(The following statement was released by the rating agency) Fitch Ratings-Sydney-July 16: Fitch Ratings has affirmed Australia-based CS Energy Limited's Long-Term and Short-Term Issuer Default Ratings at 'AA' and 'F1+', respectively. The Outlook is Positive. CS Energy's ratings reflect its strong linkage with the State of Queensland (AA/Positive); we view the company's standalone profile as being materially weaker than that of the state. The company is a Queensland merchant generator with a market share of about 36% in terms of electricity dispatched into the National Electricity Market (NEM). Queensland's electricity market has benefitted from a ramp-up of the liquefied natural gas (LNG) industry; however, we expect demand to moderate in the coming years. KEY RATING DRIVERS Strong State Linkages: CS Energy is fully owned by the state and we view the status, ownership and control linkages between the company and Queensland as very strong. The company operates as a commercial entity but the state appoints its board and senior management, and reviews CS Energy's annual business plan.
CS Energy's ratings are equalised with the state at 'AA' with a Positive Outlook under Fitch's Government-Related Entities Rating Criteria. This reflects the Queensland government's policy to rule out the lease or privatisation of its energy assets. The state does not explicitly guarantee CS Energy's obligations, but Fitch believes the links are sufficiently strong to warrant equalisation of CS Energy's ratings with those of the state. Strong Support Incentive: Should CS Energy default, the socio-political implications are evaluated as strong and the financial implications as very strong. A default could affect about 36% of the power supply in Queensland, though we would expect the government to take measures to ensure that energy supply is uninterrupted. We view a default as having significant implications as all funding is provided by the state. Improving Standalone Credit Profile: CS Energy has resolved several of its legacy issues, in particular the coal supply dispute for Callide Power Station. The company has also entered a retail joint venture with Alinta in south-east Queensland to supply electricity, providing CS Energy some exposure to downstream integration. However, its standalone credit quality is constrained by its limited equity in upstream fuel assets and downstream integration, as well as minimal generation-source and revenue diversification. On a positive note, the company hedges a proportion of its forward production to improve cash flow predictability. Ramp-up of Queensland's LNG Industry: The ramp-up of the LNG industry that caused a resurgence in Queensland's electricity demand is now largely complete. We expect continued demand in energy from gas processing and production facilities, which feed the state's LNG projects. However, this will be partially offset by falling electricity demand from lower energy-intensive manufacturing and residential sector consumption. Lower Market Prices: A hotter-than-usual summer and lower supply across the NEM led to a significant rise in electricity prices over the financial year ended June 2017 (FY17). However, the Queensland government has directed Stanwell Corporation Limited (AA/Positive), the state's largest electricity-generation company, to dispatch higher levels of generation into the NEM at a lower price to provide electricity price stability and put downward pressure on the wholesale electricity price in the state. Additional renewable energy supply should also contain prices. Regulatory Impact Limited: The Australia Competition and Consumer Commission recommended that the Queensland government split its two generators, CS Energy and Stanwell, into three equally sized separate companies to reduce concentration and increase competition. Fitch believes the likelihood of this being implemented is limited, as the state government is planning on creating a new 'CleanCo' for renewable generation, which will provide competition. Fitch has however not factored in the creation of a clean-energy generator, which could lead to a further increase in supply and lower prices, into our base case due to uncertainty over policy and timing. DERIVATION SUMMARY CS Energy is rated in line with Queensland due to its strong linkage with the state, which owns 100% of the company. The state also provides the company with its long- and short-term financial requirements. CS Energy's rating is in line with Stanwell, which is also fully owned by Queensland. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer - Funding support from Queensland Treasury Corporation (QTC) - 80% dividend payout ratio RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action - Any positive movement in Queensland's rating Developments That May, Individually or Collectively, Lead to Negative Rating Action - Any negative movement in Queensland's rating - Any weakening of CS Energy's linkages with Queensland For the rating on Queensland, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 30 August 2017 An upgrade could arise if Queensland continues to maintain strong fiscal discipline with positive current balances and moderate debt metrics in line with Fitch's expectations. Measures will include a projected net debt (adjusted for the surplus on the superannuation scheme) to current revenue ratio of around 60% by FYE20 and operating margins in the 5%-7% range. LIQUIDITY Full Funding Support from QTC: CS Energy has a sound liquidity profile with all its financial needs met entirely by QTC. The borrowings from QTC have no fixed repayment date and can only be called by QTC with 24 months' notice. Contact: Primary Analyst James Hollamby Associate Director +61 2 8256 0347 Fitch Australia Pty Ltd Level 15, 77 King Street, Sydney, NSW 2000 Secondary Analyst Leo Park Associate Director +61 2 8256 0323 Committee Chairperson Ying Wang Senior Director +86 21 6898 7980 Media Relations: Leslie Tan, Singapore, Tel: +6567967234, Email: leslie.tan@fitchratings.com. 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