximately 28% of its total net income in 2014. Hydro One’s distribution business also includes the business of its wholly-owned subsidiary, Hydro One Remote Communities Inc., which operates on a cost-recovery basis and supplies electricity to customers in remote communities in northern Ontario.

Hydro One’s transmission and distribution businesses are both operated through Hydro One Networks Inc. This allows both businesses to utilize common operating platforms, technology, work processes, equipment and field staff and thereby take advantage of operating efficiencies and synergies. For regulatory purposes, Hydro One Networks Inc. files separate rate applications with the Ontario Energy Board for each of its licensed transmission and distribution businesses.

Hydro One’s other business segment principally consists of its telecommunications business, which provides telecommunications support for the Company’s transmission and distribution businesses, and also markets and sells fibre optic capacity to telecommunications carriers and commercial customers with broadband network requirements. Hydro One’s other business segment is not rate-regulated. This segment represented approximately 2% of Hydro One’s total assets as at June 30, 2015, and accounted for less than 1% of its total net income in 2014. The telecommunications business is carried out by the Company’s wholly-owned subsidiary, Hydro One Telecom Inc.

Upon completion of this offering, Hydro One Limited will be one of Canada’s largest publicly-listed electricity companies, measured by assets. With a stable regulated business, strong “A” category credit ratings and projected increases in its rate base, Hydro One expects to continue generating stable and growing net cash from operating activities to fund its ongoing sustaining capital investments and to support a strong and growing dividend. The Company will operate independently of the Province and will be overseen by an experienced and independent board of directors.

Investment Highlights

Stable Regulated Cash Flows and Strong Balance Sheet

The transmission and distribution of electricity are essential infrastructure services. Hydro One’s transmission and distribution businesses are fully rate-regulated and represent 99% of its overall business, measured by revenues. These businesses generate stable and growing net cash from operating activities and net income. Hydro One’s net cash from operating activities grew to $1,256 million in 2014 from $892 million in 2009 and $911 million in 2004, representing a

 

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compound annual growth rate of 7.1% and 3.3% on a five and ten year basis, respectively. Hydro One’s net income grew to $747 million in 2014 from $470 million in 2009 and $498 million in 2004, representing a compound annual growth rate of 9.7% and 4.1% on a five-and ten-year basis, respectively.

Hydro One Inc. has been a reporting issuer in Canada for over 15 years and has been an active participant in the public debt markets. Hydro One Inc. has one of the strongest credit profiles of any public regulated electricity utility in Canada, with its debt currently rated A (stable) by Standard & Poor’s, A1 (negative) by Moody’s, and A (high) (stable) by DBRS. Hydro One Inc. has a strong track record of raising capital in the public debt markets, and has raised over $3.2 billion in gross proceeds through the sale of debt in the past three and a half years alone. Management expects that maintaining a strong credit profile and low cost of borrowing will be a key element of Hydro One’s business and regulatory strategy following this offering, and that Hydro One will have significant debt capacity to fund future investments.

Driven by a stable regulated business, strong “A” category credit ratings and projected increases in its rate base, Hydro One expects to continue generating stable and growing net cash from operating activities to fund its ongoing sustaining capital investments and to support a strong and growing dividend. Additionally, the Company intends to use a portion of its net cash from operating activities in combination with additional debt to fund future development capital investments.

Robust and Predictable Growth Profile

Additions to Rate Base through Approved Capital Expenditures

Hydro One must continually invest in its transmission and distribution businesses in order to provide safe and reliable electricity service and meet its obligations as a regulated utility. A significant number of Hydro One’s transmission and distribution assets were built in the 1960s and 1970s or earlier and are reaching the end of their service lives. The Company therefore expects that it will be required to make significant investments in its existing infrastructure over the long term. Over the past five fiscal years, the Company has spent an average of $1.5 billion per year on capital expenditures. When placed into service, these investments add to Hydro One’s rate base, which grew during that period from $11.6 billion to $16.3 billion, representing a compound annual growth rate of 7.1%.

The Company incurs capital expenditures to maintain safety, reliability and integrity of its transmission and distribution assets and to allow for prudent growth necessary to continue to meet the evolving needs of its customers and the electricity market. This is achieved through a combination of sustaining capital expenditures, which are required to support the continued operation of Hydro One’s existing assets, and development capital expenditures, which involve both additions to existing assets and large scale projects such as new transmission lines and transmission stations. Sustaining capital expenditures are recurring in nature and involve less regulatory and completion risk compared to large scale development projects.

Hydro One anticipates that it will spend an average of $1.5 billion per year over the next five years on total capital expenditures, with sustaining capital expenditures representing an average of approximately 60% of total capital expenditures in each year. The Company anticipates that these investments will contribute to improved reliability, customer service and operating efficiencies, as well as increased net cash from operating activities and net income from a growing rate base.

 

Projected Capital Expenditures for Transmission and Distribution Businesses

   2015      2016      2017      2018      2019  
     (millions)  

Transmission

   $ 899       $ 866       $ 848       $ 839       $ 832   

Distribution

   $ 665       $ 669       $ 674       $ 678       $ 682   

Total

   $ 1,564       $ 1,535       $ 1,522       $ 1,517       $ 1,514   

 

Projected Capital Expenditures by Category

   2015      2016      2017      2018      2019  
     (millions)  

Sustaining

   $ 905       $ 891       $ 955       $ 1,022       $ 978   

Development

   $ 470       $ 444       $ 381       $ 321       $ 379   

Other

   $ 189       $ 200       $ 186       $ 174       $ 157   

Total

   $ 1,564       $ 1,535       $ 1,522       $ 1,517       $ 1,514   

 

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Notes:

 

(1) Projected capital expenditures may be considered forward-looking information, and reflect the Company’s current expectations and assumptions relating to projects contemplated in the Company’s capital expenditure programs and Ontario Energy Board approvals received to date. Transmission capital expenditures for 2015 and 2016 were previously approved by the board of directors of Hydro One Inc. and are consistent with the capital expenditures information presented in the most recent transmission rates application filed with the Ontario Energy Board, which led to the Ontario Energy Board’s approval of Hydro One’s 2015 rate order for transmission services. Distribution capital expenditures for 2015, 2016 and 2017 were previously approved by the board of directors of Hydro One Inc. and are consistent with the capital expenditures information presented in the most recent distribution rate application filed with the Ontario Energy Board, which led to the Ontario Energy Board’s distribution rates decision for Hydro One’s 2015, 2016 and 2017 years. Actual capital expenditures for any of the years referred to above may be greater or less than projected capital expenditures. See “Forward-Looking Information”. See “Risk Factors” for a discussion of material factors that could cause actual capital expenditures to differ from projected capital expenditures.

 

(2) “Other” capital expenditures consist of special projects, such as those relating to information technology.

The impact of Hydro One’s capital expenditures on its rate base is illustrated in the following graph, which shows both the historical rate base of Hydro One for the past five fiscal years and its projected rate base over the next five fiscal years through the addition of assets that are anticipated to be placed into service.

Rate Base

($ millions)

 

LOGO

 

Notes:

 

(1) “CAGR” means compound annual growth rate.

 

(2) Projected rate base may be considered forward-looking information. The rate base in each year represents the combined rate base for Hydro One’s transmission and distribution businesses. The transmission rate bases of Hydro One Networks Inc. for 2015 and 2016 have been approved by the Ontario Energy Board, subject to certain conditions in respect of in-service additions. The distribution rate bases of Hydro One Networks Inc. for 2015, 2016 and 2017, have been approved by the Ontario Energy Board. Transmission rate bases for 2017, 2018 and 2019, and distribution rate bases for 2018 and 2019, are projected based on Hydro One’s current expectations and assumptions regarding investments in its transmission and distribution infrastructure and the timing of assets being included in Hydro One’s rate base, and will be subject to Ontario Energy Board approval in connection with Hydro One’s rate applications for those years. Transmission rate bases for 2017, 2018 and 2019, and distribution rate bases for 2018 and 2019, as approved by the Ontario Energy Board, may be higher or lower than the rate bases shown. See “Forward-Looking Information”.

Development Capital Projects

Hydro One anticipates spending an average of approximately $400 million per year over the next five years on development capital projects for its transmission and distribution businesses. These capital projects typically involve longer development timelines. Hydro One has significant development experience, having designed and built substantially all of Ontario’s transmission system and a large portion of its distribution system. This includes the Bruce-to-Milton transmission project, which was completed in 2012 on budget and six months ahead of schedule. This was the largest transmission infrastructure project in Ontario in 20 years and involved the construction of

 

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approximately 700 transmission towers and approximately 180 kilometres of double circuit lines. More recently, Hydro One was selected to develop the Northwest Bulk Transmission Line, another large scale transmission project that, if approved by the Ontario Energy Board, would reinforce the connection between Thunder Bay and Dryden.

As the Company owns substantially all of Ontario’s transmission network, the Company believes that additional development opportunities for Hydro One may arise as a result of the requirement to connect new transmission lines to Hydro One’s transmission system, even where Hydro One may not be the developer of the new line. For instance, in the case of the East-West Tie Line, which is being developed by NextBridge Infrastructure, management estimates that Hydro One may need to invest over $100 million in station upgrades in order to connect the new line to Hydro One’s transmission system if the project is approved by the Ontario Energy Board.

Acquisition Opportunities

As the largest distributor in Ontario, Hydro One has been an active consolidator of local distribution companies. In the late 1990s and early 2000s, when significant changes were made to the electricity sector in Ontario, Hydro One acquired 88 individual local distribution companies, which were subsequently integrated into Hydro One’s distribution business (with the exception of Hydro One Brampton Networks Inc., which was operated as a stand-alone entity). More recently, the Company acquired Haldimand Hydro in June 2015 and Norfolk Power in August 2014, adding approximately 40,000 customers to its distribution network. A third Hydro One acquisition, of Woodstock Hydro, received Ontario Energy Board approval on September 11, 2015 and is expected to close later in 2015. Through these recent acquisitions, the Company will have increased its customer base by approximately 5%. Hydro One will continue to evaluate local distribution company consolidation opportunities in Ontario in the future and intends to pursue those acquisitions which deliver value to the Company and its shareholders.

Over time, the Company may also consider larger-scale acquisition opportunities or other strategic initiatives outside of Ontario to diversify its asset base and to leverage its strong operational expertise. These acquisition opportunities may include other providers of electrical transmission, distribution and other similar services in Canada or in the United States.

Significant Scale and Leadership Position in Ontario

Hydro One plays an essential role in the electricity system of Canada’s most populous province. Hydro One owns and operates substantially all of Ontario’s transmission system, and is also the largest electricity distributor in Ontario. Management believes that Hydro One’s significant scale and leading position in the electricity industry in Ontario provides it with several key competitive advantages that may not be available to smaller utilities, including:

 

    a lower cost of borrowing and access to the public debt markets in order to fund its development and growth initiatives,

 

    the ability to draw on a large and highly experienced in-house team of experts covering all key aspects of Hydro One’s business, including asset management, operations, post-outage recovery, project design, engineering, procurement, project management and construction,

 

    the resources and commitment to prudently invest in innovation and continuous improvement initiatives to enhance customer service, improve the reliability and performance of Hydro One’s transmission and distribution systems and reduce operations, maintenance and administration costs,

 

    a refined and comprehensive stakeholder engagement process that covers Hydro One’s customers, municipalities, remote communities and other parties,

 

    extensive experience building and maintaining effective relationships with First Nations and Métis communities, and

 

    a leading role in working with regulatory authorities on developments with respect to energy policy, regulatory changes, new transmission and distribution investments, regional planning and new technologies.

Management believes that these strengths have increased Hydro One’s operational effectiveness, helped it maintain a positive and constructive relationship with its regulators, customers and stakeholders and ultimately contributed to achieving successful outcomes in its applications for the approval of transmission and distribution rates, new development projects and the acquisition of local distribution companies.

Consistent and Stable, Rate-Regulated Environment

Hydro One’s transmission and distribution businesses operate in a stable, rate-regulated environment. Hydro One does not set the price of electricity and has nominal direct exposure to the cost of electricity because this cost is passed

 

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on directly to consumers. The rates approved by the Ontario Energy Board for transmission and distribution services are intended to allow utilities to recover their cost of providing services and earn an allowed return on equity, while achieving productivity gains for the mutual benefit of utilities and their customers.

Over the past six years, the Company’s allowed return on equity approved by the Ontario Energy Board has ranged from 8.39% to 9.66% for its transmission business and 9.30% to 9.85% for its distribution business.

 

Allowed Return on Equity

 
     2010        2011        2012        2013        2014        2015  

Transmission

     8.39%           9.66%           9.42%           8.93%           9.36%           9.30%   

Distribution

     9.85%           9.66%           9.66%           9.66%           9.66%           9.30%   

 

Notes:

 

(1) Management anticipates that the return on equity set by the Ontario Energy Board will be lower in 2016 compared to 2015 due to decreases in interest rates.

Historically, Hydro One has earned or exceeded its allowed return on equity on a consolidated basis.

Proven Senior Management Team and Experienced Independent Board of Directors

Following this offering, Hydro One Limited will operate as an independent, commercially-oriented public company, with an experience board of directors and senior leadership team. Hydro One’s current leadership has demonstrated the capability to execute Hydro One’s strategic plan and drive performance improvements and shareholder returns. As a shareholder of Hydro One Limited, the Province will engage in the business and affairs of Hydro One as an investor and not as a manager, as contemplated by the Governance Agreement. To support Hydro One’s new direction, a new board of directors and senior leadership team were appointed in connection with this offering. Members of the new board of directors meet high standards of independence, commercial experience and director expertise and will oversee the Company’s strategy, operations and growth as a publicly-listed company. The group includes Canadian business leaders, electricity sector experts, corporate directors and a former provincial Ombudsman.

Hydro One will be led by a highly experienced management team that together has extensive industry, operating and public company experience. Mayo Schmidt, the Company’s new President and Chief Executive Officer, was formerly the Chief Executive Officer of Viterra Inc. and its predecessor, Saskatchewan Wheat Pool. Mr. Schmidt has a track record of leading large scale business transformation and growth while generating value and benefits for investors, employees and customers. At Viterra, Mr. Schmidt transformed a relatively small regional co-operative into a publicly-held, multi-billion dollar corporation with nearly 7,000 employees and operations around the world. In recognition of his accomplishments at Viterra, Mr. Schmidt was named “Chief Executive of the Year in 2009” by Canadian Business Magazine. Michael Vels, the Company’s new Chief Financial Officer, was formerly the Chief Financial Officer of Maple Leaf Foods Inc. Mr. Vels brings to Hydro One considerable executive level experience in public company governance, debt and equity capital raising, mergers and acquisitions, business transformation and information technology. Mr. Schmidt and Mr. Vels join an established management team at Hydro One that has extensive experience with the Company’s operations, assets and regulators.

Transmission Business

Overview

Hydro One’s transmission business consists of owning, operating and maintaining Hydro One’s transmission system, which accounts for 96% of Ontario’s transmission network. This includes the Company’s 66% interest in B2M Limited Partnership, a limited partnership between Hydro One and the Saugeen Ojibway Nation, which owns most of the assets relating to specific Bruce-to-Milton transmission line assets. The Company’s transmission business is one of the largest in North America, and is a rate-regulated business that earns revenues mainly from charging transmission rates that must be approved by the Ontario Energy Board. The Company’s transmission rates are determined based on a cost of service model. Transmission rates are collected by the IESO and are remitted by the IESO to Hydro One on a monthly basis.

Transmission rates are based on monthly peak electricity demand across Hydro One’s transmission network. This gives rise to seasonal variations in Hydro One’s transmission revenues, which are generally higher in the summer and winter due to increased demand, and lower during other periods of reduced demand. Hydro One’s transmission

 

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revenues also include export revenues associated with transmitting excess generation to markets outside of Ontario. Ancillary revenue include revenues from providing maintenance services to generators and from allowing third parties to use certain Company lands.

Business

The Company’s transmission system serves substantially all of Ontario, with the exception of the Sault Ste. Marie, James Bay and Fort Erie areas, and transported approximately 139.8 TWh of energy throughout the province in 2014. Hydro One’s transmission customers consist of 48 local distribution companies (including Hydro One’s own distribution business) and 90 large industrial customers connected directly to the transmission network, including automotive, manufacturing, chemical and natural resources businesses. Electricity delivered over the Company’s transmission network is supplied by 116 generators in Ontario and electricity sourced from outside the province through interties.

The high voltage power lines in Hydro One’s transmission network are categorized as either lines which form part of the “bulk electricity system”, or “area supply lines”. Power lines which form part of the bulk electricity system typically connect major generation facilities with transmission stations and often cover long distances, while area supply lines serve a local region. Ontario’s transmission system is connected to the transmission systems of Manitoba, Michigan, Minnesota, New York and Québec through the use of interties, allowing for the import and export of electricity to and from Ontario.

Hydro One’s transmission assets were $12,822 million as at June 30, 2015 and include transmission stations, transmission lines, a control centre and telecommunications facilities. Hydro One has approximately 291 transmission stations and approximately 29,000 circuit kilometres of high voltage lines whose major components include cables, conductors and wood or steel support structures. All of these lines are overhead power lines except for approximately 274 circuit kilometres of underground cables located in certain urban areas.

B2M Limited Partnership is Hydro One’s partnership with the Saugeen Ojibway Nation with respect to the Bruce-to-Milton transmission line. B2M Limited Partnership owns the high-voltage transmission lines and related equipment, such as the steel support structures, conductors and foundations, while Hydro One owns the transmission stations that connect to the lines. Hydro One maintains and operates the Bruce-to-Milton line. It also owns the general partner of B2M Limited Partnership, and has a 66% economic interest in the partnership.

Hydro One’s transmission network is managed from a central location north of Toronto, Ontario. This centre monitors and controls the Company’s entire transmission network, and has the capability to remotely monitor and operate transmission equipment, respond to alarms and contingencies and restore and re-route interrupted power. There is a fully functional back-up facility which would be staffed in the event of an evacuation of the centre. The Company is currently developing plans to replace its current back-up facility with a new facility.

Hydro One uses special telecommunications systems that are necessary for the protection and operation of its transmission and distribution networks. These systems are subject to very stringent reliability and security requirements, as they must be secure and continue to function during periods of prolonged power outages. These systems help the Company meet its reliability obligations and facilitate the restoration of power following service interruptions.

Regulation

Transmission Rate Setting

In Ontario, transmission rates are currently determined based on a cost of service model. The Ontario Energy Board sets transmission rates based on a two-step process.

First, all transmitters, including Hydro One, apply to the Ontario Energy Board for the approval of their revenue requirements, which cover the transmitters’ cost of service for providing transmission services and allowed return on equity. Once approved by the Ontario Energy Board, transmission revenue requirements generally cover the subsequent two-year period with an acknowledged adjustment to occur in the second year to update for the then current cost of debt and return on equity.

 

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Second, the Ontario Energy Board aggregates the total revenue requirements of all transmitters in Ontario and applies a formula in order to arrive at a single set of rates that are charged for the three types of transmission services applicable in Ontario. These consist of network services, line connection services and transformation connection services. The three separate rates charged for these services are the same for all transmitters, and are referred to in Ontario as “uniform transmission rates”.

Uniform transmission rates for all transmitters are set by the Ontario Energy Board on an annual basis, using the revenue requirements set out in the most recent rate decision issued with respect to each transmitter.

Applications to the Ontario Energy Board for the approval of a transmitter’s revenue requirements use a forward test year. See “Rate-Regulated Utilities – Rate Applications in Ontario – Application Process”. A transmitter earns more revenues from transmission rates when peak electricity demand is higher than forecast in its rate application, and conversely earns less revenues from transmission rates when peak electricity demand is lower than forecast in its rate application.

Recent Transmission Rate Applications

Hydro One and B2M Limited Partnership make separate applications for the approval of their revenue requirements for transmission services based on a cost of service model.

On January 8, 2015, the Ontario Energy Board approved Hydro One’s 2015 transmission rate order for transmission services, which provided for a revenue requirement of $1,477 million for 2015 and $1,516 million for 2016. These revenue requirements reflect an approved rate base of $9,651 million, return on equity of 9.30% and deemed capital structure of 60% debt and 40% equity. The Ontario Energy Board annually adjusts Hydro One’s revenue requirements previously approved in a rate decision to reflect more current costs of debt and return on equity. The adjustment to Hydro One’s 2016 revenue requirement will be reflected in a subsequent rate order. Management anticipates that the revenue requirement for 2016 will be adjusted downward due to an anticipated decrease in the allowable return on equity set by the Ontario Energy Board, reflecting lower interest rates.

B2M Limited Partnership is currently subject to an interim rate order that was approved by the Ontario Energy Board in December 2014. In March 2015, B2M Limited Partnership filed an application for revenue requirements covering the 2015 to 2019 period. B2M Limited Partnership has requested revenue requirements of $39 million for 2015, $36 million for 2016, $37 million for 2017, $38 million for 2018 and $37 million for 2019. A decision is expected in the fourth quarter of 2015.

For a summary of Hydro One’s recent applications to the Ontario Energy Board, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Developments in 2015 – Applications to the Ontario Energy Board”.

Reliability Standards for Transmission

The Company’s transmission business is required to comply with various rules and standards for transmission reliability, including mandatory standards established by the NERC and the NPCC, both of which are industry organizations involved in promoting and improving the reliability of transmission networks in North America. These reliability standards are enforced by both the IESO and the National Energy Board.

Among its standards, the NERC has also established and continues to issue revised requirements to ensure that utilities and other users, owners and operators of the bulk electricity system in North America have appropriate procedures in place to protect critical infrastructure from cyber-attack. Hydro One’s physical, electronic and information security processes have been and are being upgraded to meet these revised requirements. Hydro One expects to continue to perform additional work and incur further costs in order to comply with the NERC’s updated and revised standards.

Hydro One anticipates that the costs associated with meeting applicable reliability and critical infrastructure standards will be incurred annually over a number of years, and will be recovered in rates.

 

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Regional Planning

The Ontario Energy Board oversees regional planning processes to ensure that transmission and distribution investments are coordinated at a regional level. The Ontario Energy Board has indicated it will rely on regional planning studies and reports to support rate applications submitted by transmitters and distributors and “leave to construct” applications submitted by transmitters. In Ontario, the regional planning process is led by the transmitter responsible for a particular geographic region. For this purpose, the province is divided into 21 regions. As Hydro One is the largest transmitter in Ontario, it plays a key role in the regional planning process and is responsible for leading the regional planning process in 19 of the 21 designated regions. The completion of the first cycle of regional plans is expected over the next two years. Once a plan is finalized and approved by the Ontario Energy Board, the transmitter responsible for each region will implement the recommended transmission investments and distributors in the region will implement the recommended distribution investments in their respective service territories.

In conducting the regional planning, Hydro One works closely with the IESO and all distributors in the region to jointly identify needs and develop transmission and distribution investment options. Hydro One also coordinates with the IESO on its Integrated Regional Resource Planning process.

Capital Expenditures

The Company’s transmission capital expenditure plan is designed to address Ontario’s changing generation profile, accommodate load growth in areas throughout Ontario and support the expected increase in renewable energy generation. Additionally, this plan seeks to sustain or improve Hydro One’s transmission reliability performance, as determined by measures such as the average length (in minutes) of unplanned interruptions per delivery point. The Company’s capital expenditure plans are included in Hydro One’s applications for transmission rates submitted to the Ontario Energy Board.

Investments in Hydro One’s existing infrastructure are critical in order to maintain the safety, reliability and integrity of its transmission network. The Company incurs both sustaining capital expenditures and development capital expenditures required to upgrade or to enhance Hydro One’s system capabilities and networks. Sustaining capital expenditures are those investments required to replace or refurbish lines or station components to ensure that existing transmission assets function as originally designed. Development capital expenditures include those investments required to develop and build large-scale projects such as new transmission lines and stations as well as smaller projects such as transmission line or station reinforcements, extensions or additions. The Company expects that it will be required to make significant investments in its existing infrastructure over the long term. The Company anticipates that it will spend $800 million to $900 million per year over the next five years on capital expenditures relating to its transmission business. See “Business of Hydro One – Investment Highlights – Robust and Predictable Organic Growth Profile”.

Hydro One’s plans to maintain, refurbish or replace existing assets are developed on the basis of maintenance standards, transmission asset condition assessments and end-of-service life criteria specific to each type of asset. Priorities are assigned to each type of investment based on the risks that it mitigates. Hydro One is continuously enhancing its asset planning process through the development and use of new tools. Multi-variable planning optimization software is employed to develop a prioritized portfolio of investments spanning Hydro One’s entire operations, in order to establish investment plans that manage the risks associated with electrical safety, reliability, environmental considerations, customer satisfaction and operational efficiencies.

A key input to Hydro One’s planning process and the optimization software is an accurate assessment of transmission asset condition. In 2013, Hydro One began using its Asset Analytics tool, which uses data regarding its assets and performance algorithms to improve its ability to establish transmission asset condition and criticality. The results from the tool support fact-based decisions regarding maintenance, refurbishment or replacement needs of specific assets and are a key input into the planning process.

The Company also engages with various stakeholders, including its customers, to determine the need, timing and technical solutions for new connection and transmission facilities or upgrades, as well as with affected communities and parties who may be impacted by the project. The Company also engages with First Nations and Métis communities whose rights may be affected as part of the project development process for new or upgraded transmission lines.

 

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Competitive Conditions

The Company’s operations are currently limited to Ontario, where the Company operates and maintains substantially all of Ontario’s transmission system. Competition for transmission services in Ontario is currently limited. The adoption by the Ontario Energy Board of uniform transmission rates that apply to all transmitters also reduces the financial incentive for customers to seek alternative transmission providers, since each transmitter in Ontario charges the same uniform rate for transmission services. Hydro One competes with other transmitters for the opportunity to build new large-scale transmission facilities in Ontario. Management believes that Hydro One is well-positioned to pursue the development of such facilities. Hydro One does not compete with other transmitters with respect to investments which are made to sustain or develop its existing transmission infrastructure.

Distribution Business

Overview

Hydro One’s distribution business consists of owning, operating and maintaining Hydro One’s distribution system, which it owns primarily through Hydro One Networks Inc., the largest local distribution company in Ontario. The Company’s distribution system is also the largest in Ontario. The Company’s distribution business is a rate-regulated business that earns revenues mainly by charging distribution rates that must be approved by the Ontario Energy Board. The Company’s distribution rates are generally determined using a performance-based model, except for the distribution rates of Hydro One Remote Communities Inc., which are set on a cost recovery basis and do not include a return on equity.

Distribution revenues include distribution rates approved by the Ontario Energy Board and amounts to reimburse Hydro One for the cost of purchasing electricity delivered to its distribution customers. Distribution revenues also include minor ancillary service revenues, such as fees related to the joint use of the Company’s distribution poles by participants in the telecommunications and cable television industries, as well as miscellaneous charges such as charges for late payments.

As at June 30, 2015, Hydro One’s distribution assets were $9,888 million, including Hydro One Brampton Networks Inc. Hydro One’s current distribution business no longer includes the business of Hydro One Brampton Networks Inc. as on August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions.

Business

During 2014, Hydro One (excluding Hydro One Brampton Networks Inc.) delivered electricity through its distribution network to approximately 1.2 million residential and business customers, most of whom are located in rural areas, as well as 56 local distribution companies.

Hydro One’s distribution system (excluding Hydro One Brampton Networks Inc.) includes approximately 122,000 circuit kilometres of primary low-voltage distribution lines and approximately 1,000 distribution and regulating stations. Other distribution assets include poles, transformers, service centres and equipment.

Hydro One’s distribution system was designed to service a rural territory. Because of the lower population density in the Company’s service territory, the Company’s costs to provide distribution services may be higher than distributors who service urban areas. As well, unlike the distribution systems found in urban areas, Hydro One’s distribution system was not designed to be inter-connected in loops with other distribution lines, with the result that interruptions experienced at any point along a distribution line in Hydro One’s network can cause all customers downstream of the interruption point to lose power. Fallen trees and component failures on the Company’s distribution lines require immediate repair or replacement in order to restore service. As a result, the Company engages in vegetation management activities to maintain the reliability of Hydro One’s distribution system on a preventative basis. This consists of the trimming or removal of trees to lower the risk of contact with distribution lines, thereby reducing the risk of power outages. The Company’s monitoring systems assist with determining areas of priority and with system restoration. The Company relies on its full-time workforce of local line crews for these preventive power outage and restoration activities.

 

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The Company completed the acquisitions of Haldimand Hydro in June 2015 and Norfolk Power in August 2014, adding approximately 40,000 customers to its distribution network. A third acquisition – Hydro One’s acquisition of Woodstock Hydro – received Ontario Energy Board approval on September 11, 2015 and is expected to close later in 2015. Woodstock Hydro has approximately 15,000 customers. Through these acquisitions, the Company will have increased its customer base by approximately 5%. Customers of Haldimand Hydro and Norfolk Power have seen, and customers of Woodstock Hydro are expected to see, a reduction in their monthly distribution rates, as well as a freeze in distribution rates for five years.

Hydro One is committed to continuously improving customer service and putting customers first. This includes specific, measurable commitments to customers that encompass all areas of service, backed-up by best-in-class practices and performance metrics that Hydro One will share openly with its customers. The Company implemented a new billing system in 2013 as part of a larger initiative to adopt a new enterprise management platform. In connection with this implementation, some of Hydro One’s customers experienced problems with their electricity bills, including errors or delays in receiving bills. The Company corrected the cause of these errors and delays and sought to address the resulting inconvenience caused to customers. Hydro One’s new billing system is now outperforming its previous system in terms of timeliness, accuracy and reliability. Better processes have also been implemented for addressing and resolving billing issues in a timely manner. For the second quarter of 2015, “billing accuracy”, as defined by the Ontario Energy Board, was 98.6% against Hydro One’s target of 98.0% (assuming the approval by the Ontario Energy Board of an exemption application excluding certain customers from this calculation), and the Company’s internal measure of billing quality was 99.8% against a target of 99.0%. Further action and improvements are continuing to be pursued. Despite having taken these measures, the Company understands that a customer of Hydro One has commenced an action, proposed as a class action, alleging improper billing and account management practices in connection with the implementation of Hydro One’s billing system. This claim is in a very early stage and has not been certified as a class action. Hydro One intends to defend the action. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Developments in 2015 – Class Action Lawsuit”.

Hydro One’s distribution business is involved in the connection of new sources of electricity generation, including renewable energy. Hydro One invests in upgrades and modifications to its distribution system in order to accommodate these new sources of generation and ensure the continued reliability of its distribution network. Hydro One has connected approximately 13,000 small, mid-size and large embedded generators to its distribution network, including approximately 12,200 generators with capacities of up to 10 kW. Hydro One also currently has approximately 1,500 generators that are pending connection.

As the largest distributor in Ontario, Hydro One played a major role in the installation of smart meters and the migration of distribution customers to time of use pricing. Smart meters are regarded by the Province and Hydro One as an integral means of promoting a culture of conservation. As of December 31, 2014, Hydro One had installed approximately 1.4 million smart meters (including smart meters for customers of Hydro One Brampton Networks Inc.), which provide customers with access to information about their electricity consumption on a daily basis, allowing customers to change their electricity consumption patterns and reduce their costs. Hydro One has completed all material activities associated with the implementation of smart meters, and has transitioned the vast majority of its customers to time of use pricing.

Hydro One’s distribution business also includes the business of its wholly-owned subsidiary, Hydro One Remote Communities Inc., which supplies electricity to customers in remote communities in northern Ontario. Electricity used by these remote communities is produced by diesel generators, supplemented by small amounts of wind or hydroelectric generation. Hydro One operates this business on a cost recovery basis.

Regulation

Distribution Rates

In Ontario, distribution rates are determined using a performance-based model set out in the Ontario Energy Board’s Renewed Regulatory Framework for Electricity Distributors: A Performance-Based Approach, which is sometimes referred to as the “RRFE”. Under the RRFE, which was issued in 2012, distributors in Ontario may choose one of three rate-setting methods, depending on their capital requirements:

 

    4th Generation Incentive Rate-Setting – suitable for distributors that anticipate some incremental investment needs will arise during the plan term,

 

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    Custom Incentive Rate-Setting – suitable for those distributors with large or highly variable capital requirements, and

 

    Annual Incentive Rate-Setting Index – suitable for distributors with limited incremental capital requirements.

The RRFE contemplates that a distributor will apply for the approval of its revenue requirement for an initial base year covered by the rate decision. The revenue requirement for subsequent years is determined based on a formula that accounts for inflation and certain productivity factors set by the regulator. The revenue requirement in these subsequent years is set on the assumption that the distributor is lowering its cost of service over the period covered by the rate decision due to efficiency or productivity improvements. The RRFE allows the distributor to retain all or a portion of the cost savings achieved in excess of those established by the regulator during the period covered by the rate decision. This allows the distributor to earn more than its allowed return on equity.

The RRFE provides incentives for distributors to achieve certain performance outcomes, namely:

 

    Customer Focus – services are provided in a manner that responds to identified customer preferences,

 

    Operational Effectiveness – continuous improvement in productivity and cost performance is achieved, and utilities deliver on system reliability and quality objectives,

 

    Public Policy Responsiveness – utilities deliver on obligations mandated by government, and

 

    Financial Performance – financial viability is maintained and savings from operational effectiveness are sustainable.

A distributor must submit proposed performance measures as part of its application for distribution rates under the RRFE. The Ontario Energy Board issued its report, Performance Measurement for Electricity Distributors: A Scorecard Approach, which sets out its policies on measures to assess a distributor’s effectiveness and methods of improvement in achieving the performance outcomes referred to above. The scorecard currently contains quantitative measures in the areas of service quality, customer satisfaction, safety, system reliability, asset management, cost control and financial ratios.

Distributors may also propose their own performance measures for approval by the Ontario Energy Board. In its most recent distribution application, Hydro One submitted eight additional quantitative measures relating to areas that will be the subject of increased spending levels over the next few years, such as pole replacements, distribution station refurbishments and vegetation management. Distributors are required to report to the Ontario Energy Board on their performance against the performance measures approved as part of their most recent rate decision.

The Ontario Energy Board’s review process under the RRFE follows a similar process to that of a transmission rate application for the review of the anticipated cost of service for providing distribution services, other than as noted above. Once the revenue requirement for distribution services is determined, it is allocated across the distributor’s customer rate classes using a methodology approved by the Ontario Energy Board. This results in the setting of individual rates for distribution services based on each customer rate class. Customer rate classes for Hydro One are reflective of the size and type of customer (such as residential, small commercial, large commercial/industrial, etc.) and are in part tied to the population density of the areas served (such as high density urban areas, medium density areas, and low density rural areas). Hydro One currently has 13 customer classes.

Unlike uniform transmission rates, distribution rates in Ontario are not the same for all distributors and reflect the particular circumstances of each distributor, including its own costs of providing electricity service to its own particular customers. The recently issued Ontario Energy Board policy, A New Distribution Rate Design for Residential Electricity Customers, will change the current distribution rate design (a combination of a fixed monthly rate and a variable charge) to a fixed monthly charge only. Implementation will occur over the next four years.

The OEB has also initiated a working group to consider possible changes to the design of rates for commercial industrial customers. Changes to rate design will not impact the rates revenue requirement to be collected for each customer class.

 

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Distribution Rate Applications

The Company’s distribution rates, other than the distribution rates of Hydro One Remote Communities Inc., are determined using a performance-based model.

In December 2013, Hydro One filed its 2015 to 2019 distribution rate application with the Ontario Energy Board under the RRFE framework. Hydro One selected the Custom Incentive Rate-Setting option because it believed that this option most closely fit the Company’s circumstances, as the Company is contemplating significant capital expenditures over the term of its application, which would have been in excess of what would be permitted under the two other RRFE rate application options. On March 12, 2015, the Ontario Energy Board issued a decision regarding Hydro One’s distribution rates for a three year period from 2015 to 2017, providing for a revenue requirement of $1,326 million for 2015, $1,430 million for 2016 and $1,486 million for 2017. The 2015 revenue requirement reflects an approved rate base of $6,552 million, return on equity of 9.30% and a deemed capital structure of 60% debt and 40% equity. The rates are effective as of January 1 in each year. Hydro One’s revenue requirement for 2016 and 2017 are anticipated to be adjusted to reflect more current costs of debt and return on equity. These adjustments will be reflected in subsequent rate orders. Management anticipates that the revenue requirement for 2016 will be adjusted downward due to an anticipated decrease in the allowable return on equity set by the Ontario Energy Board, reflecting lower interest rates.

Hydro One filed its application as a “Custom Cost of Service” application and included within the application certain productivity improvements and cost performance metrics. However, the Ontario Energy Board did not consider Hydro One’s application to be sufficiently aligned with the objectives of the RRFE policy to approve the application as presented. The Ontario Energy Board approved rates for 2015, 2016 and 2017 using a cost of service methodology, based on the evidence that was provided. The Ontario Energy Board directed Hydro One to enhance its next distribution rate application in the areas of outcome-based regulation, externally imposed incentives, benchmarking, continuous improvement and value to customers. This includes the preparation of a number of benchmarking and cost related studies in order to provide the necessary benchmarking evidence and incentives for continuous improvement. Hydro One intends to comply with these directions.

Hydro One Remote Communities Inc. is not subject to the Ontario Energy Board’s performance-based model for rate-setting, as it is exempt from certain provisions of the Electricity Act which relate to the competitive market. Hydro One Remote Communities Inc. applies for rates on an annual basis. The Ontario Energy Board has approved its distribution rates for 2015. The distribution rates of Hydro One Remote Communities Inc. are set on a cost recovery basis and do not include a return on equity.

For a summary of Hydro One’s recent applications to the Ontario Energy Board, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Developments in 2015 – Applications to the Ontario Energy Board”.

Conservation and Demand Management

Conservation initiatives are becoming a more important part of energy policy in Ontario and other jurisdictions. Conservation and demand management (“CDM”) requirements in Ontario require distributors to achieve specific energy savings targets by encouraging their customers to reduce their energy usage. Distributors seek to achieve these targets through a number of different initiatives, including by offering customers energy saving devices for use at home, cash rebates for the purchase of energy efficient appliances and incentives for the purchase of energy efficient lightbulbs and other products. Distributors are responsible for developing and submitting CDM plans and reporting on their progress towards achieving specific energy-savings targets. The IESO oversees compliance with CDM requirements in Ontario, and also reimburses distributors for the costs of complying with CDM requirements. Hydro One expects that its costs of complying with CDM requirements will be fully reimbursed by the IESO. As a result, CDM-related costs that are reimbursed by the IESO are not included in Hydro One’s rate applications to the Ontario Energy Board.

Distributors in Ontario are collectively required to achieve a total of 7 TWh of electricity savings by December 31, 2020, with each local distribution company being allocated individual energy-savings targets. Hydro One Networks Inc.’s distribution business was assigned a peak demand reduction target of approximately 214 MW and an energy reduction target of 1,130 GWh for the 2011-2014 years, which was equivalent to approximately a 5% peak demand reduction and a 5% energy reduction. Hydro One Networks Inc. achieved less than its reduction targets.

 

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New targets and budgets were allocated to distributors in October 2014. Hydro One Networks Inc.’s 2015-2020 CDM savings target is 1,159 GWh. Hydro One Networks Inc.’s CDM plan was approved by the IESO on July 8, 2015.

Capital Investments

Hydro One is continually engaged in the replacement of distribution assets that have reached the end of their service lives. Capital expenditures for the Company’s distribution business in the near term are anticipated to focus on new load connections, trouble calls and storm damage, wood pole replacement, and system capability reinforcement. In addition, the Company expects to continue to construct new distribution lines and stations in the future in response to system growth forecasts, continued suburban community development, high load relief requirements and requirements to connect new sources of generation.

Hydro One is continuing its efforts to make the distribution system more efficient and reliable, including investments in Hydro One’s smart grid project, which it refers to as its Distribution Modernization Project. The Distribution Modernization Project involves the development of a functioning smart grid located in Owen Sound, Ontario. Through this project, Hydro One is piloting, testing, validating and creating a foundation for implementing a smart grid on a larger scale in order to enable distributed generation integration, improve reliability and operations, and enhance outage restoration and network planning. Work on the initial phase of the Distribution Modernization Project is expected to be completed by 2017.

Competitive Conditions

Hydro One’s distribution service area is set out in its licence issued by the Ontario Energy Board. Only one distributor is permitted to provide distribution services in a service territory, and distributors have exclusive rights to provide service to new customers located within their service territory. As a result, there is very little direct competition for distribution services in Ontario, except near the borders of adjoining service territories where a distributor may apply to the Ontario Energy Board to claim the right to serve new customers who are not currently connected to its distribution grid. In order to create more efficiency in the distribution sector, the Council has endorsed the need for faster consolidation among local distribution companies in Ontario. This may result in competition for acquisition or merger opportunities. Potential acquirors may include strategic and financial buyers, in addition to other local distribution companies.

Other Business

Hydro One’s other business segment principally consists of its telecommunications business, which provides telecommunications support for the Company’s transmission and distribution businesses, and also markets and sells fibre optic capacity to telecommunications carriers and commercial customers with broadband network requirements. This business is carried out by its wholly-owned subsidiary, Hydro One Telecom Inc.

Hydro One’s telecommunications business is not rate-regulated. However, Hydro One Telecom Inc. is registered with the Canadian Radio-television and Telecommunications Commission as a non-dominant, facilities-based carrier, providing broadband telecommunications services in Ontario with connections to Montreal, Québec, Buffalo, New York and Detroit, Michigan.

First Nations and Métis Communities

Management believes that building and maintaining effective relationships with First Nations and Métis communities is important to achieving the Company’s corporate objectives. Hydro One is committed to working with First Nations and Métis peoples in a spirit of cooperation and shared responsibility, which it believes it has been able to demonstrate by developing an equity partnership with the Saugeen Ojibway Nation in respect of the Bruce-to-Milton transmission line. Hydro One’s First Nations and Métis Relations policy guides all employees of Hydro One, and the Company has a dedicated team responsible for First Nations and Métis matters. Hydro One has several programs in place to ensure that the interests of First Nations and Métis communities and their citizens are considered and addressed. These include dedicated summer student positions, pre-apprenticeship training opportunities, scholarships which provide opportunities for work terms, First Nations and Métis procurement procedures and community investments.

 

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The Company’s engagement with First Nations and Métis communities is overseen by the Company’s Health, Safety, Environment and First Nations & Métis Committee. This Committee is responsible for assisting the Board in discharging the Board’s oversight responsibilities relating to effective occupational health and safety and environmental policies and practices at Hydro One, and its relationship with First Nations and Métis communities.

Employees and Outsourced Services

Hydro One has a highly skilled and flexible work force of over 5,400 regular employees and over 3,300 non-regular employees province-wide, comprising a mix of skilled trades, lines staff, engineering, professional, managerial and executive personnel. Employees work on a variety of projects covering different aspects of the Company’s business, which include field work in relation to the Company’s transmission and distribution networks, engineering and construction services and stations and operations and maintenance activities. Hydro One’s experienced engineering and construction services team was responsible for designing and building Hydro One’s transmission system, with approximately one-third of the engineering, procurement and construction work being executed by external contractors.

Hydro One’s regular employees are supplemented primarily by accessing a large external labour force available through arrangements with the Company’s trade unions for variable workers, sometimes referred to as “hiring halls”, and also by access to contract personnel. The hiring halls offer Hydro One the ability to access highly trained and appropriately skilled workers on a project-by-project basis. This provides the Company with more flexibility to address seasonal needs and unanticipated changes to its budgeted work programs. The Company also offers apprenticeship and technical training programs to ensure that future staffing needs will continue to be met.

Hydro One’s capital projects are staffed using a combination of in-house engineering, design, procurement, project management, construction and commissioning personnel and third party service providers who may be contracted to provide some or all of these services, depending on the circumstances. Decisions with respect to the use of third party service providers are made based on the complexity of the capital project, estimated cost differential and an evaluation of various risks and factors. These factors include project risk, potential risks to other assets of Hydro One, the impact on customers and worker safety considerations. Hydro One’s experienced hiring hall construction staff is typically utilized for sustainment work on assets involving working in a “live” electricity environment, while third parties are typically engaged for new construction, standard design work or lower risk projects. All construction personnel, regardless of their source, are unionized.

To gain efficiencies and cost reductions, Hydro One has outsourced certain non-core functions, including facilities management services with respect to its stations and other facilities, and certain back-office services such as information technology, payroll, supply chain, call centre and accounting services. Inergi LP (an affiliate of Capgemini Canada Inc.) provides the Company with back-office services and call centre services under an agreement that expires on December 31, 2019 for back-office services and February 28, 2018 for call centre services. The Company has an option to renew the agreement for two additional terms of one year each. Brookfield Global Integrated Solutions (formerly Brookfield Johnson Controls Canada) provides the Company with facilities management services under an agreement that expires on December 31, 2024, with an option in favour of the Company to renew the agreement for an additional term of three years.

The following table sets out the number of Hydro One employees represented by unions as of June 30, 2015. The Company also has 614 regular management employees and 28 non-regular management employees.

 

Union

  Regular Employees     Non-Regular Employees  

Power Workers’ Union

    3,455        1,932 (1) 

The Society of Energy Professionals

    1,402        55   

Canadian Union of Skilled Workers and construction building trade unions(2)

    0        1,351   

 

Notes:

 

(1) Includes 1642 non-regular “hiring hall” employees covered by the Power Workers’ Union agreement.

 

(2) Employees are jointly represented by both unions. The construction building trade unions have collective agreements with the Electrical Power Sector Construction Association (“EPSCA”).

 

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The Power Workers’ Union represents the majority of the skilled trade personnel employed by Hydro One. On April 14, 2015, Hydro One Inc. reached an agreement with the Power Workers’ Union for the renewal of their collective agreement. This new collective agreement was ratified by the board of directors of Hydro One Inc. on July 21, 2015 and by the Power Workers’ Union on July 3, 2015. The agreement is for a three-year term, covering the period from April 1, 2015 to March 31, 2018. It provides a 1% wage increase annually to the employees represented by the Power Workers’ Union, which is offset by savings derived from flexibility negotiated in the collective agreement, including new contracting-out provisions. Under the renewal collective agreement, employees represented by the Power Workers’ Union will also be subject to increased annual employee pension contributions. Regular employees who were contributing to the Hydro One Inc. pension plan as of April 1, 2015 will receive, while they remain employed by Hydro One, lump sum cash payments in 2015 and 2016 and annual share grants for a 12 year period after that, made possible as a result of increased employee pension contributions. The share grants will be made under an employee share grant plan to be established by Hydro One Limited prior to the closing of this offering. See “Share Grant Plans”. The annual share grant per participant under such plan will be based on 2.7% of an eligible employee’s salary as at April 1, 2015. New employees will be subject to the pension contribution increases but will not be eligible for these cash payments and share grants.

The Society of Energy Professionals represents professional and first-level supervisory staff employed by Hydro One. On July 24, 2015, Hydro One Inc. reached an agreement with The Society of Energy Professionals for an early renewal collective agreement. This new collective agreement was ratified by the board of directors of Hydro One Inc. on August 11, 2015 and by The Society of Energy Professionals on August 31, 2015. The agreement is for a three-year term, covering the period from April 1, 2016 to March 31, 2019. It provides a 0.5% wage increase annually to the employees represented by The Society of Energy Professionals, which is offset by savings derived from flexibility within the collective agreement. Under the renewal collective agreement, employees represented by The Society of Energy Professionals will also be subject to increased annual employee pension contributions. Regular employees who were contributing to the Hydro One Inc. pension plan as September 1, 2015 will receive, while they remain employed by Hydro One, lump sum cash payments in 2016 and 2017 and annual share grants for a 12 year period after that, made possible as a result of increased employee pension contributions. The share grants will be made under an employee share grant plan to be established by Hydro One Limited prior to the closing of this offering. See “Share Grant Plans”. The annual share grant per participant under such plan will be based on 2.0% of an eligible employee’s salary as at September 1, 2015. New employees will be subject to the pension contribution increases but will not be eligible for these cash payments and share grants.

Regular employees represented by The Society of Energy Professionals who are not participants in the employee share grant plan referred to above or whose participation has ended will have the opportunity to participate in an employee share ownership plan to be established by Hydro One Limited. Participants under this plan may elect to contribute between 1% and 4% of their base salary to the plan, with the Company matching 25% of each participant’s total contributions, subject to a two year holding requirement. Common shares delivered under this plan will be purchased on the open market.

On July 28, 2015, Hydro One Inc. and the Canadian Union of Skilled Workers reached a renewal collective agreement for a three-year term, covering the period from May 1, 2014 to April 30, 2017. The agreement was ratified by the board of directors of Hydro One Inc. on August 31, 2015 and remains subject to ratification by the Canadian Union of Skilled Workers.

The EPSCA is an employers’ association of which Hydro One Inc. is a member. A number of the EPSCA construction collective agreements, which bind Hydro One Inc., expired on April 30, 2015. Tentative agreements have been reached with the United Association of Plumbers and Pipefitters, the Boilermakers, and the Insulators for a five-year term, covering May 1, 2015 to April 30, 2020. These agreements have been ratified by the board of directors of the EPSCA and the unions. Negotiations for renewals for the remaining collective agreements have commenced.

Health, Safety and Environmental Management

Hydro One has integrated the management of health and safety into a single Health, Safety and Environment Management System, which holds OHSAS 18001 registration and is ISO 14001 compliant. OHSAS 18001 is an international recognized standard for occupational health and safety management systems. Effective risk assessment and management are key elements to the successful minimization of risk and performance improvements. Within

 

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Hydro One, health, safety and environmental hazards and risks have been identified and assessed and controls have been implemented to mitigate significant risks. The Company has policies in place regarding health and safety, public safety, environmental and workplace human rights and anti-harassment.

In January 2015, Hydro One Networks Inc. was designated a “Sustainable Electricity Company”. The Sustainable Electricity Company™ brand mark is a designation established by the Canadian Electricity Association. Companies that wish to use the Sustainable Electricity Company™ brand mark must commit to core subjects, issues and related actions and expectations contained in the standard that are deemed applicable and significant to the Company and its stakeholders. The brand mark is granted for five years, with the option for renewal thereafter. The use of the Sustainable Electricity Company™ brand mark demonstrates Hydro One’s commitment to responsible environmental, social and economic practices, and to the principles of sustainable development.

Given the nature of the work undertaken by Hydro One employees, health and safety remains one of the Company’s top priorities. The Company is committed to creating and maintaining an injury-free workplace and maintaining public safety through a concentrated focus on the elimination of serious injuries or “near-misses” which have the potential to cause serious injuries. The Company has developed and is continuing to develop a number of programs and initiatives for accident prevention and to minimize the risk of injury to the public associated with its facilities and operations.

Measures are in place to monitor, on a regular basis, health, safety and environment performance using proactive and reactive measures and/or qualitative and quantitative measures. The 10 year evolution of Hydro One’s recordable rate, its key health and safety performance measure, has seen an approximate 75% reduction. All measures are monitored by management and by the Health, Safety & Environment and First Nations & Métis Committee. Management compensation has been tied, in part, to success in achieving annual health and safety performance targets. A program allowing for an effective early and safe return to work has allowed the Company to ensure that, when injuries occur, employees recover and return to the workplace as soon as possible.

In 2015, Hydro One continued with its “Journey to Zero” safety initiative that was started in 2009. This initiative compares Hydro One to other companies to see where performance gaps might exist. Safety perception assessments were completed in 2009 and 2013 and will continue in 2015. The results of these assessments identify opportunities for improvement and the development of new health and safety initiatives using cross-functional teams from across the province.

Environmental Regulation

Hydro One is subject to extensive federal, provincial and municipal regulation relating to the protection of the environment that governs, among other things, environmental assessments, discharges to water and land and the generation, storage, transportation, disposal and release of various hazardous substances. Estimated environmental liabilities are reviewed annually or more frequently if significant changes in regulation or other relevant factors occur. Estimated changes are accounted for prospectively.

Permits and Approvals

The Company is required to obtain and maintain specified permits and approvals from federal, provincial and municipal authorities relating to the design, construction and operation of new and upgraded transmission and distribution facilities. Examples include environmental assessment approvals, permits for facilities to be located in parks or other regulated areas, water crossing permits, and approvals to discharge to air and water. Some projects may require environmental approvals from the federal government. Interconnections with neighbouring utilities in other provinces and states also require federal approval and will be subject to federal regulatory review.

In general, larger projects are subject to an individual environmental assessment process. The majority of approvals fall under a class environmental assessment process which provides for more streamlined approvals. The scope, timing and cost of environmental assessments are dependent on the scale and type of project, the location (urban versus rural), the environmental sensitivity of affected lands and the significance of potential environmental effects.

 

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Regulation of Releases

Federal, provincial and municipal environmental legislation regulates the release of specific substances into the environment through the prohibition of discharges that will or may have an adverse effect on the environment. Spills and leaks of substances occur in the course of our normal operations. Accordingly, Hydro One has spill, leak prevention and leak mitigation programs involving the testing, replacement, repair and installation of containment systems including re-gasketting of transformers and sulphur-hexafluoride filled equipment. In addition, the Company has an emergency response capability which the Company believes is sufficient to minimize the environmental impact of spills and to comply with its legal obligations.

Hazardous Substances

Hydro One manages a number of hazardous substances, such as PCBs, herbicides, and wood preservatives. In addition, some facilities have substances present which are designated for special treatment under occupational health and safety legislation, such as asbestos, lead and mercury. The Company has environmental management programs in place to deal with PCBs, herbicides, asbestos, and other hazardous substances.

Land Assessment and Remediation

Hydro One has a voluntary land assessment and remediation program in place to identify and, where necessary, remediate historical contamination that has resulted from past operational practices and uses of certain long-lasting chemicals at the Company’s facilities. These programs involve the systematic identification of any contamination at or from these facilities and, where necessary, the development of remediation plans for the Company’s properties and affected adjacent private properties. Future consolidated expenditures related to Hydro One’s land assessment and remediation program are currently estimated at approximately $66 million. These expenditures are expected to be spent over the period ending 2023. The consolidated expenditures on this program for 2014 were approximately $13 million. These costs are expected to be recovered in the Company’s transmission and distribution rates.

Insurance

Hydro One maintains insurance coverage, including liability, all risk property, boiler and machinery and directors’ and officers’ insurance. The Company also maintains other insurance coverage that is required by law, covering risks such as automobile liability, pesticide liability and aircraft liability. The Company does not have insurance for damage to its transmission and distribution wires, poles or towers located outside transmission and distribution stations, including damage caused by severe weather, other natural disasters or catastrophic events or for environmental remediation costs. The Ontario Energy Board has generally permitted the recovery of costs associated with extreme weather events, such as the ice storm that occurred in 1998.

USE OF PROCEEDS

Hydro One will not receive any proceeds from the sale of the common shares by the Province.

The net proceeds of this offering to the Province will be $     ●     ($     ●    , assuming the exercise of the Over-Allotment Option in full), after deducting the Underwriters’ Fee (assuming that 70% of the common shares offered under this prospectus are sold to institutional investors), but excluding the expenses of the offering set out on the cover page of this prospectus, all of which will be borne by the Province.

 

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SELECTED CONSOLIDATED FINANCIAL INFORMATION

The following presents historical and pro forma summary consolidated financial information of Hydro One Inc., in each case, for the periods ended and as at the dates indicated below. The selected consolidated financial information has been derived from the unaudited interim financial statements of Hydro One Inc. as at and for the three and six month periods ended June 30, 2015 and June 30, 2014 and the audited consolidated financial statements of Hydro One Inc. as at and for the years ended December 31, 2014, December 31, 2013 and December 31, 2012 appearing elsewhere in this prospectus. Hydro One’s historical results for any prior period are not necessarily indicative of its results to be expected in any future period. The selected pro forma condensed financial information as at and for the six months ended June 30, 2015 and for the year ended December 31, 2014 has been derived from the unaudited pro forma condensed consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, and give effect to the transactions described in the notes to those statements as if they had occurred on January 1, 2014 for the unaudited pro forma condensed consolidated statements of operations and June 30, 2015 for the unaudited pro forma condensed consolidated balance sheet. Those transactions relate to the following events:

 

    the payment by Hydro One Inc. and certain of its subsidiaries of the “departure tax”, as described in “Departure Tax”,

 

    the recognition by Hydro One Inc. of a deferred tax asset as a consequence of leaving the PILs regime and entering the corporate tax regime (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Factors Affecting Results of Operations – Payments in Lieu of Corporate Income Taxes”),

 

    the recapitalization of Hydro One Networks Inc., as described in “Pre-Closing Transactions”, and

 

    the transfer of all of the issued and outstanding shares of Hydro One Brampton Networks Inc. to a company wholly-owned by the Province, as described in “Pre-Closing Transactions”.

The selected pro forma condensed financial information is unaudited, for informational purposes only, and not necessarily indicative of what Hydro One Inc.’s financial position or results of operations would have been had such transactions been completed as at the dates indicated and does not purport to represent what the financial position or results of operations might be for any future period.

The following information should be read in conjunction with “Risk Factors”, “Consolidated Capitalization”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the consolidated financial statements of Hydro One Inc., and the unaudited pro forma condensed consolidated financial statements of Hydro One Inc. and the related notes included elsewhere in this prospectus. The financial statements of Hydro One Inc. included in this prospectus have been prepared in accordance with U.S. GAAP.

 

     Six Months Ended June 30  

Statement of Operations Data(1)

   2015      2015      2014  
     (pro forma)                
     ($, in millions)  

Revenues

        

Distribution

     2,320         2,574         2,497   

Transmission

     770         770         804   

Other

     27         27         29   
  

 

 

    

 

 

    

 

 

 

Total revenues

     3,117         3,371         3,330   
  

 

 

    

 

 

    

 

 

 

Costs

        

Purchased power

     1,590         1,808         1,746   

Operation, maintenance and administration

     546         560         645   

Depreciation and amortization

     368         377         348   
  

 

 

    

 

 

    

 

 

 

Total costs

     2,504         2,745         2,739   
  

 

 

    

 

 

    

 

 

 

Income before financing charges and provisions for payments in lieu of corporate income taxes

     613         626         591   

Financing charges

     193         187         185   

Provision for payments in lieu of corporate income taxes

     64         68         51   

Net income

     356         371         355   
  

 

 

    

 

 

    

 

 

 

 

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     Year ended December 31  

Statement of Operations Data(1)

   2014      2014      2013      2012  
     (pro forma)                       
     ($, in millions)  

Revenues

           

Distribution

     4,408         4,903         4,484         4,184   

Transmission

     1,588         1,588         1,529         1,482   

Other

     57         57         61         62   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     6,053         6,548         6,074         5,728   
  

 

 

    

 

 

    

 

 

    

 

 

 

Costs

           

Purchased power

     2,993         3,419         3,020         2,774   

Operation, maintenance and administration

     1,165         1,192         1,106         1,071   

Depreciation and amortization

     708         722         676         659   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total costs

     4,866         5,333         4,802         4,504   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before financing charges and provisions for payments in lieu of corporate income taxes

     1,187         1,215         1,272         1,224   

Financing charges

     392         379         360         358   

Provision for payments in lieu of corporate income taxes

     87         89         109         121   

Net income

     708         747         803         745   

 

     As at June 30      As at December 31  

Selected Balance Sheet Data(1)

   2015      2015      2014      2013      2012  
     (pro forma)                              
     ($, in millions)  

Total assets

     23,671         23,167         22,550         21,625         20,811   

Long-term debt (including current portion)

     10,090         9,290         8,925         9,057         8,479   

 

Notes:

 

(1) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc. Because this transfer occurred after the dates of, and periods covered by, the historical consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, those financial statements and the historical summary data appearing in the table above include the assets, liabilities and results of operations of Hydro One Brampton Networks Inc. during the periods and as at the dates indicated, except in the columns marked as “pro forma”.

 

     Six months ended June 30     Year ended December 31  

Other Financial Measures(1)

   2015     2014     2014     2013     2012  
     ($, in millions)  

Reconciliation of net income to adjusted net income

          

Net income

     371        355        747        803        745   

Adjustments

                                   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income(2)

     371        355        747        803        745   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation of net cash from operating activities to FFO

          

Net cash from operating activities

     713        334        1,256        1,404        1,294   

Change in non-cash operating working capital

     59        304        55        (11     31   

Preferred dividends

     (9     (9     (18     (18     (18

Noncontrolling interest distributions(3)

     (2                            
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

FFO(2)

     761        629        1,293        1,375        1,307   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Notes:

 

(1) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc. Because this transfer occurred after the dates of, and periods covered by, the historical consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, those financial statements and the other financial measures appearing in the table above include amounts contributed by Hydro One Brampton Networks Inc. during the periods indicated.

 

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(2) Adjusted net income and FFO are non-GAAP measures. See “Non-GAAP Measures”.

 

(3) In 2014, there was a $72 million noncontrolling interest contribution. This was a one-time item, and has been excluded from the calculation of FFO in 2014.

 

Operating Statistics and Other Information (Including

Hydro One Brampton Networks Inc. except where noted)(1)

   Year Ended December 31  
   2014      2013      2012  

Transmission

        

Electricity transmitted (TWh)

     139.8         140.7         141.3   

Total transmission lines spanning the province (circuit-kilometres)

     29,344         29,344         29,327   

Rate base(2) ($ millions)

     9,934         9,353         8,774   

Capital expenditures ($ millions)

     845         714         776   

Distribution

        

Electricity distributed to Hydro One customers (TWh)

     29.8         29.8         29.2   

Electricity distributed through Hydro One lines (TWh)

     42.4         42.5         42.4   

Total distribution lines spanning the province (circuit kilometres)

     123,657         122,853         121,525   

Distribution customers (Hydro One Networks Inc.)(4)

     1,268,745         1,270,817         1,236,526   

Distribution customers (Hydro One Brampton Networks Inc.)

     149,681         146,039         141,860   

Rate base(2) ($ millions)

     6,315         5,925         5,550   

Capital expenditures ($ millions)

     680         673         671   

Certain Operating Statistics for Hydro One Brampton Networks Inc.(3)

        

Total distribution lines (circuit kilometres)

     3,242         3,104         2,952   

Distribution customers

     149,681         146,039         141,860   

 

Notes:

 

(1) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions. Hydro One Brampton Networks Inc. was previously a wholly-owned subsidiary of Hydro One Inc. Because this transfer occurred after the dates of, and periods covered by, the historical consolidated financial statements of Hydro One Inc. appearing elsewhere in this prospectus, those financial statements and the summary operating statistics appearing in the table above include amounts contributed by Hydro One Brampton Networks Inc. during the periods indicated.

 

(2) Rate base in each year refers to the rate base of Hydro One’s transmission business or distribution business, as the case may be, approved by the Ontario Energy Board for that year. See “Meaning of Certain References”.

 

(3) On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred to a company wholly-owned by the Province. See “Pre-Closing Transactions” for additional detail concerning the transfer and related transactions.
(4) Includes certain classes of customers which are excluded in the Ontario Energy Board Yearbook of Distributors (2014).

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

Hydro One Limited was incorporated on August 31, 2015. It has not completed its first fiscal year and has had limited activity. Prior to the completion of this offering, Hydro One Inc. will become a wholly-owned subsidiary of Hydro One Limited. See “Pre-Closing Transactions”.

This management’s discussion and analysis of financial condition and results of operations (“MD&A”) has been prepared with respect to Hydro One Inc. (the “Company” or “Hydro One”). In this MD&A only, references to the “Company” or “Hydro One” refer to Hydro One Inc. and its consolidated subsidiaries, and do not include or refer to Hydro One Limited.

This MD&A should be read in conjunction with the consolidated financial statements and accompanying notes of Hydro One that appear elsewhere in this prospectus. Those financial statements consist of the unaudited interim financial statements of Hydro One for the three and six month periods ended June 30, 2015 and the balance sheet as at June 30, 2015 and December 31, 2014, the audited consolidated financial statements of Hydro One as at and for the years ended December 31, 2014 and 2013, and the audited consolidated financial statements of Hydro One as at and for the years ended December 31, 2013 and 2012, in each case, together with the notes accompanying such financial statements.

On August 31, 2015, all of the issued and outstanding shares of Hydro One Brampton Networks Inc. were transferred from Hydro One Inc. to a company wholly owned by the Province, as described in “Pre-Closing Transactions”. Hydro One Brampton Networks Inc. was previously a wholly owned subsidiary of Hydro One. Because this transfer occurred after the dates of, and periods covered by, the consolidated financial statements of Hydro One appearing elsewhere in this prospectus, those financial statements and the summary consolidated financial information derived from those financial statements include the assets, liabilities and results of operations of Hydro One Brampton Networks Inc. Accordingly, all financial information of Hydro One referred to or discussed in this MD&A includes the assets, liabilities and results of operations of Hydro One Brampton Networks Inc. To see the impact of certain transactions related to the offering on the financial statements of Hydro One Inc., including the transfer of all of the issued and outstanding shares of Hydro One Brampton Networks Inc. to a company wholly owned by the Province, see the unaudited pro forma condensed consolidated financial statements of Hydro One Inc., together with “Summary Consolidated Financial Information” and “Selected Consolidated Financial Information” elsewhere in this prospectus.

The Company’s consolidated financial statements are presented in Canadian dollars and have been prepared in accordance with U.S. GAAP. The Ontario Energy Board approved the use of U.S. GAAP for rate setting and regulatory accounting and reporting by Hydro One Networks Inc.’s (“Hydro One Networks”) transmission and distribution businesses, as well as by Hydro One Remote Communities Inc., beginning with the 2012 financial year. Hydro One Networks and Hydro One Remote Communities Inc. are wholly owned subsidiaries of Hydro One. During the periods presented, Hydro One Brampton Networks Inc. used Canadian GAAP (Part V) for its distribution rate-setting purposes.

All financial information in this MD&A is presented in Canadian dollars, unless otherwise indicated.

Some of the information contained in this MD&A contains forward-looking information that involves risks and uncertainties. See “Forward-Looking Information” and “Risk Factors” for a discussion of the uncertainties and assumptions associated with these statements. Actual results may differ materially from those indicated or underlying forward-looking information as a result of various factors, including those described under “Risk Factors” and elsewhere in this MD&A.

Overview

Hydro One has three business segments: (i) transmission; (ii) distribution; and (iii) other business (primarily telecommunications).

Hydro One’s transmission business consists of owning, operating and maintaining Hydro One’s transmission system, which accounts for 96% of Ontario’s entire transmission network based on revenue approved by the Ontario

 

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Energy Board. This includes the Company’s 66% ownership interest in B2M Limited Partnership, a limited partnership between Hydro One and the Saugeen Ojibway Nation in respect of the Bruce-to-Milton transmission line. All of the Company’s transmission business is carried out by Hydro One Networks, except for the portion of its business held through B2M Limited Partnership, which the Company controls and operates.

Hydro One’s distribution business consists of owning, operating and maintaining Hydro One’s distribution system, which the Company owns primarily through Hydro One Networks, the largest local distribution company in Ontario. The Company’s distribution system is also the largest in Ontario, spanning approximately 75% of the geographic area of the province. Hydro One’s distribution business also includes the business of Hydro One Remote Communities Inc., which supplies electricity to customers in remote communities in northern Ontario, as well as the distribution businesses of Norfolk Power and Haldimand Hydro.

Hydro One’s other business segment principally consists of its telecommunications business, which provides telecommunications support for the Company’s transmission and distribution businesses, and also markets and sells fibre optic capacity to telecommunications carriers and commercial customers with broadband network requirements. The telecommunications business is carried out by the Company’s wholly-owned subsidiary, Hydro One Telecom Inc.

Summary of Results for Three and Six Month Periods

 

Consolidated Statements of Operations

and Comprehensive Income

   Three months ended June 30      Six months ended June 30  
     2015      2014      2015      2014  
     (millions of Canadian dollars, except per share amounts)  

Total revenue

     1,563         1,566         3,371         3,330   

Net income attributable to Shareholder of Hydro One

     136         115         368         355   

Earnings per common share (Canadian dollars)

     1,308         1,099         3,594         3,456   

Dividends per common share (Canadian dollars)

     250         250         500         2,196   

Dividends per preferred share (Canadian dollars)

     0.34         0.34         0.69         0.69   

 

Consolidated Balance Sheets

   June 30,
2015
     December 31,
2014
 
       
     (millions of Canadian dollars)  

Total assets

     23,167         22,550   

Total long-term debt

     9,290         8,925   

Preferred shares

     323         323   

Net assets

     8,257         7,947   

During the six months ended June 30, 2015, Hydro One earned net income of $368 million and revenues of $3,371 million. The Company made capital investments totalling $774 million to improve its transmission and distribution systems’ reliability and performance, address its aging power system infrastructure, facilitate new generation, and improve service to its customers.

Developments in 2015

Change in Credit Ratings

On April 17, 2015, Moody’s Investors Service Inc. (Moody’s) affirmed the credit ratings of Hydro One, and revised their outlook on the Company to negative from stable.

On April 20, 2015, Standard & Poor’s Rating Services Inc. (S&P) downgraded their long-term corporate credit rating on Hydro One to A from A+, and revised their outlook on the Company to stable from negative.

Both the Moody’s and S&P rating changes were made in response to the announcement by the Province that it intended to dispose of up to 15% of its shares in Hydro One via an initial public offering.

A summary of the Company’s corporate credit ratings can be found in the section “Liquidity and Capital Resources – Financing Activities” in this MD&A and under “Credit Ratings of Securities.”

 

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Haldimand Hydro Acquisition

In June 2015, Hydro One acquired 100% of the common shares of Haldimand Hydro, an electricity distribution company located in southwestern Ontario, following approval of the acquisition by the Ontario Energy Board in March 2015. The Haldimand Hydro acquisition is part of the Company’s local distribution company consolidation strategy to better serve Ontario’s distribution system and improve system reliability and efficiency across the grid. Hydro One is committed to delivering reliable service for Haldimand Hydro’s customers and improving efficiencies in both the Haldimand Hydro and Hydro One systems as a result of the acquisition. The purchase price for Haldimand Hydro was approximately $65 million, subject to final closing adjustments. Closing adjustments to the purchase price and the final allocation of the consideration paid are expected to be completed by the end of 2015.

Class Action Lawsuit

On July 22, 2015, two Toronto law firms issued a joint press release announcing that a $125 million lawsuit had been commenced in the Ontario Superior Court of Justice against Hydro One and four of its subsidiaries. The action is proposed as a class action. The statement of claim dated September 9, 2015 alleges improper billing and account management practices. This claim is in a very early stage and has not been certified as a class action. It is too early to assess the merits of the claim. Hydro One intends to defend the action.

Outlook

The following is a discussion of certain factors that have impacted or are anticipated to impact the Company’s results of operations in 2015, as well as certain events that occurred in 2014 that may impact the comparability of the Company’s results of operations for 2015 and interim periods during 2015.

 

    The Company continues to benefit from increased transmission and distribution rates in 2015 as a result of the Company’s most recent transmission and distribution rate decisions.

 

    During the first half of 2015, operation, maintenance and administration costs relative to the same period in 2014 were lower due to the stabilization of the Company’s customer information system and the acceleration of collections on aged accounts receivable.

 

    During 2014, the Company’s results of operations were positively affected by increased system usage and transmission load due to weather conditions. These positive impacts may not recur during 2015.

 

    As part of its settlement of 2013 and 2014 transmission rates, the Company is subject to a revenue clawback intended to account for the difference between actual and forecast load attributable to any shortfalls in the forecasted province-wide conservation and demand management or “CDM” savings. The Company is obligated to transfer to a variance account the amount of transmission revenues that reflects the impact on the Company’s revenue requirement of actual province-wide CDM savings versus the forecast province-wide CDM savings for those years. The amount for 2014 will not be known until the IESO provides the Company with information on the amount of the clawback. Without this information, the Company cannot reasonably estimate the impact on its revenues. Any impact would be expected to be recorded in either the third or fourth quarter of 2015.

 

    During the fourth quarter of 2015, the Company is anticipated to incur costs related to the granting of shares to certain unionized employees pursuant to the share grant plans to be established for the benefit of certain members of the Power Workers’ Union and The Society of Energy Professionals, as described in “Share Grant Plans”. These costs are anticipated to result in a non-cash charge to net income of approximately $8 million, which would be included in operation, maintenance and administration costs.

 

    In the third and fourth quarters of 2014, Hydro One recognized in net income non-recurring insurance proceeds of $11 million related to 2013 floods at the Company’s Richview and Manby transformer stations.

 

    During 2014, the Company realized an effective tax rate of approximately 10%. For the six months ended June 30, 2015, the Company realized an effective tax rate of approximately 16% and anticipates an effective tax rate of approximately 15% for the remainder of 2015. The difference in the effective tax rate between 2014 and 2015 is due primarily to accelerated capital cost allowance recognized in 2014 for certain classes of assets.

 

    The transfer of Hydro One Brampton Networks Inc. as described in “Pre-Closing Transactions” is expected to have a non-material effect on net income in 2015, but will more significantly impact distribution revenues and purchased power costs.

 

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In addition to the factors described above, see the unaudited pro forma condensed consolidated financial statements of Hydro One Inc. and the related notes included elsewhere in this prospectus which give effect to certain transactions described in the notes to those statements for the periods shown, including the transfer of Hydro One Brampton Networks Inc.

Applications to the Ontario Energy Board

The following table summarizes Hydro One’s recent major regulatory applications to the Ontario Energy Board:

 

Application

   Year(s)    Type    Date Filed   

Status

Electricity Rates – Transmission Rate Applications

  

Hydro One Networks

   2015-2016    Cost-of-service    September 16, 2014    Decision received on January 8, 2015

B2M Limited Partnership

   2015    Interim    October 24, 2014    Decision received on December 11, 2014

B2M Limited Partnership

   2015-2019    Cost-of-service    March 30, 2015    Decision anticipated in 2015

Electricity Rates – Distribution Rate Applications

Hydro One Networks

   2015-2017    Custom    December 19, 2013    Decision received on March 12, 2015(1)

Hydro One Brampton Networks Inc.

   2015    Cost-of-service    April 23, 2014    Decision received on January 15, 2015

Hydro One Remote Communities Inc.

   2015    IRM    September 24, 2014    Decision received on March 19, 2015

Mergers Acquisitions Amalgamations and Divestitures (MAAD) Applications

Woodstock Hydro

   n/a    Acquisition    July 9, 2014    Decision received on September 11, 2015

Leave to Construct Application

Supply to Essex County Transmission Reinforcement Project   

 

n/a

  

 

Section 92

  

 

January 22, 2014

  

Decision for Phase 1 received on

July 16, 2015

Decision for Phase 2 anticipated in late 2015

 

(1) The application filed by Hydro One Networks on December 19, 2013 was for years 2015-2019. On March 12, 2015, the Ontario Energy Board issued a Decision and Rate Order for years 2015-2017 only. See “Business of Hydro One – Distribution Business – Regulation.”

Factors Affecting Results of Operations

Transmission Revenues

Transmission revenues primarily consist of the Company’s transmission rates approved by the Ontario Energy Board, which are based on the monthly peak electricity demand across Hydro One’s high-voltage network. Transmission rates are designed to recover revenues necessary to support a transmission system with sufficient capacity to accommodate maximum forecasted demand. Demand is primarily influenced by weather and economic conditions. Transmission revenues also include export revenues associated with transmitting excess generation to surrounding markets, ancillary revenues primarily attributable to maintenance services provided to generators, and secondary use of the Company’s land rights.

Distribution Revenues

Distribution revenues include the distribution rates approved by the Ontario Energy Board and amounts to recover the cost of purchased power used by the customers of the distribution business. Accordingly, distribution revenues are influenced by the amount of electricity the Company distributes, the cost of purchased power and distribution rates. Distribution revenues also include minor ancillary distribution service revenues, such as fees related to the joint use of Hydro One’s distribution poles by the telecommunications and cable television industries, as well as miscellaneous charges such as charges for late payments.

Purchased Power Costs

Purchased power costs are incurred by the distribution business and represent the cost of purchased electricity delivered to customers within Hydro One’s distribution service territory. These costs comprise the wholesale commodity cost of energy, the IESO wholesale market service charges, and transmission charges levied by the IESO. The commodity cost of energy is based on the Ontario Energy Board’s regulated price plan or the market price for electricity. Except for short-term timing differences, Hydro One recovers the cost of electricity that it delivers, and is therefore not financially exposed to commodity price risk related to electricity.

 

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Operation, Maintenance and Administration Costs

Operation, maintenance and administration costs include work program costs and costs to support the operation and maintenance of the transmission and distribution systems. Also included in these costs are payments in lieu of property taxes related to the transmission and distribution lines, stations and buildings. The transmission operation, maintenance and administration costs are incurred to sustain the Company’s high-voltage transmission stations, lines and rights-of-way, and include preventive and corrective maintenance costs related to power equipment, overhead transmission lines, transmission station sites, and brush control. The distribution operation, maintenance and administration costs are required to maintain the Company’s low-voltage distribution system, and include costs related to distribution line clearing and brush control, line maintenance and repair, as well as land assessment and remediation. Hydro One continues to focus on managing its costs, while continuing to complete its planned work programs for both its transmission and distribution businesses.

Depreciation and Amortization

Depreciation and amortization costs relate primarily to depreciation and amortization of the Company’s property, plant and equipment, intangible assets and certain regulatory assets. Depreciation expense also includes the costs incurred to remove property, plant and equipment where no asset retirement obligations have been recorded.

Financing Charges

Financing charges relate to the Company’s financing activities, and include interest expense on the Company’s long-term debt, gains and losses on interest rate swap agreements, interest earned on short-term and long-term investments. A portion of financing charges incurred by the Company is capitalized to the cost of property, plant and equipment.

Payments in Lieu of Corporate Income Taxes

Generally, Hydro One Inc. and its subsidiaries have been exempt from regular federal and Ontario income tax and instead paid an equivalent amount referred to as payments in lieu of corporate income taxes or “PILs” to the Ontario Electricity Financial Corporation under the Electricity Act. Once Hydro One is less than 90% owned by the Province, it will cease to be exempt from regular federal and Ontario income tax, and will be deemed, for purposes of the Tax Act, to have disposed of its assets before it loses its tax-exempt status for proceeds equal to the fair market value of those assets at that time, and will be deemed to have acquired all such assets at the time of the loss of tax-exempt status at a cost equal to fair market value. See “Departure Tax”.

Results of Operations – Three Months Ended June 30, 2015 Compared to Three Months Ended June 30, 2014

 

Three months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Revenues

     1,563         1,566         (3     (0.2

Purchased power

     838         824         14        1.7   

Operation, maintenance and administration

     282         334         (52     (15.6

Depreciation and amortization

     190         181         9        5.0   
  

 

 

    

 

 

    

 

 

   

 

 

 
     1,310         1,339         (29     (2.2

Income before financing charges and provision for PILs

     253         227         26        11.5   

Financing charges

     93         95         (2     (2.1
  

 

 

    

 

 

    

 

 

   

 

 

 

Income before provision for PILs

     160         132         28        21.2   

Provision for PILs

     23         17         6        35.3   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income

     137         115         22        19.1   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) attributable to noncontrolling interest

     1                 1        100.0   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income attributable to Shareholder of Hydro One

     136         115         21        18.3   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Net Income

The net income attributable to the Shareholder of Hydro One for the three months ended June 30, 2015 was $136 million, compared to $115 million during the same period in 2014, an increase of $21 million or 18.3%. The increase is primarily due to the following:

 

    a decrease in operation, maintenance and administration costs, primarily resulting from lower expenditures related to the Company’s Customer Information System (“CIS”); lower bad debt expense resulting from the reinstatement of certain collection activities in September 2014; lower expenditures associated with responding to and restoring power outages; and decreased vegetation management requirements for brush control programs; partially offset by

 

    a decrease in transmission revenues, mainly due to lower average Ontario 60-minute peak demand in the second quarter of 2015, as the weather in the quarter was milder than last year, and

 

    an increase in depreciation and amortization costs, mainly due to higher property, plant and equipment depreciation expense related to growth in capital assets as the Company continues to place new assets in-service, consistent with its ongoing capital work programs.

Revenues

 

Three months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Transmission

     364         382         (18     (4.7

Distribution

     1,185         1,170         15        1.3   

Other

     14         14                  
  

 

 

    

 

 

    

 

 

   

 

 

 
     1,563         1,566         (3     (0.2
  

 

 

    

 

 

    

 

 

   

 

 

 

Average annual Ontario 60-minute peak demand (MW)(1)

     18,986         19,403         (417     (2.1
  

 

 

    

 

 

    

 

 

   

 

 

 

Distribution – units distributed to Hydro One customers (TWh)(1)

     6.7         6.7                  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) System-related statistics are preliminary.

Transmission

Transmission revenues for the three months ended June 30, 2015 were $364 million, compared to $382 million during the same period in 2014, a decrease of $18 million or 4.7%. The components of the decrease include the following:

 

    lower average Ontario 60-minute peak demand in the second quarter of 2015, as peak demand towards the end of the quarter did not reach the Company’s forecast, as weather patterns during the quarter and extending into the third quarter have been milder than 2014, and

 

    disposition of certain Ontario Energy Board-approved transmission regulatory accounts; partially offset by

 

    higher new transmission rates effective January 1, 2015 approved by the Ontario Energy Board in January 2015.

Distribution

Distribution revenues for the three months ended June 30, 2015 were $1,185 million, compared to $1,170 million during the same period in 2014, an increase of $15 million or 1.3%. The components of the increase include the following:

 

    higher purchased power costs, as described below under “Purchased Power Costs”, and

 

    higher new distribution rates effective January 1, 2015 approved by the Ontario Energy Board in March 2015; partially offset by

 

    the expiry of certain Ontario Energy Board-approved rate riders and regulatory accounts.

 

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Purchased Power Costs

Purchased power costs for the three months ended June 30, 2015 were $838 million, compared to $824 million during the same period in 2014, an increase of $14 million or 1.7%. The components of the increase include the following:

 

    higher Ontario Energy Board Regulated Price Plan rates for residential and other eligible customers, and

 

    higher purchased power costs for customers who are not eligible for the Regulated Price Plan; partially offset by

 

    lower demand for electricity in the second quarter of 2015, , as the weather in the quarter was milder than last year; and

 

    lower wholesale market service charges levied by the IESO.

Operation, Maintenance and Administration Costs

 

Three months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Transmission

     98         105         (7     (6.7

Distribution

     168         214         (46     (21.5

Other

     16         15         1        6.7   
  

 

 

    

 

 

    

 

 

   

 

 

 
     282         334         (52     (15.6
  

 

 

    

 

 

    

 

 

   

 

 

 

Transmission

Transmission operation, maintenance and administration costs for the three months ended June 30, 2015 were $98 million, compared to $105 million during the same period in 2014, a decrease of $7 million or 6.7%. The components of the decrease include the following:

 

    decreased forestry expenditures related to brush control and line clearing on the Company’s transmission rights-of-way, and

 

    lower volume of corrective maintenance work required on overhead lines; partially offset by

 

    higher expenditures related to compliance with NERC Critical Infrastructure Protection (“Cyber Security”) standards. See “Business of Hydro One – Transmission Business – Regulation”.

Distribution

Distribution operation, maintenance and administration costs for the three months ended June 30, 2015 were $168 million, compared to $214 million during the same period in 2014, a decrease of $46 million or 21.5%. The components of the decrease include the following:

 

    lower expenditures related to the CIS system, as remediation of issues related to the installation of the system is completed, and the system is now stable,

 

    decrease in bad debt expense, resulting from the reinstatement of certain collection activities in September 2014, which were temporarily suspended during several months in 2014 due to system issues, as Hydro One has made improvements in its customer service during 2015, restored service levels at its call centre, and restored its billing system performance, which has enabled more active collections of overdue balances,

 

    decreased vegetation management requirements for the brush control program,

 

    lower expenditures associated with locating and restoring power outages, as well as responding to power quality-related issues, and

 

    lower volume of work on the land assessment and remediation program to assess the degree of environmental contamination at Hydro One’s owned stations and facilities.

 

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Financing Charges

Financing charges for the three months ended June 30, 2015 were $93 million, compared to $95 million during the same period in 2014, a decrease of $2 million or 2.1%. The decrease is primarily due to an increase in capitalized interest, resulting from higher average property, plant and equipment construction in progress balances eligible for interest capitalization.

Provision for PILs

The provision for PILs for the three months ended June 30, 2015 was $23 million, compared to $17 million during the same period in 2014, an increase of $6 million or 35.3%. The increase is primarily due to higher pre-tax income.

Results of Operations – Six Months Ended June 30, 2015 Compared to Six Months Ended June 30, 2014

 

Six months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Revenues

     3,371         3,330         41        1.2   

Purchased power

     1,808         1,746         62        3.6   

Operation, maintenance and administration

     560         645         (85     (13.2

Depreciation and amortization

     377         348         29        8.3   
  

 

 

    

 

 

    

 

 

   

 

 

 
     2,745         2,739         6        0.2   

Income before financing charges and provision for PILs

     626         591         35        5.9   

Financing charges

     187         185         2        1.1   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income before provision for PILs

     439         406         33        8.1   

Provision for PILs

     68         51         17        33.3   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income

     371         355         16        4.5   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) attributable to noncontrolling interest

     3                 3        100.0   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income attributable to Shareholder of Hydro One

     368         355         13        3.7   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net Income

Net income attributable to the Shareholder of Hydro One for the six months ended June 30, 2015 was $368 million, compared to $355 million during the same period in 2014, an increase of $13 million or 3.7%. The increase is primarily due to the following:

 

    a decrease in operation, maintenance and administration costs, primarily resulting from lower expenditures related to the Company’s CIS; lower bad debt expense resulting from the reinstatement of certain collection activities in September 2014; lower expenditures associated with responding to and restoring power outages; and lower volume of work on the land assessment and remediation program,

 

    an increase in distribution revenues, mainly due to higher new Ontario Energy Board-approved 2015 distribution rates, partially offset by the expiry of certain Ontario Energy Board-approved rate riders and regulatory accounts,

 

    a decrease in transmission revenues, mainly due to lower average Ontario 60-minute peak demand in the first half of 2015, as well as the disposition of certain Ontario Energy Board-approved regulatory accounts, partially offset by an increase due to higher new Ontario Energy Board-approved 2015 transmission rates, and

 

    an increase in depreciation and amortization costs, mainly due to higher property, plant and equipment depreciation expense, related to the growth in capital assets as the Company continues to place new assets in-service, consistent with its ongoing capital work programs.

 

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Revenues

 

Six months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Transmission

     770         804         (34     (4.2

Distribution

     2,574         2,497         77        3.1   

Other

     27         29         (2     (6.9
  

 

 

    

 

 

    

 

 

   

 

 

 
     3,371         3,330         41        1.2   
  

 

 

    

 

 

    

 

 

   

 

 

 

Average annual Ontario 60-minute peak demand (MW)(1)

     20,182         20,757         (575     (2.8
  

 

 

    

 

 

    

 

 

   

 

 

 

Distribution – units distributed to Hydro One customers (TWh)(1)

     15.4         15.4                  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) System-related statistics are preliminary.

Transmission

Transmission revenues for the six months ended June 30, 2015 were $770 million, compared to $804 million during the same period in 2014, a decrease of $34 million or 4.2%. The components of the decrease include the following:

 

    lower average Ontario 60-minute peak demand in the first six months of 2015, partially due to industrial customers shifting their energy use away from system-wide peaks in the winter months of 2015, as well as milder weather in 2015, compared to the same period in 2014, and

 

    disposition of certain Ontario Energy Board-approved transmission regulatory accounts; partially offset by

 

    higher new transmission rates effective January 1, 2015 approved by the Ontario Energy Board in January 2015.

Distribution

Distribution revenues for the six months ended June 30, 2015 were $2,574 million, compared to $2,497 million during the same period in 2014, an increase of $77 million or 3.1%. The components of the increase include the following:

 

    higher purchased power costs, as described below under “Purchased Power Costs”, and

 

    higher new distribution rates effective January 1, 2015 approved by the Ontario Energy Board in March 2015; partially offset by

 

    the expiry of certain Ontario Energy Board-approved rate riders and regulatory accounts.

Purchased Power Costs

Purchased power costs for the six months ended June 30, 2015 were $1,808 million, compared to $1,746 million during the same period in 2014, an increase of $62 million or 3.6%. The components of the increase include the following:

 

    higher Ontario Energy Board Regulated Price Plan rates for residential and other eligible customers, and

 

    higher purchased power costs for customers who are not eligible for the Regulated Price Plan; partially offset by

 

    lower demand for electricity in the first six months of 2015, mainly resulting from milder weather in 2015, and

 

    lower wholesale market service charges levied by the IESO.

 

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Operation, Maintenance and Administration

 

Six months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Transmission

     197         220         (23     (10.5

Distribution

     334         395         (61     (15.4

Other

     29         30         (1     (3.3
  

 

 

    

 

 

    

 

 

   

 

 

 
     560         645         (85     (13.2
  

 

 

    

 

 

    

 

 

   

 

 

 

Transmission

Transmission operation, maintenance and administration costs for the six months ended June 30, 2015 were $197 million, compared to $220 million during the same period in 2014, a decrease of $23 million or 10.5%. The components of the decrease include the following:

 

    decreased forestry expenditures related to brush control and line clearing on the Company’s transmission rights-of-way,

 

    lower volume of corrective maintenance work required on overhead lines,

 

    decreased requirements related to corrective maintenance work for mineral oil spills,

 

    increased attribution of overheads to capital project expenditures reflecting the higher expenditures related to capital projects in the first half of 2015, and

 

    cost savings reflecting various management initiatives to reduce overhead costs; partially offset by

 

    higher expenditures related to compliance with NERC’s Cyber Security standards. See “Business of Hydro One – Transmission Business – Regulation”.

Distribution

Distribution operation, maintenance and administration costs for the six months ended June 30, 2015 were $334 million, compared to $395 million during the same period in 2014, a decrease of $61 million or 15.4%. The components of the decrease include the following:

 

    lower expenditures related to the Company’s CIS, as remediation of issues related to the installation of the system was completed, and the system is now stable,

 

    decrease in bad debt expense, resulting from the reinstatement of certain collection activities in September 2014, which were temporarily suspended during several months in 2014 due to system issues,

 

    lower volume of work associated with locating and restoring power outages, responding to and resolving power quality customer complaints, identifying and correcting abnormal system conditions, as well as responding to power quality-related issues and outages as a result of lower storm activity and enhanced response times, and

 

    lower volume of work on the land assessment and remediation program to assess the degree of environmental contamination at Hydro One’s owned stations and facilities; partially offset by

 

    increased volume of lines maintenance work to ensure long term sustainability of line assets and safety.

Depreciation and Amortization

Depreciation and amortization costs for the six months ended June 30, 2015 were $377 million, compared to $348 million during the same period in 2014, an increase of $29 million or 8.3%. The increase was primarily attributable to higher property, plant and equipment depreciation expense in the first half of 2015, mainly related to the growth in capital assets as the Company continues to place new assets in-service, consistent with its ongoing capital work program.

Financing Charges

Financing charges for the six months ended June 30, 2015 were $187 million, compared to $185 million during the same period in 2014, an increase of $2 million or 1.1%. The increase is primarily due to a decrease in interest earned on the Company’s investment in Province of Ontario floating-rate notes which matured in November 2014.

 

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Provision for PILs

The provision for PILs for the six months ended June 30, 2015 was $68 million, compared to $51 million during the same period in 2014, an increase of $17 million or 33.3%. The increase is primarily due to the following:

 

    higher pre-tax income, and

 

    changes in temporary differences, such as capital cost allowance in excess of depreciation.

Selected Financial Highlights and Ratios

 

         Three months ended June 30              Six months ended June 30      
     2015      2014      2015      2014  
     (millions of Canadian dollars, except per share
amounts and ratios)
 

Net income attributable to Shareholder of Hydro One

     136         115         368         355   

Net cash from operating activities

     287         185         713         334   

Capital investments

     429         380         774         676   

Earnings per common share (Canadian dollars)

     1,308         1,099         3,594         3,456   
                   June 30,
2015
     December 31,
2014
 

Earnings coverage ratio(1)

           2.79         2.81   

Net assets coverage on long-term debt ratio(2)

           1.89         1.89   

Total debt to capitalization ratio(3)

           53.2      53.1

 

(1) The earnings coverage ratio has been presented for the twelve months ended June 30, 2015 and June 30, 2014, and has been calculated as the sum of net income attributable to Shareholder of Hydro One, provision for PILs and financing charges divided by the sum of financing charges, capitalized interest and cumulative preferred dividends.

 

(2) The net asset coverage on long-term debt ratio has been presented as at June 30, 2015 and December 31, 2014, and has been calculated as total assets minus total liabilities excluding long-term debt (including current portion) divided by long-term debt (including current portion).

 

(3) Total debt to capitalization ratio has been presented as at June 30, 2015 and December 31, 2014, and has been calculated as total long-term debt divided by total long-term debt plus total shareholder’s equity and preferred shares.

Liquidity and Capital Resources for Three and Six Months Periods

Hydro One’s primary sources of liquidity and capital resources are funds generated from operations, debt capital market borrowings and bank financing that are used to satisfy Hydro One’s capital resource requirements, including the Company’s capital expenditures, servicing and repayment of debt, and dividends.

Summary of Sources and Uses of Cash

 

       Three months ended June 30          Six months ended June 30    
     2015      2014      2015      2014  
     (millions of Canadian dollars)  

Operating activities

     287         185         713         334   

Financing activities

           

Long-term debt issued

     350         453         350         628   

Dividends paid

     (30      (30      (59      (229

Investing activities

           

Capital expenditures

     (422      (367      (766      (659

Net cash paid for Haldimand Hydro

     (58              (58        

Other financing and investing activities

     (38      17         (10        
  

 

 

    

 

 

    

 

 

    

 

 

 

Net change in cash and cash equivalents

     89         258         170         74   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Cash from Operating Activities

Three months ended June 30, 2015

Net cash from operating activities increased by $102 million to $287 million during the three months ended June 30, 2015, compared to the same period in 2014. The increase was primarily due to the following:

 

    changes in regulatory accounts, primarily due to the retail settlement and external revenue variance accounts,

 

    changes in accounts receivable balances, due to improved collections in 2015, and

 

    higher net income before taxes and depreciation; partially offset by

 

    changes in accrual balances, mainly related to timing and higher activity of capital projects.

Six months ended June 30, 2015

Net cash from operating activities increased by $379 million to $713 million during the six months ended June 30, 2015, compared to the same period in 2014. The increase was primarily due to the following:

 

    changes in accounts receivable balances, due to improved collections in 2015,

 

    changes in regulatory accounts, primarily due to the retail settlement and external revenue variance accounts,

 

    lower pension plan contributions compared to last year, as contributions are being made evenly over the year in 2015, compared to 2014, when payments were made in advance in the beginning of the year, and

 

    higher net income before taxes and depreciation; partially offset by

 

    changes in accrual balances, mainly related to timing and higher activity of capital projects.

Financing Activities

Short-term liquidity is provided through funds from operations, the Company’s commercial paper program, and the Company’s revolving credit facility.

Under the commercial paper program, Hydro One is authorized to issue up to $1 billion in short-term notes with a term to maturity of less than 365 days. The commercial paper program is supported by a $1.5 billion committed revolving credit facility with a syndicate of banks, which matures in June 2020. The short-term liquidity under this program and anticipated levels of funds from operations are expected to be sufficient to fund the Company’s normal operating requirements.

At June 30, 2015, Hydro One had $9,289 million in long-term debt outstanding, including the current portion. The Company’s notes and debentures mature between 2015 and 2064. Long-term financing is primarily provided by Hydro One’s medium-term note program (“MTN Program”). The maximum authorized principal amount of medium-term notes issuable under this program is $3 billion. At June 30, 2015, $837 million remained available until October 2015. The Company plans to file a base shelf prospectus to renew its MTN Program for another 25 months by the end of 2015.

Hydro One relies on debt financing through its MTN Program and commercial paper program to repay its existing indebtedness and fund a portion of its capital expenditures. The credit ratings assigned to Hydro One’s debt securities by external rating agencies are important to the Company’s ability to raise low-cost capital and funding to support its business operations. Maintaining strong credit ratings allows Hydro One to access capital markets on competitive terms. A material downgrade of the Company’s credit ratings would likely increase its cost of funding significantly, and its ability to access funding and capital through the capital markets could be reduced.

At June 30, 2015, Hydro One’s corporate credit ratings from approved rating organizations were as follows:

 

     Rating (at June 30, 2015)

Rating Agency

   Short-term Debt    Long-term Debt

DBRS Limited

   R-1 (middle)    A (high)

Moody’s(1)

   Prime-1    A1

S&P(2)

   A-1    A

 

(1) On April 17, 2015, Moody’s revised their outlook on Hydro One to negative from stable.

 

(2) On April 20, 2015, S&P downgraded the rating on Hydro One’s long-term debt to A from A+, and revised their outlook to stable from negative.

 

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Hydro One is subject to customary covenants normally associated with long-term debt. The Company’s long-term debt covenants limit its permissible debt as a percentage of its total capitalization, limit the Company’s ability to sell assets, and impose a negative pledge provision, subject to customary exceptions. The agreements also provide limitations that debt cannot exceed 75% of total capitalization and that third party debt issued by Hydro One’s subsidiaries cannot exceed 10% of the total book value of the Company’s assets. Hydro One was in compliance with all of these and other covenants and limitations as at June 30, 2015.

Three months ended June 30, 2015

During the three months ended June 30, 2015, Hydro One issued $350 million of long-term debt under its MTN Program, and assumed $16 million of debt as part of the Haldimand Hydro acquisition, compared to $453 million of long-term debt issued during the same period in 2014. No long-term debt matured or was repaid during the three months ended June 30, 2015 or 2014. The Haldimand Hydro debt was repaid in July 2015.

During the three months ended June 30, 2015, Hydro One paid dividends to the Province in the amount of $30 million, consisting of $25 million of common share dividends and $5 million of preferred share dividends, consistent with dividends paid to the Province during the same period in 2014.

Six months ended June 30, 2015

During the six months ended June 30, 2015, Hydro One issued $350 million of long-term debt under its MTN Program, and assumed $16 million of debt as part of the Haldimand Hydro acquisition, compared to $628 million of long-term debt issued during the same period in 2014. No long-term debt matured or was repaid during the six months ended June 30, 2015 or 2014. The Haldimand Hydro debt was repaid in July 2015.

During the six months ended June 30, 2015, Hydro One paid dividends to the Province in the amount of $59 million, consisting of $50 million of common share dividends and $9 million of preferred share dividends, compared to dividends of $229 million, consisting of $220 million of common share dividends and $9 million of preferred share dividends, paid to the Province during the same period in 2014.

Investing Activities

During the six months ended June 30, 2015, Hydro One continued to focus on making important investments in its transmission and distribution systems to address its aging power system infrastructure, improve system reliability and performance, and improve service to its customers. During the six months ended June 30, 2015, the Company made capital investments totalling $774 million and placed $531 million of new assets in-service, compared to $676 million of capital investments and $533 million of new assets placed in-service during the same period in 2014.

The Company’s current transmission sustainment programs include transformers, circuit breakers, switches, protection and control systems, wood poles, and other equipment replacements. Current transmission development projects include transmission system upgrades, local area supply projects, and inter-area network projects. These investments will expand and reinforce power reliability for electricity customers throughout the province, including the Company’s residential and industrial customers.

The Company’s current distribution sustainment programs include wood pole and meter replacements, emergency work for storm restoration, distribution station refurbishments and upgrades, and work related to joint-use and relocation of its distribution lines. Current development projects to expand and reinforce the Company’s distribution network include new customer connections and upgrades, system capability reinforcement projects, line transfers requested by customers, and connections to new generation facilities.

 

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The following table presents Hydro One’s capital investments by reportable segment during the three and six months ended June 30, 2015 and 2014:

 

     Three months ended June 30      Six months ended June 30  
     2015      2014      2015      2014  
     (millions of Canadian dollars)  

Transmission

     234         203         445         376   

Distribution

     192         175         324         298   

Other

     3         2         5         2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital investments

     429         380         774         676   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended June 30, 2015

 

Three months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change      % change  

Transmission

     234         203         31         15.3   

Distribution

     192         175         17         9.7   

Other

     3         2         1         50.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital investments

     429         380         49         12.9   
  

 

 

    

 

 

    

 

 

    

 

 

 

Transmission Capital Investments

The following table presents the main components of the Company’s transmission capital investments during the three months ended June 30, 2015 and 2014:

 

Three months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Sustainment

     193         167         26        15.6   

Development

     40         26         14        53.8   

Other

     1         10         (9     (90.0
  

 

 

    

 

 

    

 

 

   

 

 

 

Total transmission capital investments

     234         203         31        15.3   
  

 

 

    

 

 

    

 

 

   

 

 

 

Transmission Sustainment Capital Investments

During the three months ended June 30, 2015, Hydro One’s transmission sustainment capital investments were $193 million, compared to $167 million during the same period in 2014, an increase of $26 million or 15.6%. The increase was mainly due to the following:

 

    system re-investments, and end-of-life equipment replacement work at several transmission stations, including the Bruce, Richview, and Wiltshire Transmission Stations, as well as the completion of refurbishments of the Dunnville Transmission Station,

 

    increased volume of work related to station security upgrades to prevent unauthorized entry to stations and enhance safety, and increased cyber system replacements to adhere to NERC’s Cyber Security standards,

 

    increased work on overhead lines refurbishment and replacement projects and programs, and

 

    increased volume of transformer purchases for the Company’s station demand and spares program to ensure readiness for unplanned replacements; partially offset by

 

    decreased expenditures related to underground lines system replacements, as the end-of-life underground transmission cables between the Strachan Transformer Station and Riverside Junction, which were originally planned for a 2015 in-service date, were replaced earlier and put in-service in 2014.

 

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Transmission Development Capital Investments

During the three months ended June 30, 2015, Hydro One’s transmission capital investments to expand and reinforce its transmission system were $40 million, compared to $26 million during the same period in 2014, an increase of $14 million or 53.8%. The increase was mainly due to the following:

 

    the timing of work on some of the Company’s major inter-area network and local area supply projects, such as the Clarington transmission station and Guelph area transmission refurbishment projects; partially offset by

 

    decreased expenditures on generation customer connection related projects mainly due to the completion of the Barwick and Orleans transmission station projects to replace end-of-life equipment and ensure reliable supply to customers; and

 

    the completion of transmission station upgrades at the Allanburg transmission station in the Niagara area to enhance system reliability.

Distribution Capital Investments

The following table presents the main components of Hydro One’s distribution capital investments during the three months ended June 30, 2015 and 2014:

 

Three months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Sustainment

     123         96         27        28.1   

Development

     57         60         (3     (5.0

Other

     12         19         (7     (36.8
  

 

 

    

 

 

    

 

 

   

 

 

 

Total distribution capital investments

     192         175         17        9.7   
  

 

 

    

 

 

    

 

 

   

 

 

 

Distribution Sustainment Capital Investments

During the three months ended June 30, 2015, Hydro One’s distribution sustainment capital investments were $123 million, compared to $96 million during the same period in 2014, an increase of $27 million or 28.1%. The increase was mainly due to the following:

 

    increased work within the station refurbishment programs due to the timing of transformer purchases and more refurbishments accomplished during the second quarter of 2015,

 

    increased focus on capital lines work, mainly due to a higher volume of component replacements and the lines large sustainment initiatives program, which includes line relocations and voltage upgrades,

 

    the investment in a project to ensure continuity of smart meter and enhance network communications,

 

    increased volume of joint use and line relocations,

 

    higher volume of emergency equipment replacements caused by an increased number of trouble calls, and

 

    higher volume of end-of-life wood pole replacements; partially offset by

 

    the completion of iTron Sentinel 16S meter replacements in 2014.

Distribution Development Capital Investments

During the three months ended June 30, 2015, Hydro One’s distribution development capital investments were $57 million, compared to $60 million during the same period in 2014, a decrease of $3 million, or 5.0%. The decrease is mainly due to the following:

 

    the completion of the Company’s smart meter project in 2014,

 

    lower volume of distribution generation connection customer-driven work, and

 

    lower investments related to smart grid initiatives as the next phase is solidified, which will modernize the Company’s distribution system to enable remote capability for some functions; partially offset by

 

    investments in distribution system modifications to improve supply reliability and load capacity.

 

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Distribution Other Capital Investments

During the three months ended June 30, 2015, Hydro One’s distribution other capital investments were $12 million, compared to $19 million during the same period in 2014, a decrease of $7 million or 36.8%, due to investments in the Company’s payroll, human resources reporting, expense transformation and talent management systems nearing completion.

Six months ended June 30, 2015

 

Six months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change      % change  

Transmission

     445         376         69         18.4   

Distribution

     324         298         26         8.7   

Other

     5         2         3         150.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital investments

     774         676         98         14.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Transmission Capital Investments

The following table presents the main components of Hydro One’s transmission capital investments during the six months ended June 30, 2015 and 2014:

 

Six months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Sustainment

     362         290         72        24.8   

Development

     73         64         9        14.1   

Other

     10         22         (12     (54.5
  

 

 

    

 

 

    

 

 

   

 

 

 

Total transmission capital investments

     445         376         69        18.4   
  

 

 

    

 

 

    

 

 

   

 

 

 

Transmission Sustainment Capital Investments

During the six months ended June 30, 2015, Hydro One’s transmission sustainment capital investments were $362 million, compared to $290 million during the same period in 2014, an increase of $72 million or 24.8%. The increase was mainly due to the following:

 

    several system re-investments, including various end-of-life transformer replacements at the Wiltshire, Dunnville and Timmins transmission stations, the expedited work on 27 circuit breakers replacements at the Richview transmission station to address their deteriorated condition, breaker replacements at the Bruce transmission station to improve reliability and to meet the needs of Bruce Power. In addition, the Company placed in-service the refurbishments work at the Dunnville transmission station in Haldimand County and the transformer replacements at the Dymond transmission station in northeastern Ontario,

 

    increased volume of station component replacements related to addressing aging equipment as part of the new Station Centric Bundling methodology which addresses a number of capital requirements and enables savings in materials job planning and reduces outage requirements,

 

    the continued work on overhead lines refurbishment and replacement projects and programs, including investments to address the condition of the conductors on a circuit from the Chats Falls switching station to the Havelock transmission station in southeastern Ontario, as well as increased work on clearance corrections,

 

    increased volume of transformer purchases for the Company’s station demand and spares program,

 

    increased volume of work related to station security upgrades to prevent unauthorized entry to stations and enhance safety, and increased cyber system replacements to adhere to NERC’s Cyber Security standards, and

 

    a firewall replacement project which will ensure secure access to corporate applications from within the electronic security perimeters at the Company’s grid control centre and back-up centre; partially offset by

 

    decreased expenditures related to underground lines system replacements, as the end-of-life underground transmission cables between the Strachan transformer station and Riverside Junction, which were originally planned for a 2015 in-service date, were replaced and placed in-service in 2014; as well as the completion of refurbishment conductor work on a circuit from the Bannockburn Junction to the Havelock transmission station in the Peterborough area.

 

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Transmission Development Capital Investments

During the six months ended June 30, 2015, Hydro One’s transmission development capital investments to expand and reinforce its transmission system were $73 million, compared to $64 million during the same period in 2014, an increase of $9 million or 14.1%. The increase was mainly due to the following:

 

    increased expenditures related to the timing of work on some of the Company’s major local area supply and inter-area network projects, such as the Clarington transmission station and Guelph Area transmission refurbishment projects; partially offset by

 

    the completion of end-of-life equipment replacements at the Barwick transmission station to meet the needs of transmission customers and ensure reliable supply; and

 

    the completion of transmission station upgrades at the Allanburg transmission station in the Niagara area to enhance system reliability and allow for the incorporation of new generation in the area, including both transmission and distribution connected renewable generation.

Transmission Other Capital Investments

During the six months ended June 30, 2015, Hydro One’s transmission other capital investments were $10 million, compared to $22 million during the same period in 2014, a decrease of $12 million or 54.5%, due to investments in the Company’s payroll, human resources reporting, expense transformation and talent management systems nearing completion.

Distribution Capital Investments

The following table presents the main components of Hydro One’s distribution capital investments during the six months ended June 30, 2015 and 2014:

 

Six months ended June 30 (millions of Canadian dollars)

   2015      2014      $ change     % change  

Sustainment

     193         154         39        25.3   

Development

     101         109         (8     (7.3

Other

     30         35         (5     (14.3
  

 

 

    

 

 

    

 

 

   

 

 

 

Total distribution capital investments

     324         298         26        8.7   
  

 

 

    

 

 

    

 

 

   

 

 

 

Distribution Sustainment Capital Investments

During the six months ended June 30, 2015, Hydro One’s distribution sustainment capital investments were $193 million, compared to $154 million during the same period in 2014, an increase of $39 million or 25.3%. The increase was mainly due to the following:

 

    increased work within the station refurbishment programs due to more refurbishments accomplished and timing of transformer purchases,

 

    increased focus on capital lines work, primarily related to the large and small sustainment initiatives programs and higher volume of component replacements,

 

    higher volume of end-of-life wood pole replacements, and

 

    increased focus on investment in a project to ensure continuity of smart meter and enhance network communications; partially offset by

 

    the completion of iTron Sentinel 16S meter replacements in 2014.

Distribution Development Capital Investments

During the six months ended June 30, 2015, Hydro One’s distribution development capital investments were $101 million, compared to $109 million during the same period in 2014, a decrease of $8 million, or 7.3%. The decrease is mainly due to the following:

 

    the completion of the Company’s smart meter project in 2014,

 

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    lower volume of distribution generation connection customer-driven work, and

 

    lower expenditures related to smart grid initiatives; partially offset by

 

    investments in distribution system modifications to improve supply reliability and load capacity.

Distribution Other Capital Investments

During the six months ended June 30, 2015, Hydro One’s distribution other capital investments were $30 million, compared to $35 million during the same period in 2014, a decrease of $5 million or 14.3%, due to investments in the Company’s payroll, human resources reporting, expense transformation and talent management systems nearing completion.

Major Transmission Projects

The following table summarizes Hydro One’s major transmission projects in process during the six months ended June 30, 2015:

 

Project Name

 

Location

 

Type

 

Anticipated
In-Service
Date

 

Estimated
Cost

 

Capital Cost

To-Date

 

Status

Toronto Midtown Transmission Reinforcement

 

Toronto

Southwestern Ontario

  New transmission line   2016   $115 million   $88 million   Project is in progress

Guelph Area Transmission Refurbishment

 

Guelph area

Southwestern Ontario

  Transmission line upgrade   2016   $103 million   $45 million   Project is in progress

Manby Transmission Station

 

Toronto

Southwestern Ontario

  Transmission station upgrade   2016   $24 million   $19 million   Project is in progress

Clarington Transmission Station

 

Oshawa area

Eastern GTA

  New transmission station   2018/2019   $297 million   $68 million   Project is in progress

Supply to Essex County Transmission Reinforcement

 

Windsor-Essex area

Southwestern Ontario

  New transmission line and station   2018   To be determined     Ontario Energy Board decision for Phase 1 received in July 2015.

Northwest Bulk Transmission Line

 

Thunder Bay

Northwestern Ontario

  New transmission line   As early as 2020   To be determined     Development work is in progress.

Off-Balance Sheet Arrangements

There are no off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

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Summary of Contractual Obligations and Other Commercial Commitments

The following table presents a summary of Hydro One’s debt and other major contractual obligations, as well as other major commercial commitments:

 

June 30, 2015 (millions of Canadian dollars)

   Total      Less than
1 year
     1-3 years      3-5 years      More than
5 years
 

Contractual obligations (due by year)

              

Long-term debt – principal repayments(1)

     9,289         1,016         650         1,628         5,995   

Long-term debt – interest payments(1)

     7,581         416         758         675         5,732   

Pension(2)

     272         173         99                   

Environmental and asset retirement obligations(3)

     275         27         73         66         109   

Outsourcing agreements(4)

     583         158         264         149         12   

Operating lease commitments

     46         9         19         11         7   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

     18,046         1,799         1,863         2,529         11,855   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other commercial commitments (by year of expiry)

              

Bank line(5)

     1,500                         1,500           

Letters of credit(6)

     131         131                           

Guarantees(6)

     348         348                           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total other commercial commitments

     1,979         479                 1,500           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The “long-term debt – principal repayments” amounts are not charged to the Company’s results of operations, but are reflected on the Company’s Consolidated Balance Sheets and Consolidated Statements of Cash Flows. Interest associated with the long-term debt is recorded in financing charges on the Company’s Consolidated Statements of Operations and Comprehensive Income or as a cost of capital programs.

 

(2) Contributions to the Hydro One Pension Fund are generally made one month in arrears. The 2015 and 2016 minimum pension contributions are based on an actuarial valuation as at December 31, 2013. Minimum pension contributions beyond 2016 will be based on an actuarial valuation effective no later than December 31, 2016, and will depend on future investment returns, changes in benefits, or actuarial assumptions. Pension contributions beyond 2016 are not estimable at this time.

 

(3) Hydro One records a liability for the estimated future expenditures associated with the removal and destruction of PCB-contaminated insulating oils and related electrical equipment, and for the assessment and remediation of chemically-contaminated lands owned by the Company. Hydro One also records a liability for asset retirement obligations associated with the removal and disposal of asbestos-containing materials installed in some of its facilities. The forecasted expenditure pattern reflects the company’s planned work programs for the periods.

 

(4) In 2014, Hydro One has finalized a new outsourcing agreement with Inergi LP (Inergi) for the provision of certain services, as well as a facilities outsourcing agreement with Brookfield Johnson Controls Canada LP (Brookfield). The contractual amounts disclosed include an estimated contractual annual inflation adjustment in the range of 1.9% to 2.1%. Payments in respect of the Company’s outsourcing agreements are recorded in operation, maintenance and administration costs on the Company’s Consolidated Statements of Operations and Comprehensive Income or as a cost of capital programs.

 

(5) In support of Hydro One’s liquidity requirements, the Company had a $1,500 million revolving standby credit facility with a syndicate of banks. On June 1, 2015, the Company extended the maturity date of the revolving standby credit facility from June 2019 to June 2020. No amount was drawn on this facility as at June 30, 2015.

 

(6) Hydro One currently has outstanding bank letters of credit of $126 million relating to retirement compensation arrangements. These letters of credit have been issued to provide security for the Company’s liability under the terms of a trust fund established pursuant to the supplementary pension plan for eligible employees of Hydro One. The supplementary pension plan trustee is required to draw upon these letters of credit if Hydro One is in default of its obligations under the terms of this plan. The Company also provides prudential support to the IESO in the form of letters of credit, the amount of which is calculated based on forecasted monthly power consumption. At June 30, 2015, Hydro One has provided a letter of credit to the IESO in the amount of $5 million to meet the Company’s current prudential requirement. Hydro One has also provided prudential support to the IESO on behalf of its subsidiaries as required by the IESO’s Market Rules, using parental guarantees of $347 million, and on behalf of a distributor using total guarantees of $1 million.

 

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Summary of Annual Results

 

Consolidated Statements of Operations and Comprehensive Income

   Year ended December 31  
     2014      2013      2012  
     (millions of Canadian dollars,
except per share amounts)
 

Total revenue

     6,548         6,074         5,728   

Net income attributable to Shareholder of Hydro One

     749         803         745   

Earnings per common share (Canadian dollars)

     7,319         7,850         7,280   

Dividends per common share (Canadian dollars)

     2,696         2,000         3,523   

Dividends per preferred share (Canadian dollars)

     1.375         1.375         1.375   
  

 

 

    

 

 

    

 

 

 

 

 

Consolidated Balance Sheets

   At December 31  
     2014      2013      2012  
     (millions of Canadian dollars)  

Total assets

     22,550         21,625         20,811   

Total long-term debt

     8,925         9,057         8,479   

Preferred shares

     323         323         323   

Net assets

     7,947         7,415         6,830   
  

 

 

    

 

 

    

 

 

 

During 2014, the Company earned net income of $749 million and revenues of $6,548 million. The Company made capital investments totalling $1,530 million to improve its transmission and distribution systems’ reliability and performance, address its aging power system infrastructure, facilitate new generation, and improve service to its customers.

In August 2014, Hydro One completed the acquisition of Norfolk Power, an electricity distribution and telecom company located in southwestern Ontario. Hydro One has been an electricity distributor in Norfolk County for decades, serving approximately 14,000 Norfolk County customers. The acquisition of Norfolk Power enables the Company to extend its service to the entire Norfolk County and a further 18,000 distribution customers. Hydro One is committed to delivering cost-effective service for Norfolk Power’s customers and it remains focused on prudent management, efficient operations and improving the customer experience for everyone it serves. In 2014, the Company also signed agreements to purchase two more local distribution companies: Woodstock Hydro and Haldimand Hydro.

In addition, the Company completed a partnership transaction with the Saugeen Ojibway Nation, where the Saugeen Ojibway Nation acquired a noncontrolling equity interest in a new limited partnership, B2M Limited Partnership.

Performance Measures and Targets

The Company targets and measures its performance by using a balanced scorecard approach. Key performance drivers are closely monitored throughout the year to ensure that Hydro One maintains a focus on its strategic objectives and take mitigating actions as required. In 2014, the Company met or exceeded eight of 14 performance measure targets. Overall, the Company is making progress towards achieving many of the Company’s strategic goals.

Injury-free Workplace

The safety of Hydro One’s employees is paramount. For 2014, the Company used the measure of all work-related injuries or illnesses as the performance measure for this strategic objective. A “recordable” injury/illness is one of the following: medical attention (treatment beyond first aid); modified work (restricted duties); lost time; or death. For 2014, the Board of Directors set the target at 1.9 recordable injuries per 200,000 hours worked for this measure. The Company exceeded this target.

 

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Satisfying Hydro One’s Customers

In 2014, the Company approached the objective of customer satisfaction by addressing five measures related to improving customer relations. These measures relate to transmission and distribution customer satisfaction, and connection of new services, as well as estimated bills and no bill volume, as part of the Company’s customer service recovery project. The Company customer service recovery project was a result of billing issues it encountered due to the implementation in May 2013 of its new customer information system.

 

    Customer Satisfaction – Transmission

This measure is to determine the degree to which the Company’s transmission customers are satisfied with the service they receive from the Company. It is based on survey results of customer surveys conducted on the Company’s behalf by independent third parties. The survey is given to three major groups of transmission customers. In 2014, the Company targeted a transmission customer satisfaction rate of 84%. The Company did not meet this target, achieving 77%.

 

    Customer Satisfaction – Distribution

Similar to the transmission customers, the Company surveys its distribution customers to assess the degree to which they are satisfied with the service they receive from the Company. The results arise from surveys conducted on the Company’s behalf by independent third parties. This measure reflects the overall satisfaction levels of three major distribution customer segments, based on transaction satisfaction levels, annual satisfaction surveys and the meeting of Ontario Energy Board milestones, respectively, for the three segments. For 2014, the Company set a target for distribution customer satisfaction at 87%, and did well on the transactional elements, but did not meet this target on an overall basis, achieving 85%.

 

    Connection of New Customers

This measure relates to distribution low-voltage connections that is reported annually to the Ontario Energy Board. It addresses the Company’s customers’ needs for a specific and timely connection date and assesses its efficiency in connecting new customers. It measures the percentage of connections for a requested new service (< 750 volts). The connection must be completed within five business days from the day on which all applicable service conditions are satisfied, or at a later date agreed upon by the customer and the Company. Hydro One set a 2014 target of 90%, which it exceeded, by achieving 97%.

 

    Unscheduled Estimated Bills

With respect to this measure, Hydro One seeks to track its ability to provide accurate bills to customers. The Company tracks the percentage of total customers that have received unscheduled estimates in any billing period. The Company established a target of 1.8% of all bills for this measure. The Company exceeded the target, with only 1.2% of customers receiving unscheduled bills.

 

    No Bill Volume

No bill volume is a customer service measure related to the Company’s ability to provide timely bills to customers. This measure tracks the number of customers who have not received a bill in three consecutive billing periods. The Company’s expectation was to have fewer than 8,000 no-bill customers by September 2014, and sustain this level beyond that date. The Company exceeded this target with only 2,600 no-bill customers.

 

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Continuous Improvement and Cost-effectiveness

As part of the Company’s strategic objectives to increase productivity through efficiency improvements and effective management of costs, the Company measures transmission unit cost and distribution unit cost and sets targets for those costs. Regarding the maintenance and reliability of the transmission and distribution systems, the Company continues to build and retain public confidence and trust in the Company’s operations. In 2014, the Company continued its focus on this strategic priority by investing in the key assets of the electricity delivery system and by operating the existing system for customers in a safe, reliable and efficient fashion. The Company is conscious that commercial customers of all sizes require reliable service to allow them to deliver their products and services and that customers’ expectations are for a reasonably limited duration when interruptions occur. Transmission and distribution reliability is measured through the duration of customer interruptions.

 

    Transmission Unit Costs

For 2014, the transmission unit cost measure shows the transmission business cost-effectiveness by comparing the ratio of operation, maintenance and administration spending to gross fixed asset costs, using benchmarking initiatives. The Company set a target of 2.9% for 2014, and exceeded the target, with a 2.7% ratio.

 

    Distribution Unit Costs

Similar to transmission unit cost, the distribution unit cost measure demonstrates the distribution cost-effectiveness by comparing the ratio of operation, maintenance and administration spending to gross fixed asset costs, using benchmarking initiatives. For 2014, the Company set a target of 5.7%, but did not meet this target, with a 6.1% ratio.

 

    Customer Interruption Duration – Transmission

This measure monitors the reliability of the transmission system by tracking the average length of unplanned interruptions (in minutes) to multiple-circuit supplied delivery points. The Company has set a target of 8.9 minutes per delivery point for 2014. During 2014, the Company was aware that it would miss the target, which was not indicative of degrading reliability, but rather a result of refurbishing aging assets. In doing so, this resulted in occasions where load with a multiple-circuit supply was placed on single supply to accommodate the work program. This exposed the system to interruptions if there was a loss of the single supply. The Company determined that it was important to continue with the maintenance program even if this would result in missing the target. The Company, in fact, did not meet this target, with actual performance at 11.8 minutes per delivery point.

 

    Customer Interruption Duration – Distribution

This measure is an indicator of the distribution system reliability that expresses the average length of outages in hours that a customer can expect to experience in the year. This measure excludes force majeure events and loss of supply events (events caused by the transmission system or other distributors). The Company set a target of 6.7 hours per customer for this measure. In 2014, there were numerous storm events which were not considered force majeure events and comparatively more equipment outages that resulted in higher than normal customer interruptions. In the circumstances, the Company did not meet this target, with actual outage duration of 7.4 hours per customer.

Maintaining a Commercial Culture

 

    Net Income

Achievement of strong financial performance is measured by a performance measure of targeted level of net income after tax. The Company’s target was $668 million net income after tax for 2014, and the Company exceeded the target, with net income after tax of $749 million.

 

    Customer Service Recovery Cost

As a result of billing issues that arose from the implementation of the Company’s customer information system in 2013, the effects of which became acute in early 2014, the Company established the customer service recovery project to dedicate staff to resolve outstanding and any new billing issues and stabilize the billing system. The Company anticipated, and fixed as a target, costs of $48 million (including revenue impacts) for this project. The project was completed in 2014 and the customer information system is now in

 

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sustainment mode. As the costs of the customer service recovery project exceeded the target, the Company did not meet this anticipated target, with actual costs of $88.3 million.

 

    In-Service Capital – Transmission

This new measure for 2014 evaluates how the Company is meeting the Ontario Energy Board targets for in-service capital. For the transmission business, the 2014 target of 85% of in-service capital to the Company’s business plan is based on historical performance, its increasing capital work program, and the additional variability caused by external commitments and required approvals. The Company’s 2014 result shows that the Company exceeded the target, with 99% of in-service capital.

 

    In-Service Capital – Distribution

For the distribution business, the Company set the 2014 target of 87% of in-service capital to the Company’s business plan based on historical performance, with adjustments to reflect that its distribution business has more storm-related capital spending than its transmission business, as well as the performance of the Company’s smart meter and distributed generation capital work programs. The Company’s 2014 result was better than the target, with 97% of in-service capital.

B2M Limited Partnership

In 2012, Hydro One entered into an agreement with the Saugeen Ojibway Nation, where a noncontrolling equity interest in B2M Limited Partnership was made available for purchase at fair value by the Saugeen Ojibway Nation. B2M Limited Partnership was formed by Hydro One in 2013 to hold certain assets relating to the Bruce-to-Milton transmission line and a licence to use the related land. Hydro One maintains and operates the Bruce-to-Milton line. In November 2013, the Ontario Energy Board issued a Decision and Order granting B2M Limited Partnership a transmission licence and granting Hydro One leave to sell the relevant Bruce-to-Milton line transmission assets to B2M Limited Partnership.

On December 16, 2014, the relevant Bruce-to-Milton line transmission assets totalling $526 million were transferred from Hydro One to B2M Limited Partnership. This was financed by 60% debt ($316 million) and 40% equity ($210 million). On December 17, 2014, the Saugeen Ojibway Nation acquired a 34.2% equity interest in B2M Limited Partnership for consideration of $72 million, representing the fair value of the equity interest acquired.

Norfolk Power Acquisition

On August 29, 2014, the Company completed the acquisition of the outstanding shares of Norfolk Power from The Corporation of Norfolk County. Norfolk Power is a holding company that owns Norfolk Power Distribution Inc. (“NPDI”), a local electricity distribution company, and Norfolk Energy Inc., a non-rate regulated energy services company, located in southwestern Ontario. The selection of Hydro One as successful bidder followed a comprehensive, competitive sales process initiated by Norfolk Power.

The total purchase price for Norfolk Power, net of the long-term debt assumed and adjusted for preliminary working capital and other closing adjustments, was approximately $68 million. The determination of the fair values of assets acquired and liabilities assumed has been based upon management’s estimates and certain assumptions with respect to the fair values of the assets acquired and liabilities assumed. Hydro One determined the preliminary purchase price adjustments based on agreed working capital and other balances at the acquisition date. The resulting preliminary goodwill of approximately $40 million arising from the Norfolk Power acquisition consists largely of the synergies and economies of scale expected from combining the operations of Hydro One and Norfolk Power. The purchase price was finalized during the three months ended March 31, 2015 with no adjustments to the preliminary purchase price allocation as disclosed at December 31, 2014. Norfolk Power contributed revenues of $18 million and net income of less than $1 million for the year ended December 31, 2014.

Woodstock Hydro Acquisition

On May 21, 2014, Hydro One entered into an agreement with the City of Woodstock to acquire 100% of the common shares of Woodstock Hydro for approximately $29 million, subject to final closing adjustments. Woodstock Hydro is an urban electricity distribution company located in southwestern Ontario. The transaction is the result of extensive discussions between Hydro One and the City of Woodstock which involved consideration of economic

 

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development opportunities and other benefits resulting from the sale of Woodstock Hydro. On July 9, 2014, Hydro One filed a Mergers Acquisitions Amalgamations and Divestitures application with the Ontario Energy Board for the approval of the acquisition of Woodstock Hydro. Ontario Energy Board approval of the Woodstock Hydro acquisition was received on September 11, 2015 and closing of the acquisition is anticipated later in 2015.

Outsourcing Agreements

On November 28, 2014, the Company entered into an agreement with Inergi LP (“Inergi”), an affiliate of Capgemini Canada Inc., for back office and information technology outsourcing services for a term of 58 months, from March 1, 2015 to December 31, 2019. Under the agreement, Inergi will provide Hydro One with payroll, pay operations, information technology and accounting services. Coincident with the conclusion of negotiations on the Inergi agreement, Hydro One reached agreement with Inergi to provide it with call centre operations outsourcing services for a fixed period of three years beginning March 1, 2015 to February 28, 2018.

In September 2014, the Company entered into an agreement with Brookfield Johnson Controls Canada LP (“Brookfield”) for facilities management services for a term of ten years, from January 1, 2015 to December 31, 2024, with the option to renew for an additional term of three years. The Brookfield agreement has a value of up to approximately $658 million over the ten-year term of the agreement, including the facilities management portion of the contract, plus a variable amount of capital work depending on the needs that may arise as determined by Hydro One, with no minimum capital work guarantee.

See “Liquidity and Capital Resources – Summary of Contractual Obligations and Other Commercial Commitments” in this MD&A.

Results of Operations – Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

 

Year ended December 31 (millions of Canadian dollars)

   2014     2013      $ change     % change  

Revenues

     6,548        6,074         474        7.8   

Purchased power

     3,419        3,020         399        13.2   

Operation, maintenance and administration

     1,192        1,106         86        7.8   

Depreciation and amortization

     722        676         46        6.8   
  

 

 

   

 

 

    

 

 

   

 

 

 
     5,333        4,802         531        11.1   

Income before financing charges and provision for PILs

     1,215        1,272         (57     (4.5

Financing charges

     379        360         19        5.3   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income before provision for PILs

     836        912         (76     (8.3

Provision for PILs

     89        109         (20     (18.3
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

     747        803         (56     (7.0
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss) attributable to noncontrolling interest

     (2             (2     (100.0
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income attributable to Shareholder of Hydro One

     749        803         (54     (6.7
  

 

 

   

 

 

    

 

 

   

 

 

 

Net Income

The Company’s 2014 net income attributable to the Shareholder of Hydro One decreased by $54 million, or 6.7%, to $749 million, compared to 2013. The decrease is primarily due to the following:

 

    $70 million increase in the Company’s 2014 distribution operation, maintenance and administration costs, mainly due to its customer service recovery initiatives and the increase in its bad debt expense, resulting from higher electricity consumption due to a substantially colder than normal winter, combined with higher electricity prices and the suspension of certain collection tools and efforts during several months in 2014, and

 

    $46 million increase in the Company’s 2014 depreciation and amortization costs, mainly due to higher property, plant and equipment depreciation expense in 2014, related to the growth in capital assets as it continues to place new assets in-service, consistent with its ongoing capital work program; partially offset by

 

    $59 million increase in its 2014 transmission revenues, mainly due to new Ontario Energy Board-approved 2014 transmission rates.

 

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Revenues

 

Year ended December 31 (millions of Canadian dollars)

   2014      2013      $ change     % change  

Transmission

     1,588         1,529         59        3.9   

Distribution

     4,903         4,484         419        9.3   

Other

     57         61         (4     (6.6
  

 

 

    

 

 

    

 

 

   

 

 

 
     6,548         6,074         474        7.8   
  

 

 

    

 

 

    

 

 

   

 

 

 

Average annual Ontario 60-minute peak demand (MW)(1)

     20,596         21,493         (897     (4.2
  

 

 

    

 

 

    

 

 

   

 

 

 

Distribution – units distributed to Hydro One customers (TWh)(1)

     29.8         29.8                  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) System-related statistics are preliminary.

Transmission

The Company’s 2014 transmission revenues increased by $59 million, or 3.9%, compared to 2013. The components of the increase include the following:

 

    $90 million increase due to new transmission rates effective January 1, 2014 approved by the Ontario Energy Board in January 2014, and

 

    $42 million increase due to the Ontario Energy Board’s approval of increased export service revenues in recognition of higher electricity exports to other jurisdictions and the disposition of certain Ontario Energy Board-approved transmission regulatory accounts; partially offset by

 

    $45 million decrease due to lower average Ontario 60-minute peak demand in 2014. The lower electricity demand in 2014 was mainly due to milder weather in the summer and fall of 2014, compared to 2013, and

 

    $28 million decrease due to ancillary transmission revenues, primarily associated with Ontario Energy Board-approved regulatory accounts.

Distribution

The Company’s 2014 distribution revenues increased by $419 million, or 9.3%, compared to 2013. The components of the increase include the following:

 

    $399 million increase due to the recovery of higher purchased power costs, as described below under “Purchased Power Costs”,

 

    $12 million increase due to new distribution rates effective January 1, 2014 approved by the Ontario Energy Board in December 2013, and

 

    $8 million increase due to ancillary distribution revenues, primarily associated with Ontario Energy Board-approved regulatory accounts.

Purchased Power Costs

The Company’s purchased power costs increased by $399 million, or 13.2%, in 2014, compared to 2013. The components of the increase include the following:

 

    $291 million increase resulting from higher purchased power costs for customers who are not eligible for the Regulated Price Plan,

 

    $78 million increase resulting from the impact of changes in the Ontario Energy Board’s Regulated Price Plan rates for residential and other eligible customers,

 

    $26 million increase resulting from the Ontario Energy Board transmission rate decision effective January 1, 2014,

 

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    $10 million increase due to wholesale market service charges levied by the IESO, and

 

    $4 million increase resulting from the IESO’s smart metering entity charge effective May 1, 2013; partially offset by

 

    $10 million decrease due to lower energy consumption in 2014, mainly resulting from a milder summer and a warmer fall in 2014.

Operation, Maintenance and Administration Costs

 

Year ended December 31 (millions of Canadian dollars)

   2014      2013      $ change     % change  

Transmission

     394         375         19        5.1   

Distribution

     742         672         70        10.4   

Other

     56         59         (3     (5.1
  

 

 

    

 

 

    

 

 

   

 

 

 
     1,192         1,106         86        7.8   
  

 

 

    

 

 

    

 

 

   

 

 

 

Transmission

The Company’s 2014 transmission operation, maintenance and administration costs increased by $19 million, or 5.1%, compared to 2013. The components that contributed to the increase include the following:

 

    increased forestry expenditures related to brush control and line clearing on the Company’s transmission rights-of-way,

 

    higher volume of corrective and preventive maintenance on power equipment and overhead lines, and transmission site facilities maintenance requirements, and

 

    one-time reduction to Hydro One’s provision for payments in lieu of property taxes in 2013 related to transmission stations for the years 1999 to 2012, inclusive, following the finalization of the related regulations and receipt of a final assessment of its property tax returns; partially offset by

 

    lower expenditures due to the recovery of insurance proceeds for the 2013 floods at Hydro One’s Richview and Manby transmission stations, and

 

    increased attribution of overheads to capital project expenditures in 2014.

Distribution

The Company’s 2014 distribution operation, maintenance and administration costs increased by $70 million, or 10.4%, compared to 2013. The increase is mainly due to the following:

 

    the Company’s customer service recovery initiatives and the increase in its bad debt expense, resulting from higher electricity consumption due to a substantially colder than normal winter, combined with higher electricity prices and the suspension of certain collection tools and efforts during several months in 2014. The Company resumed some of its collection tools and efforts in September 2014. Hydro One Networks Inc.’s customer service recovery initiatives and related bad debt expense totalled $88 million in 2014.

The increase was partially offset by decreased expenditures in 2014 related to the CIS, as it was placed in-service in May 2013.

Depreciation and Amortization

The Company’s 2014 depreciation and amortization costs increased by $46 million, or 6.8%, compared to 2013. This increase was primarily attributable to higher property, plant and equipment depreciation expense in 2014, mainly related to the growth in capital assets as Hydro One continues to place new assets in-service, consistent with its ongoing capital work program.

 

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Financing Charges

The Company’s 2014 financing charges increased by $19 million, or 5.3%, compared to 2013. The increase is primarily due to the following:

 

    increase in interest expense on its long-term debt due to a higher average level of debt; partially offset by

 

    lower average interest rate.

Provision for PILs

The provision for PILs decreased by $20 million, or 18.3%, to $89 million in 2014, compared to 2013, primarily due to lower levels of pre-tax income in 2014 compared to 2013.

Quarterly Results of Operations

The following table sets forth unaudited quarterly information for each of the eight quarters, from the quarter ended March 31, 2013 through to December 31, 2014. This information has been derived from the Company’s unaudited interim consolidated financial statements and its audited annual consolidated financial statements.

 

    2014     2013  

Quarter ended

  Dec. 31     Sept. 30     Jun. 30     Mar. 31     Dec. 31     Sept. 30     Jun. 30     Mar. 31  
    (millions of Canadian dollars)  

Total revenue

    1,662        1,556        1,566        1,764        1,557        1,542        1,403        1,572   

Net income attributable to Shareholder of Hydro One

    221        173        115        240        160        218        168        257   

Net income to common Shareholder of Hydro One

    216        169        110        236        155        214        163        253   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Electricity demand generally follows normal weather-related variations, and consequently, the Company’s electricity-related revenues and profit, all other things being equal, would tend to be higher in the first and third quarters than in the second and fourth quarters.

Results of Operations – Three Months Ended December 31, 2014 Compared to Three Months Ended December 31, 2013

 

Three months ended December 31 (millions of Canadian dollars)

   2014     2013      $ change     % change  

Revenues

     1,662        1,557         105        6.7   

Purchased power

     893        794         99        12.5   

Operation, maintenance and administration

     247        286         (39     (13.6

Depreciation and amortization

     190        184         6        3.3   
  

 

 

   

 

 

    

 

 

   

 

 

 
     1,330        1,264         66        5.2   

Income before financing charges and provision for PILs

     332        293         39        13.3   

Financing charges

     98        93         5        5.4   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income before provision for PILs

     234        200         34        17.0   

Provision for PILs

     15        40         (25     (62.5
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

     219        160         59        36.9   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss) attributable to noncontrolling interest

     (2             (2     (100.0
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income attributable to Shareholder of Hydro One

     221        160         61        38.1   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net Income

Net income attributable to the Shareholder of Hydro One for the three months ended December 31, 2014 was $221 million, compared to $160 million during the same period in 2013, an increase of $61 million or 38.1%. The increase is mainly due to the following:

 

    decreased distribution operation, maintenance and administration costs, primarily due to lower storm response expenditures as a result of lower storm activity in 2014, compared to 2013, and decreased expenditures related to brush control and distribution line maintenance work,

 

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    decrease in the Company’s provision for PILs, primarily due to changes in net temporary differences, and

 

    increase in the Company’s 2014 transmission revenues, mainly due to new Ontario Energy Board-approved 2014 transmission rates.

Revenues

Hydro One’s total revenues for the three months ended December 31, 2014 were $1,662 million, compared to $1,557 million during the same period in 2013, an increase of $105 million or 6.7%. The increase is mainly due to the following:

 

    the recovery of higher purchased power costs,

 

    new transmission and distribution rates effective January 1, 2014, and

 

    the Ontario Energy Board’s approval of increased export service revenues in recognition of higher electricity exports to other jurisdictions and the disposition of certain Ontario Energy Board-approved transmission regulatory accounts; partially offset by

 

    lower average Ontario 60-minute peak demand and energy consumption in the fourth quarter of 2014, mainly due to milder weather in the fall of 2014, and

 

    lower ancillary revenues, primarily associated with Ontario Energy Board-approved regulatory accounts.

Purchased Power Costs

The Company’s purchased power costs for the three months ended December 31, 2014 were $893 million, compared to $794 million during the same period in 2013, an increase of $99 million or 12.5%. The increase is mainly due to the following:

 

    higher purchased power costs for customers who are not eligible for the Regulated Price Plan; and

 

    partially offset by lower energy consumption in the fourth quarter of 2014, mainly due to milder weather in the fall of 2014,

 

    wholesale market service charges levied by the IESO, and

 

    Ontario Energy Board transmission rate decision effective January 1, 2014.

Operation, Maintenance and Administration

The Company’s operation, maintenance and administration costs for the three months ended December 31, 2014 were $247 million, compared to $286 million during the same period in 2013, a decrease of $39 million or 13.6%. The decrease is mainly due to the following:

 

    decreased distribution operation, maintenance and administration costs, primarily due to lower storm response expenditures as a result of lower storm activity in 2014, compared to 2013, and

 

    decreased expenditures related to brush control and distribution line maintenance work.

Depreciation and Amortization

The Company’s depreciation and amortization costs for the three months ended December 31, 2014 were $190 million, compared to $184 million during the same period in 2013, an increase of $6 million or 3.3%. The increase is mainly due to higher property, plant and equipment depreciation expense in 2014, mainly related to the growth in capital assets as the Company continue to place new assets in-service, consistent with its ongoing capital work program.

Financing Charges

The Company’s financing charges for the three months ended December 31, 2014 were $98 million, compared to $93 million during the same period in 2013, an increase of $5 million or 5.4%. The increase is mainly due to the following:

 

    increase in interest expense on its long-term debt due to a higher average level of debt; partially offset by

 

    lower average interest rates.

 

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Provision for PILs

Hydro One’s provision for PILs for the three months ended December 31, 2014 was $15 million, compared to $40 million during the same period in 2013, a decrease of $25 million or 62.5%. The decrease is due to the following:

 

    changes in net temporary differences, such as capital cost allowance in excess of depreciation, deductions for pension payments made in excess of amounts expensed for accounting purposes, and interest deducted for tax purposes in excess of interest expensed for accounting purposes; partially offset by

 

    higher pre-tax income for the three months ended December 31, 2014 compared to the same period in 2013.

Results of Operations – Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

 

Year ended December 31 (millions of Canadian dollars)

   2013      2012      $ change     % change  

Revenues

     6,074         5,728         346        6.0   

Purchased power

     3,020         2,774         246        8.9   

Operation, maintenance and administration

     1,106         1,071         35        3.3   

Depreciation and amortization

     676         659         17        2.6   
  

 

 

    

 

 

    

 

 

   

 

 

 
     4,802         4,504         298        6.6   

Income before financing charges and provision for PILs

     1,272         1,224         48        3.9   

Financing charges

     360         358         2        0.6   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income before provision for PILs

     912         866         46        5.3   

Provision for PILs

     109         121         (12     (9.9
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income

     803         745         58        7.8   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) attributable to noncontrolling interest

                              
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income attributable to Shareholder of Hydro One

     803         745         58        7.8   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net Income

The Company’s 2013 net income increased by $58 million, or 7.8%, to $803 million, compared to 2012. The Company experienced higher distribution revenues in 2013 mainly reflecting increased purchased power costs, primarily related to the Ontario Energy Board’s Regulated Price Plan rate-setting process and the IESO’s spot market. It also experienced increased transmission revenues in 2013 reflecting a higher peak demand due to intermittent periods of hot weather in the summer of 2013, as well as extreme cold winter weather. The Company’s 2013 net income was also positively impacted by a lower provision for PILs and by a reduction to its provision for payments in lieu of transmission station property taxes, following the finalization of the assessment of certain prior years’ property tax returns. This reduction was partially offset by power restoration expenditures following several major storms in 2013.

Revenues

 

Year ended December 31 (millions of Canadian dollars)

   2013      2012      $ change     % change  

Transmission

     1,529         1,482         47        3.2   

Distribution

     4,484         4,184         300        7.2   

Other

     61         62         (1     (1.6
  

 

 

    

 

 

    

 

 

   

 

 

 
     6,074         5,728         346        6.0   
  

 

 

    

 

 

    

 

 

   

 

 

 

Average annual Ontario 60-minute peak demand (MW)(1)

     21,493         21,132         361        1.7   
  

 

 

    

 

 

    

 

 

   

 

 

 

Distribution – units distributed to Hydro One customers (TWh)(1)

     29.8         29.2         0.6        2.1   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) System-related statistics are preliminary.

Transmission

Hydro One’s 2013 transmission revenues were higher by $47 million, or 3.2%, compared to 2012. The average Ontario 60-minute peak demand was higher in 2013 compared to 2012, resulting in an increase in transmission

 

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revenues of $26 million, compared to 2012. The higher energy consumption in 2013 mainly resulted from a warmer summer and a colder winter, as compared to 2012. In addition, the Company experienced higher revenues of $21 million in 2013, associated with the Ontario Energy Board’s approval of export service revenues and ancillary services.

Distribution

The Company’s 2013 distribution revenues were higher by $300 million, or 7.2%, compared to 2012. The increase was primarily due to the recovery of higher purchased power costs of $246 million, as described below under “Purchased Power Costs.” In addition, energy consumption was higher by $29 million in 2013, mainly resulting from a warmer summer and a colder winter, as compared to 2012. Distribution revenues also increased by $15 million as a result of the Company’s placement in service of new smart grid and smart meter investments, which are currently being recovered through separate rate mechanisms.

In December 2012, the Ontario Energy Board approved new distribution rates effective January 1, 2013, based on its third generation incentive regulation mechanism process. As part of this decision, the Ontario Energy Board approved the Company’s application for an additional rate rider related to an incremental capital module adjustment to its rates, reflecting its placement in service of certain specific capital investments. This approval resulted in an increase in distribution revenues of $13 million, compared to 2012. In addition, the Ontario Energy Board’s incentive regulation mechanism decision resulted in higher distribution revenues of $10 million, which will support the maintenance and investment requirements of the Company’s distribution system and enable the safe and reliable delivery of electricity to its customers throughout Ontario. The 2013 distribution revenue increases were partially offset by lower 2013 ancillary distribution revenues of $13 million, primarily associated with Ontario Energy Board-approved regulatory accounts.

Purchased Power Costs

The Company’s 2013 purchased power costs increased by $246 million, or 8.9%, to $3,020 million, compared to 2012. The components of increase include the following:

 

    $104 million increase resulting from higher purchased power costs for customers who are not eligible for the Regulated Price Plan,

 

    $85 million increase resulting from the impact of changes in the Ontario Energy Board’s Regulated Price Plan rates for residential and other eligible customers,

 

    $44 million increase due to higher electricity demand, and

 

    $9 million increase resulting from the IESO’s smart metering entity charge effective May 1, 2013; partially offset by

 

    $4 million reduction in wholesale market service charges levied by the IESO.

Operation, Maintenance and Administration

 

Year ended December 31 (millions of Canadian dollars)

   2013      2012      $ change     % change  

Transmission

     375         402         (27     (6.7

Distribution

     672         608         64        10.5   

Other

     59         61         (2     (3.3
  

 

 

    

 

 

    

 

 

   

 

 

 
     1,106         1,071         35        3.3   
  

 

 

    

 

 

    

 

 

   

 

 

 

Transmission

The Company’s 2013 transmission operation, maintenance and administration costs decreased by $27 million, or 6.7%, to $375 million, compared to 2012. Within the Company’s work programs, it continued to invest in the safe and reliable operation of its transmission system.

Expenditures in support of the Company’s transmission system decreased by $33 million in 2013, compared to 2012, primarily due to a reduction to its provision for payments in lieu of property taxes related to transmission stations

 

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