Conditions for developing power projects in Canada are promising. The utilities' ratings are stable and positive, bank terms are flexible and interest rates lower than in the US. But while bigger developers can finance on balance sheet, those without this luxury are competing for deals with power income funds and for the attention of the capital markets. To top things off, Canada's provinces are actively encouraging development of clean energy as part of their attempts to meet the imbalance between demand and supply.

Canada's ten provinces boast reasonable diversity in terms of fuel type. While Ontario's power supply is made up of hydro, nuclear, coal and gas, Quebec and British Colombia rely predominantly on hydro, and Alberta has a supply mix of coal and natural gas. The markets are mainly utility-dominated, the biggest names being BC Hydro – currently bidding out 37 contracted projects – Hydro-Quebec and the Ontario Power Authority (OPA).

But in general, Canada's energy supply derives primarily from hydroelectric power. A study conducted by the Canadian Electricity Association reported that the breakdown for electricity generation by fuel source consists of nuclear (15%), thermal (26.1%) and hydro (58.9%). These percentages compared to the US breakdown – nuclear (19.9%), thermal (71.1%) and hydro (6.5%) – demonstrate a distinct divergence in resources between the neighbouring countries. Cross-border trade allows market participants to take advantage of this variance, and electricity from Canadian power sources is essential in serving peak demand in several US regional markets.

Canadian electricity and gas utilities have steadily been building up the financial resources necessary to make capacity additions. In this regard the consistency of regulatory decisions governing the operating environments of the utilities has been helpful. According to Laurie Conheady, an associate in Standard & Poor's corporate and infrastructure finance group in Toronto, there have been no recent downgrades, but instead some upgrades (British Columbia Hydro and Power Authority's outstanding debt and also Hydro One's corporate credit rating). The Canadian market may feel the effect of US volatility on occasion because of the intertwined nature of the US and Canada's transmission systems.

Despite these favourable conditions, supply has fallen short of rising demand in Canada, and the governments of several of its provinces have committed to promote investment decisions. Ontario, for example, will add 2,700MW of electricity to the grid by 2010, and British Colombia has a 50% clean energy goal over the next ten years.

In particular, wind energy appears to have a healthy future within Canada. On 4 May, the Quebec government announced an energy strategy for 2006-2015; this strategy includes 4,000MW of wind development, which would meet 10% of the province's demand. Projects developed by members of Canada's Wind Energy Association, and installed this year alone, represent C$503 million ($456 million) in investment. These include the Kettles Hill wind farm in Alberta (Kettles Hill Wind Energy), the Centennial wind power facility in Saskatchewan (Sask Power International), the St. Leon wind farm in Manitoba (Algonquin Power Income Fund), and the Kingsbridge (EPCOR) and Melancthon (Canadian Hydro Developer) projects in Ontario.

Developers sort through the options

One developer familiar with the market across the provinces is TransCanada. TransCanada's background is in transporting gas from Western Canada to the rest of the country and the US, but it is also a substantial power plant owner. TransCanada owns or has interests in over 6,700MW of power generation in both countries. Financing projects internally through the balance sheet is TransCanada's preferred method of financing projects, during the construction phase at least, according to Alex Pourbaix, executive vice-president of power at TransCanada.

In the past, TransCanada was much more active in the project finance market, especially for international projects. The decision was made in 1999 to sell off the entire international portfolio of assets in order to improve the company's financial profile. At the time TransCanada's balance sheet was overextended, and its debt to equity ratio was higher than desired. But TransCanada succeeded in raising roughly C$4 billion in equity and paid down the debt.

As a result, its balance sheet today is such that it does not need to rely as heavily on project financing. It has roughly C$2 billion in cashflow from operations per year, and from this C$0.6 billion goes towards commitments to equity, leaving the company with C$1.4 billion to play with for project development and acquisitions.

Another developer close to the market says that a project financing in Canada can use bonds with 10-20 year tenors and coupons in the 5-6% range, or roughly 150bp over the equivalent government security. Project financings are increasingly done through the private placement market rather than banks. There is strong appetite for project assets at institutional investors, for example through Canada's largest insurance companies. Insurance companies and pension funds tend to offer the longest terms for financing in Canada, the biggest names being SunLife, Manulife, AIG and Great-West Life.

Quebec and Alberta – living without hydro

The Quebec market is very attractive, yet not yet urgently in need of new capacity, But in 2004, Quebec was an importer of power during a dry year. Since then, the province's government has recognized the need for power contracts and offered two 1,000MW wind RFPs. "Quebec used to be in the enviable position of having a surplus of power, to such an extent that the power was sold outside of Quebec to the US. Now this surplus is moving towards a balance and Quebec is actively in need of power supply," says Pourbaix. The province has thousands of megawatts of hydro capacity that has not been in service for many years, and so new generation sources are being lined up to bridge the gap.

Such sources include TransCanada's 550MW Becancour cogeneration facility, which received government approval in 2004. The project will cost roughly C$500 million, and is being financed on TransCanda's balance sheet. The PPA for Becancour involves a tolling arrangement, and so the lion's share of the risk lies with offtaker Hydro Quebec. TransCanada will be responsible for transporting the gas, but will be reimbursed by Hydro-Quebec. The project was among those initiated in response to a government RFP for cogeneration power, and will supply steam to Norsk Hydro and Pioneer Chemicals.

Alberta, on the other hand, has been the beneficiary of a surge oil sands activity in its north-east. This activity, coupled with the rapidly growing population, Pourbaix believes, will result in a expanding power market. But Alberta's system differs to other provinces, since it is the only fully deregulated province with a majority of its utilities investor-owned and traded.

It was deregulated in the 90s, resulting in a system whereby the owners of a plant can retain ownership of a plant but all of its output must be sold under a PPA to new participants. Under this regime, TransCanada acquired rights to all of the output of the Sheerness 750MW coal-fired plant in Hanna, Alberta from the Alberta Balancing Pool for $585 million. TransCanada will buy the power until 2020. This, in addition to two previous PPA purchases in the province, gives TransCanada control of 17% of Alberta's output.

Ontario: A friend in need...

Ontario is the most markedly impoverished province in terms of power supply. The government of Ontario has committed to adding 2,700MW of renewable energy to Ontario's electricity system by 2010, which should make it easier to gain regulatory approvals and thus attract investors. The long-term PPAs available for renewable projects add to their financeability, with Ontario Power Authority as the offtaker.

OPA is government-formed utility that provides creditworthy equivalents to PPAs and encourages new generation capacity. In return it establishes fees to recover costs incurred from its customers. Currently OPA has a 20-year plan to boost the province's power needs; it estimates a C$20 billion need for investment in generation. OPA's credit means the projects are likely to have an AA local credit rating.

In 2005, TransCanada entered into a long-term agreement with OPA to restart nuclear reactor units 1 and 2 at the Bruce Power project, and also extend the operating life of unit 3 and replace the steam in unit 4. The units originally closed in the late 80s and early 90s, when they were operated by Ontario Hydro, which did not have the requisite staffing and resources to operate them. The Canadian Nuclear Safety Commission decided to focus its efforts on the best reactors instead. The 1 and 2 units were restarted in response to Ontario's acute generation supply shortfall – today nuclear power comprises 50% of Ontario's power supply and is promoted by the Energy Policy Act.

But no new nuclear plants have been built in Canada since 1986. The Canadian government however promotes nuclear investment through Atomic Energy of Canada and its CANDU (CANada Deuterium Uranium) technology. Ontario Power Generation (OPG) currently owns the Pickering and Darlington nuclear plants in the province. Despite its relatively low operating costs, the prevailing view amongst developers is that attracting project financing for nuclear power is difficult. Ontario Power Generation (OPG) has therefore financed development of nuclear projects through equity. Pourbaix however does not believe that this will always be the case. "At the moment it undoubtedly presents a significant challenge, but between gas and oil prices remaining at their recent highs and continuing concern over rising CO2 levels, nuclear power could gain traction."

OPG currently generates 70% of Ontario's electricity. The province's government, however, wants to encourage new interest from investors without selling any of its interest in OPG. So far the process has been slow, but is moving, since demand for power is so high that developer interest in the market is strong. OPG's most recent large project financing was for its Brighton Beach 580MW combined-cycle natural gas-fired plant in Windsor, Ontario. The $500 million club deal included Bank of Montreal and Bank of Tokyo-Mitsubishi as lead arrangers, as well as a number of insurance companies.

Ontario's government wants to close all coal plants in the province by 2009, and use natural gas to compensate. Ontario's coal plants comprise one quarter of its generating capacity and therefore several market participants believe that it is very unlikely that all of them will be closed. For example the 4,000MW Nanticoke coal plant in Lake Erie supplies stability to the grid and is therefore not likely to be retired, despite environmental concerns. The province would lose 6,000MW of power through a decision to stop coal-fired plants as well as part of its nuclear fleet. Since the price of natural gas is high, refurbishing the Bruce Power units probably represents a long-term, cheap alternative. OPG also recently invited bids to upgrade three hydroelectric stations on the Upper Mattagami River and one station on the Montreal River.

Toronto alone has roughly twice the population today that it had in the 1960s, but has not enjoyed a proportionate increase in capacity. Toronto desperately needs generation and Ontario's government has requested 250MW by summer 2008. TransCanada is planning to develop Portlands Energy Center, a 550MW natural gas-fired plant in Toronto, which would sell power to the OPA. The time-frame is very short; having a power plant up and running in time will present a challenge for the developer.

Funds of fury

In 2005, TransCanada sold its interest in its income fund Power LP to EPCOR. Power LP was created in 1997, one of the first income funds in Canada, when, according to Pourbaix, "TransCanada didn't enjoy the balance sheet it does today." TransCanada was highly levered and Power LP provided another financing option and a method of monetizing cash-flow for power assets. As big as Power LP was in terms of market capital (in excess of $1 billion), TransCanada owned 30% of the units, which represented less than 10% of equity megawatts controlled by TransCanada. In terms of impact on management time and also not having much material impact therefore, the sponsor decided that the best idea was to sell.

Power income funds are still very popular in Canada, notes Pourbaix, as well as being "potent competitors, especially in acquisition opportunities where the plants are backed by long-term contracts". The most attractive assets to these funds are those which display stable cash flow opportunities, normally underpinned by long PPAs.

Problems facing IPPs in Canada stem in one instance from permitting issues, says Evan Bahry of Canada's Independent Power Producer's Society of Alberta "Whereas generation can be discrete, transmission tends to be long-distance, causing transmission permitting issues".