OREANDA-NEWS. Fitch Ratings has affirmed independent power producer (IPP) Shanghai Electric Power Co., Ltd.'s (SEP) Long-Term Foreign-Currency Issuer Default Rating at 'BBB+'. The Outlook is Stable. Fitch has also affirmed SEP's senior unsecured rating and the rating of the USD500m 3.625% senior unsecured bonds issued by Shanghai Electric Power Finance Limited (SEP Finance) at 'BBB+'. SEP Finance is 100%-owned by SEP and the bonds are guaranteed by SEP.

SEP's ratings are credit-linked but not equalised with Fitch's internal credit assessment of its 60% parent - State Power Investment Corporation (SPI), one of China's five largest fully state-owned power generation groups. This is because SEP is one of SPI's most strategically important subsidiaries, and one of only three public power suppliers in Shanghai. The ratings also take into consideration the fragmented ownership of the SPI group's operations by its various subsidiaries - relative to the other four large state-controlled IPPs. SEP accounted for around 9% of SPI's installed capacity at end-2015.

KEY RATING DRIVERS

Core Asset of SPI: SEP is one of SPI's most important subsidiaries - it is SPI's only subsidiary operating in a Tier 1 city, and crucial to the energy security of Shanghai, China's financial and commercial centre. SPI could face reputational risk if SEP is not supported on a timely basis. SEP is also one of SPI's largest subsidiaries, with a 9.4 gigawatt (GW) installed capacity at end-2015, and a leader in thermal power technology among SPI's subsidiaries. SEP is SPI's largest onshore financing platform, and the headquarters of its eastern China operations. SEP has received tangible support from SPI, including asset injections, allocation of the central government's substantial fiscal subsidies, and low-cost internal financing from SPI.

Pillar IPP in Shanghai: SEP was formerly the Shanghai Municipal Power Company, and is the city's oldest IPP. It is now one of three public IPPs in the city, with roughly one-third of the city's power generation capacity. The three IPPs are crucial to Shanghai's power supply security because they account for about 60% of the electricity to the city. The Shanghai government has generally ensured their market positions are well-protected, although competition from renewable energy remains a risk.

Stable Core Generation Business: Power demand in Shanghai is stable due to the diverse economic activity in the city. Competition and overcapacity is also limited because there are only a small number of operators and the authorities strictly limit the addition of coal-fired power-generation capacity. In 2015, when China's overall thermal power utilisation dropped 9.5%, Shanghai's only fell 1%, which made it the second-best performer among China's 31 provinces and municipalities.

High-Quality Generation Assets: By end-2015, over 70% of SEP's coal-fired units were of 600 megawatt (MW) capacity and above, and the per unit coal consumption rate reduced to 284 grams per kilowatt hour (g/kWh), the lowest among all of SPI's subsidiaries and 10% lower than the national average. In addition, 100% of SEP's coal-fired units have completed both desulfurisation and denitration upgrades. Its emission rates of sulphur dioxide and nitrogen oxide are 70%-80% lower than the industry average. SEP should continue to benefit from its technology advancement and high environmental standards as China moves gradually towards a more liberalised power market.

Expansion Risks: SEP is increasingly active in investing in renewable energy and overseas power projects, as there is oversupply of power capacity in Shanghai and eastern China. SEP's investments in these two areas have been cautious and selective to-date; and risks associated with these projects have been mitigated by either guaranteed dispatch-or-return arrangements (for example, investments in Japan and Malta) or political risk insurance (Turkey project). Fitch expects business and operational risks to remain manageable as long as the company sticks to the cautious investment strategy and criteria, although capex will be high over the next three to four years.

'BB' Category Standalone Profile: SEP's standalone credit profile is constrained at the 'BB' category by its asset concentration, moderate credit metrics and forecast negative FCF that is due to its high capex programme. Fitch expects the geographic diversification to improve once its projects in western China and overseas are completed. Fitch forecasts negative FCF at CNY5bn to CNY8bn per year in the next four years after factoring in annual capex of around CNY10bn for the company's planned expansion, and FFO-adjusted net leverage to rise to 5.5x-6.5x (end-2015: 5.1x).

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for SEP include:

- Installed capacity to reach around 16GW by 2020, with renewable energy accounting for around 25% of total capacity and overseas projects accounting for around 20%

- Utilisation hour of coal-fired power plants to decline by 5% a year in 2016-2017 reflecting overcapacity in China's power sector

- Utilisation hours of SEP's wind and solar power plants in China to reach 1,800 hours and 1,300 hours respectively - the minimum levels that the government aims to ensure via a recently introduced policy to protect renewable energy operators

- Coal price to rebound gradually after 2016

- Annual capex around CNY10bn per year in 2016 to 2019.

RATING SENSITIVITIES

Positive: Developments that may, individually or collectively, lead to positive rating action include:

- An improvement in the credit profile of SPI, provided the linkages between SPI and SEP remain intact

- Strengthening of linkages between SEP and SPI group, although this is only likely if SEP accounts for a significantly higher share of SPI's assets and/or operations, which is not envisaged in the short to medium term

Negative: Developments that may, individually or collectively, lead to negative rating action include:

- Weakening of the credit profile of SPI

- Weakening of linkages between SPI and SEP