2019 Annual Report Energizing Life
Title goes here Contents 2019 Highlights 3 Message from Our Chair 6 Message from Our President and CEO 8 A Sustainable Future for All 10 Why Invest in Hydro One 11 Our New Corporate Strategy 12 Our Five Priorities 13 Corporate Governance 24 Financial Report 26
Title goes here The Power of Connection. Energizing Life. Hydro One energizes life for people and communities, helping Ontarians live a better and brighter future. Through our network of businesses, we are growing and evolving to meet the expectations of the shareholders, regulators, Indigenous peoples and customers we serve. 85.7% Residential & small business customer satisfaction $1.7billion In capital investments to our grid to ensure safe and reliable power for communities across Ontario Hydro One Limited | Annual Report 2019 1
Corporate Profile A Network Built for the Possibilities of Tomorrow Who We Are Hydro One Limited (TSX: H) Hydro One Limited, through its wholly-owned subsidiaries, is Ontario’s largest electricity transmission and distribution provider with approximately 1.4 million valued customers, approximately $27.1 billion in assets as at December 31, 2019, and annual revenues in 2019 of approximately $6.5 billion. Our team of approximately 8,800 skilled and dedicated employees proudly build and maintain a safe and reliable electricity system which is essential to supporting strong and successful communities. In 2019, Hydro One invested approximately $1.7 billion in its transmission and distribution networks and supported the economy through buying approximately $1.5 billion of goods and services. We are committed to the communities where we live and work through community investment, sustainability and diversity initiatives. We are designated as a Sustainable Electricity Company by the Canadian Electricity Association. Hydro One Limited’s common shares are listed on the TSX and certain of Hydro One Inc.’s medium term notes are listed on the NYSE. Additional information can be accessed at www.hydroone.com; www.sedar.com or www.sec.gov) $6.5billion 8,800 2019 annual revenue Skilled and dedicated employees 2 Hydro One Limited | Annual Report 2019
Financial Highlights Financial Highlights Year ended December 31 (millions of dollars, except as otherwise noted) 2019 2018 Revenues 6,480 6,150 Purchased power 3,111 2,899 Revenues, net of purchased power1 3,369 3,251 Operation, maintenance and administration (OM&A) costs 1,181 1,105 Depreciation, amortization and asset removal costs 878 837 Financing charges 514 459 Income tax expense (recovery) (6) 915 Net income (loss) to common shareholders of Hydro One 778 (89) Adjusted net income to common shareholders of Hydro One1 918 807 Basic earnings per common share (EPS) $1.30 ($0.15) Diluted EPS $1.30 ($0.15) Basic adjusted non-GAAP EPS (Adjusted EPS)1 $1.54 $1.35 Diluted Adjusted EPS1 $1.53 $1.35 Net cash from operating activities 1,614 1,575 Funds from operations (FFO)1 1,532 1,572 Capital investments 1,667 1,575 Assets placed in-service 1,703 1,813 Transmission: Average monthly Ontario 60-minute peak demand (MW) 19,896 20,485 Distribution: Electricity distributed to Hydro One customers (GWh) 27,536 27,338 Debt to capitalization ratio2 56.3% 55.6% 1. See section “Non-GAAP Measures” for description and reconciliation of adjusted net income, basic and diluted Adjusted EPS, FFO and revenues, net of purchased power. 2. Debt to capitalization ratio is a non-GAAP measure and has been presented as at December 31, 2019 and 2018, and has been calculated as total debt (including total long-term debt, convertible debentures and short-term borrowings, net of cash and cash equivalents) divided by total debt plus total shareholders’ equity, including preferred shares but excluding any amounts related to noncontrolling interest. Management believes that the debt to capitalization ratio is helpful as a measure of the proportion of debt in the Company's capital structure. Total Assets Rate Base Revenues Regulated Earnings (Net of purchased power costs) (Before financing charges and income taxes) 7% 56% 4039%% 61%60% 1% 49% 3844%% 56%62% $27.1 $20.7 $3,369 $1,493 billion billion million million 37% 50% Transmission Distribution Other Total Shareholder Return (TSR) Hydro One 29.0% January 1, 2019 to December 31, 2019 S&P/TSX Capped Utilities Index 37. 5% S&P/TSX Composite Index 22.8% S&P 500 Electric Utilities Index 27. 5% S&P 500 Index 31.5% This report contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about our business and the industry in which we operate, and includes beliefs and assumptions made by the management of our Company. Words such as “expect” and “will” are intended to identify such forward-looking statements. 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 statements. We do not intend, and we disclaim any obligation, to update any forward-looking statements, except as required by law. All figures in this document are approximate figures that are rounded to the nearest decimal place. Hydro One Limited | Annual Report 2019 3
2019 Highlights Hydro One’s Our Regulated Business Our Unregulated Business Transmission Our other segment consists principally of our telecommunications business, Hydro Our transmission system transmits high-voltage Business One Telecom Inc. (HOT), which provides electricity from nuclear, hydroelectric, natural telecommunications support for Hydro One’s gas, wind and solar sources to distribution transmission and distribution businesses. HOT companies and industrial customers Network offers comprehensive communications and across Ontario. Our system accounts for information technology services and solutions approximately 98%1 of Ontario’s transmission (cloud services, managed services and capacity with approximately 30,000 circuit security-based services) that extend beyond kilometres of high-voltage transmission lines. the core fibre and connectivity services it has We also own and operate 25 cross-border traditionally offered. interconnections with neighbouring provinces and the United States, which allow electricity to flow into and out of Ontario. Distribution Our distribution system is the largest2 in Ontario. It consists of approximately 123,000 circuit kilometres of primary low-voltage power lines serving approximately 1.4 million customers, mostly in rural areas. As well, Hydro One Remote Communities Inc. serves 1. based on revenue approved by the OEB customers in one grid-connected and 21 2. based on customers (per OEB yearbook) off-grid communities in Ontario’s far north. Hydro One’s Role in the Ontario Electric Power System Our transmission and distribution systems safely and reliably serve communities throughout Ontario. Our customers are suburban, rural and remote homes and businesses across the province. Our communities are proudly and safely serviced by a team of skilled and dedicated employees. Industrial, Commercial and Residential Customers DistributionSystem Transformer Transmission Transformer Transformer (increased to System (decreased to (decreased to higher voltage) medium voltage) lower voltage) Electricity Sources Generation Transmission Distribution 4 Hydro One Limited | Annual Report 2019
Key Highlights 1 2 High Customer Satisfaction Leadership in Power Restoration Across all lines of business including Recognized by the Edison Electric Institute (EEI) Emergency Assistance 87.2% transmission customer satisfaction, Award for our response efforts following the deadly California wildfires in 85.7% residential and small business 2018 and for helping Manitoba Hydro after a severe storm in October 2019. customer satisfaction, 89.5% First This complements response times within our own borders – Hydro One’s Nations customer satisfaction and Customer Average Interruption Duration Index (CAIDI), a key measure of 90.0% Hydro One Telecom Inc. success in delivering reliable power, improved by 9.7% in 2019. customer satisfaction. We also earned two customer service awards from the Ontario Energy Association. 3 4 5 Supporting Local Businesses Productivity Savings Reducing Costs Remaining a substantial contributor A 49.3% increase in year-over- A 4.7%, or $51 million, reduction to Ontario’s economy through the year productivity savings with in annual operating costs adjusted purchase of local goods and services, $202.3 million saved in 2019 for Avista related costs in 2019 including $41.3 million spent with as compared to $135.5 million from 2018. Indigenous businesses in 2019. in 2018. Hydro One partnered with government and industry 6 7 stakeholders, Indigenous Capital Investments Best Employer, 5th Year peoples, customers, unions Approximately $1.7 billion in capital For the fifth consecutive year, and other stakeholders investments to expand the electricity Hydro One has been recognized throughout the year to grid and renew and modernize by Forbes in its list of Canada’s Best achieve a number of key existing infrastructure. Employers for 2020, underscoring performance milestones. our commitment to creating an engaged workforce and positive working environment. Hydro One Drives Ontario’s Economy 1 98% 38 ~1.4 million 83 Of Ontario’s Electric utilities companies Residential and business Large industrial customers transmission capacity (including Hydro One’s own customers served by our local connected directly to the distribution business) that are distribution business transmission network Hydro One’s transmission customers 1. based on revenue approved by the OEB Hydro One Limited | Annual Report 2019 5
A Message From Our Chair Confident leadership, clear vision In May, following a thorough and competitive international search process, the Board officially welcomed Mark Poweska as Hydro One’s President and CEO. The Board sought a highly regarded leader in the electricity utility sector, one with a Timothy Hodgson proven record in building a strong safety Chair culture, exceeding customer expectations and improving operational performance – along with the ability to develop enduring relationships with Indigenous communities, our stakeholders, and government. We found all of the above in Mark, whose 25-year career has included responsibility A Message for all aspects of electricity generation, transmission and distribution operations at From Our Chair a major North American integrated utility. Mark’s extensive experience in the electricity sector will help ensure Hydro One is strong I am honoured to serve as Chair of this historic now and even better positioned into the company, with its 115-year legacy of adding future. economic value through transmitting and distributing To that end, the Board of Directors approved and fully endorses the corporate strategy electricity to Ontario. Hydro One has an incredibly that Mark and his team developed in 2019. important mandate in serving the people of our The five-year Ontario-focused strategy sets a clear vision for Hydro One to: build a grid province and in delivering outstanding and for the future, be the safest and most efficient cost-efficient service to approximately 1.4 million utility, be a trusted partner, be an advocate customers in communities across Ontario. The for customers, as well as innovate and grow the business. Board of Directors fully supports Hydro One’s focus on delivering greater value for its customers, Sustainable practices, best-in-class employees, communities and shareholders. performance Safety remains a priority of the Board of Directors and we support management’s renewed and intensified commitment to continually enhancing Hydro One’s culture of safety. The Board of Directors is equally committed to supporting management’s initiatives to further develop the company’s sustainable business practices. In 2019, Hydro One achieved a total return to shareholders of 29%, reflecting strong sector fundamentals and stable growth, as well as the company’s ability to capture efficiencies and reduce operating costs. The Board of Directors fully supports company initiatives that have reduced its cost of capital. We are encouraged that equity market investors have re-rated our company upward relative to our publicly traded competitors and our publicly traded debt pricing has improved with the positive rating actions of key credit rating agencies. 6 Hydro One Limited | Annual Report 2019
Strong governance, diverse viewpoints at the Board level reflects Hydro One’s In the coming year Hydro One will remain I want to thank all Board members for their understanding that it is a strategic imperative focused on enhancing shareholder value and oversight and deliberations this past year. to be a best-in-class trusted partner of on delivering safe, cost-efficient and reliable On their behalf, I welcome Susan Wolburgh Indigenous communities and to be inclusive power to customers. On behalf of the Board Jenah to Hydro One’s Board of Directors. of the many customers and stakeholders we of Directors, I appreciate your ongoing trust, This is a timely appointment of a highly serve across the province. confidence and investment in Hydro One. qualified individual and I know we all will benefit from Susan’s exceptional experience, Enhancing value, delivering results both leading and serving on boards of Our success is due to the diligence and publicly traded, regulated companies. passion of our leaders and employees. First, on behalf of the entire Board of Directors, I Hydro One values diversity at all levels want to thank all Hydro One employees for Timothy Hodgson of the organization and our commitment their extraordinary efforts this past year – Chair of the Board of Directors extends to ensuring a gender-diverse Board our employees’ record of service in times of of Directors. With the announcement of need continues to be exemplary. Secondly, Susan, the composition of our Independent I wish to thank my predecessor Chair, Tom Non-Executive Board is 50% women and Woods, for his tireless dedication and steady 50% men, reflecting best practices in board leadership. Finally, the entire Board of diversity and surpassing our Catalyst Accord Directors would like to recognize the past commitment to maintaining at least 30% leadership of our Acting President and CEO female board members. Additionally, our Paul Dobson, who led Hydro One through an commitment to Indigenous representation important period of transition. Hydro One Limited | Annual Report 2019 7
A Message from our President & CEO These conversations, along with a substantial amount of research to understand our customers’ priorities, guided the direction of Hydro One’s new five-year corporate strategy, which was developed under the direction of our Board of Directors. Mark Poweska Our new strategy outlines five priorities: President & CEO • Plan, design, and build a grid for the future • Be the safest and most efficient utility • Be a trusted partner • Adv ocate for our customers and help them make informed decisions • Innovate and grow the business A Message From These priorities focus on what really matters to customers, Indigenous peoples, Our President & CEO communities, stakeholders and investors: an unwavering commitment to exceptional customer service, safety, efficiency and Since joining the company in May, I have had the sustainability. You will find more details on these later in this report. opportunity to witness first-hand the expertise and In 2019, we made good progress on dedication of Hydro One’s team members and improving Hydro One’s financial and leadership in carrying out the company’s crucial role operating performance, capturing of delivering the power that drives Ontario’s economy efficiencies and reducing our operating costs adjusted for Avista related costs by and energizes every corner of this province. It is an 4.7% during the year. exciting time to lead this organization and I thank We improved the reliability of Hydro One’s employees and the Board of Directors for the trust network while focusing on becoming safer, they have placed in me as we charted a course for the more customer-driven, sustainable and efficient. future of Hydro One. Enhancing safety culture, improving Over the first weeks and months at Hydro One, safety reporting I had many discussions to better understand what We are deeply committed to continually enhancing Hydro One’s culture of safety. our customers, investors, stakeholders and Indigenous In March, we tragically lost one of our peoples need and expect from Hydro One. colleagues who sustained a fatal injury during a forestry incident in the Minden area. While Hydro One’s reportable injuries rates have declined in recent years and are considered industry leading, we have seen an increase in serious injuries. This is not acceptable to me and I personally will not rest until we have eliminated serious injuries from our organization. In 2019, I created a new role on my executive team, a Chief Safety Officer, dedicated to leading our safety program and driving improvements. Our renewed focus on safety includes the introduction of a new, frontline- led Safety Improvement Team to help us determine the actions we need to take to eliminate injuries at Hydro One. We are also making headway on major improvements to 8 Hydro One Limited | Annual Report 2019 our safety reporting and analytics.
Leading emergency response, selected Hydro One as an Indigenous building resilience Procurement Champion. The Canadian In 2019, we continued to experience storms Energy Association also recognized us for and weather events, which impacted our our efforts in increasing our procurement customers’ families and businesses. Our from Indigenous-owned companies. entire team – including highly trained crews, In 2019, we completed the Niagara grid control centre operators and customer Reinforcement Line (NRL), a new, major service agents – responded to these transmission project, with our equity emergencies and through careful planning, partners, the Six Nations of the Grand River assessed damage and safely restored Development Corporation, and Mississaugas power in challenging conditions. In 2019, of the Credit First Nation. This 76-kilometre Hydro One employees travelled out of the transmission line was brought to completion Our customers not only depend on us to province to assist Manitoba Hydro when it by A6N, an Indigenous-owned contractor. experienced a severe winter storm with major supply reliable electricity, they expect us impacts to its grid. We will always be proud We are also focusing our efforts on to run an efficient company and to look for to support our partners in their time of need. partnering with communities and customers ways to drive costs out of the system. to champion economic development In 2019, Hydro One achieved productivity Hydro One is rightly seen as a North opportunities. In southwestern Ontario, savings of $202.3 million and operating American leader in power restoration. In we worked with community leaders and cost reductions of $51 million adjusted for 2019, our leadership was recognized by the customers in Leamington to bring more power Avista related costs. We will continue to focus Edison Electric Institute (EEI), which presented to support the region’s booming greenhouse on improving our efficiency, while never Hydro One with an Emergency Assistance sector. We worked collaboratively with the compromising safety. Award for our response efforts following the Independent Electricity System Operator deadly California wildfire in 2018; as well to advocate for a new, major transmission In 2020, we will continue to be a champion as our 10th EEI Award for helping Manitoba line to provide 400 additional megawatts for our customers and the electricity sector Hydro restore power. of power, which will have the added benefit in Ontario. We will create a brighter, Over the next five years, we plan to invest of putting downward pressure on electricity sustainable future for Ontarians by building approximately $10 billion in our transmission rates. We will continue to work closely with strong partnerships, delivering operational and distribution systems to ensure a reliable our customers to better understand their excellence and enhancing shareholder value. grid for the future. As we make these emerging needs and ensure we have a Last year we further solidified our executive investments, we will modernize our grid power grid that continues to support local team by welcoming some industry leaders through the introduction of new technologies economic growth. to Hydro One and through several internal to prevent outages, increase resiliency, and Through our community investment program, appointments. In 2019, Paul Harricks joined protect against physical and cyber threats Building Safe Communities, I’m proud to say Hydro One as our Chief Legal Officer and we – while allowing us to restore power faster that we provided training to about 200,000 announced David Lebeter would be joining us when we experience outages. youth across Ontario to teach them life- as our new Chief Operating Officer. Internal As we prepare for more severe storms, we will saving skills and how to play safe. We also appointments included Chris Lopez as Chief continue to incorporate considering climate provided 125 donations and sponsorships to Financial Officer, Saylor Millitz-Lee as Chief change into our planning to increase resilience over 70 communities across the province. Human Resources Officer, Brad Bowness and reduce our environmental footprint. as Chief Information Officer and Darlene Exceptional service, reducing costs Bradley as Chief Safety Officer. I have full Good neighbour, trusted partner Since 2015, Hydro One has been on a confidence in this executive team to deliver on our strategic plan over the coming years. Our success depends on our ability to build journey to serve our customers better and we made great strides in the last year. In 2019, trust as a reliable partner to Indigenous I want to thank all Hydro One employees for we achieved a score of 85.7% – the highest peoples, communities, customers and the their dedication and service this past year residential and small business customer many stakeholders we serve across Ontario. and I look forward to what the future holds satisfaction score in over a decade. We also as together, we build a better and brighter In 2019, we strengthened our ties with earned two customer service awards from the future for all. Indigenous leaders and communities across Ontario Energy Association. However, we the province, increasing our procurement believe we can do better and we will do better. spending to $41.3 million with Indigenous businesses – Hydro One’s highest spend As the needs and expectations of our customers ever. In recognition of our work, the evolve, we will continue to find ways to Canadian Council for Aboriginal Business introduce new services that meet their needs Mark Poweska and make it easier to do business with us. President & CEO Hydro One Limited | Annual Report 2019 9
Partnering for a Sustainable Future A Sustainable Future for All STRONG ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) PERFORMANCE Designated as a Sustainable 50% $41.3 million Electricity Company by the Board of Directors diversity Total procurement spending with Canadian Electricity Association (Independent Non-Executive) Indigenous businesses – our highest ever spend Recognized as one of the Best 50 Corporate Citizens in $1.7billion Canada by Corporate Knights In capital investments to expand 104 electricity grid and renew and First Nations communities served by modernize existing infrastructure Hydro One Networks Inc. and Hydro One Remote Communities Inc. Selected by the Canadian Council for Aboriginal Business as an Indigenous Procurement Champion $2.8 million In sponsorships and donations in communities where we live and work Our Indigenous Partner Network A Safer Future for Families Hydro One held our first-ever provincial great opportunity for attendees to learn Hydro One and Scouts Canada announced Indigenous Business Fair in downtown about Hydro One’s purchasing needs a new partnership to launch Head Safe – a Toronto this past September. The event and showcase Indigenous products, new hands-on program aimed at educating showcased over 40 Indigenous businesses services and solutions; liaise with our families on the impacts of head injuries, the from across the province, and offered lines of business including environment, importance of prevention and safe return to Hydro One employees – as well as many transmission, distribution, station play. Launched in the fall of 2019, with Scouts of our non-Indigenous business partners construction and forestry; and underscore Canada groups, the program will provide – the opportunity to network with these Hydro One’s commitment to increase youth, volunteers and families in over 25,000 businesses, improve overall awareness of our Indigenous procurement by pursuing households with essential educational tools their capabilities, and foster relationships. mutually beneficial relationships. – head injury first aid, how to recognize the The Indigenous Business Fair was also a early symptoms of a concussion, important safety measures to protect against head injuries and role play on how to respond to real-life scenarios. 10 Hydro One Limited | Annual Report 2019
A unique low-risk Why Invest in opportunity to participate in the transformation of a premium, large scale Hydro One regulated electric utility. 1. Everyone Uses Electricity 5. Financial Performance One of the largest electric utilities in Predictable self-funding organic growth North America with significant scale and profile with expanding rate base and leadership position across Canada’s most strong cash flows, together with broad populated province. support for refurbishment of aging infrastructure and with ~5% expected five year rate base CAGR. No external 2. Strong Balance Sheet equity required to fund planned growth. One of the strongest investment grade balance sheets in the North American utility sector. 6. Attractive Dividend Annualized dividend of $0.966 per share with attractive 70% – 80% target 3. Pure-play Transmission payout ratio. and Distribution Unique combination of pure-play electric power transmission and local distribution, 7. Rate Base Expansion with no generation or material exposure Opportunity for continued dividend to commodity prices. growth with rate base expansion, continued consolidation and efficiency realization. 4. Stable Operations Stable and growing cash flows with 99% of business fully rate-regulated in a constructive, transparent and collaborative regulatory environment. “Our commitment to safety goes beyond the workplace to building safe communities where we live, work and play. Our partnership with Scouts Canada will make a difference by providing young people with the tools and training to prevent and treat head injuries.” Mark Poweska, President & CEO Hydro One Limited | Annual Report 2019 11
Hydro One’s New Strategy Our New Corporate Strategy “Hydro One is a champion for our customers and the electricity sector in Ontario. We are a leader in our sector here in Ontario and across Canada. Our ability to build enduring relationships and strong partnerships is helping us create a brighter, sustainable future for Ontarians. We are steadfast in improving the safety, reliability and environmental performance of our operations. We will remain focused on delivering operational excellence as we drive performance, reduce costs and enhance shareholder value.” Mark Poweska, President & CEO 12 Hydro One Limited | Annual Report 2019
By 2024, our corporate strategy is expected to enhance shareholder value by delivering an improved safety culture, a more reliable grid for our customers, high customer satisfaction, sustainable business practices and a lower environmental footprint. STRATEGIC PRIORITY AREAS OF FOCUS • Plan, design and build a reliable grid for today and tomorrow and embrace new technology, such as distributed energy resources, to enable customer choice. PLAN, DESIGN AND BUILD A GRID • Increase focus on grid resilience in order to FOR THE FUTURE reduce the frequency and duration of outages. Consider climate change and sustainability factors in our planning to increase resilience and lower our environmental footprint. Enhancing the Value of Hydro One • Transform and improve our safety culture Hydro One has a responsibility through robust safety analytics and grass-roots to provide safe, reliable power employee engagement. to Ontarians now and into BE THE SAFEST • Empower field operation teams to drive the future. Our new five-year AND MOST efficiency, productivity and reliability. EFFICIENT UTILITY corporate strategy focuses on • Focus on efficient capital delivery to support what really matters to customers, our ongoing growing work program. communities, stakeholders and investors – an unwavering • Build and grow relationships with Indigenous commitment to safety, peoples, government and industry partners. exceptional customer service, • Proactively address community concerns and efficiency and sustainability. BE A TRUSTED establish strong partnerships with our customers PARTNER through local investment and economic development for the benefit of all Ontarians. Enabling Success • Enrich the customer experience by acting as their trusted energy advisor, helping them save Successfully executing our money, and offering new products and services strategy will require a people to meet their energy needs. focus that inspires employees ADVOCATE FOR OUR and prepares the workforce for CUSTOMERS AND HELP • Help our customers make informed decisions THEM MAKE INFORMED with deeper insights and leverage our position our evolving needs; a regulatory DECISIONS as energy experts. focus to support our strategic vision; and a technology focus • Invest responsibly in our core transmission and to enhance the efficiency of our distribution business. workforce and better enable • Pursue incremental regulated and unregulated our customers. INNOVATE business opportunities through innovation and AND GROW our focused presence in Ontario. THE BUSINESS Hydro One Limited | Annual Report 2019 13
Hydro One’s New Strategy Plan, Design and Build a Grid for the Future We will plan, build and design a grid that meets the needs of Ontarians today and into the future. This means improving reliability by investing in technology that will allow us to modernize our grid. Sustainability is also central to our strategy. As we prepare for more severe storms, we will consider climate change in our planning to increase resilience and lower our environmental footprint. Our Focus • Improving grid flexibility to integrate and Our Performance We are pursuing various strategic initiatives operate Distributed Energy Resources In 2019, we improved the overall reliability of to build a grid for our customers that is (DERs) enabling customer choice: We will our distribution network, while also improving reliable, resilient and flexible while balancing incorporate distributed energy resources restoration times. Contributing to this our environmental responsibility in pursuit of to enable customer choice while delivering performance was $1.2 billion in expenditures these goals: exceptional value to customers through to expand our distribution grid and renew best-in-class asset management practices. and modernize existing infrastructure, as • Planning, designing and building a • Reducing our environmental footprint: well as the positive impact of our new storm reliable grid for the future: Providing safe prediction tools and vegetation management and reliable power to customers is our top Hydro One strives to continue reducing greenhouse (GHG) emissions as a part of program. Hydro One’s Customer Average priority. We will continue to invest in our Interruption Duration Index (CAIDI), a key existing infrastructure to maintain a reliable its commitment to environmental, social, and corporate governance (ESG). measure of success in delivering reliable and resilient grid, while embracing new power, improved by 9.7% in 2019 from 2018. technology for tomorrow. • Delivering value through great planning: We continued to invest in technology to • In creasing grid resiliency and A robust and efficient planning process ensures the prudent use of every dollar improve grid resiliency and to modernize sustainability to quickly recover from cybersecurity protection of our core assets events: We will continue to automate the entrusted to us, whether for capital investments or operations. – important not only for Ontario’s economy, grid and deploy NextGen solutions to but for other provinces and the United ensure the grid can withstand more extreme States with whom we share North America’s storms and weather events. We will focus on interconnected grid system. As part of our installing technologies that improve outage Distribution Modernization program, we response times and minimize impacts. installed 1,188 devices to better determine the location of a fault on the distribution 14 Hydro One Limited | Annual Report 2019
HELPING OUR COMMUNITIES RECOVER QUICKLY FROM STORMS Our new storm prediction tool allows us to take a proactive approach to preparing for bad weather by positioning our crews and equipment in areas expected to be the most impacted by storms. Our leadership in power restoration recently earned us our 10th EEI Emergency Assistance Award for helping Manitoba Hydro restore power after a severe snowstorm hit the province in October 2019. system and quickly dispatch a crew to Our grid is critical to 2019 Highlights repair it, as well as to remotely isolate the problem and restore power in some powering Ontario and 1 cases. We also continued to build our the broader Canadian Distributed Energy Resource Management economy. It is our 17. 4 % System (DERMs), which is a technology that SAIDI (System Average Interruption enables real-time control of generation and responsibility to plan for Duration Index) for Transmission load on the system. In addition, we lowered the future, to ensure the improvement in 2019 over 2018 our environmental footprint by continuing to green and rationalize our fleet of delivery of reliable and approximately 7,000 vehicles. safe power in the years 2 to come. Our Future 16.7% In 2020, we will focus on efficiently SAIFI (System Average Interruption deploying capital to meet Ontario’s Frequency Index) for Transmission needs while reducing customer service improvement in 2019 over 2018 interruptions; make incremental investments to modernize, harden and protect our assets; and develop and implement a GHG emissions reduction plan. 9.7% CAIDI improvement in 2019 over 2018 1,2. 2018 figure excludes the impact of the Ottawa tornado Hydro One Limited | Annual Report 2019 15
Hydro One’s New Strategy Be the Safest and Most Efficient Utility Safety is a core value at Hydro One and something to which we are deeply committed. Each one of our employees must go home safely after a fulfilling day of work. We believe that a safe utility is an efficient utility and that a healthy safety culture fosters accountability and discipline across all aspects of our business. Our Focus • Optimizing corporate support: New ways created role of Chief Safety Officer to lead We are pursuing a number of strategic of thinking and working, both traditional the transformation of our safety culture. She initiatives to engage with employees in approaches and digital capabilities, will has established a Safety Improvement Team, driving productivity, reliability and efficiency, help us create efficiencies in our corporate comprised of a diverse cross-section of while eliminating on-the-job injuries: support functions. We are exploring employees, which is dedicated to eliminating everything from centralizing functions and incidents from the workplace that result in • Transforming and improving our safety employing lean process improvements, injuries. culture: In a healthy safety culture, there is a to automating business processes and high-degree of accountability across every analytics-enabled decision-making. We purchased four electric vehicles (EVs) level of the organization. Through discipline during 2019 and are on track to purchase and grassroots employee engagement, we • Driving efficient capital delivery: We 16 more EVs in 2020. As we continue will improve our safety culture and increase are building an efficient end-to-end to green out fleet, we are planning on safety reporting and accountability. capital process to ensure we can deliver converting 50% of our fleet of sedans and on our work program to build a safe and SUVs to electric vehicles or hybrids by 2025. • Enabling field operations to drive reliable grid for our customers. Rigorous Additionally, we continued to optimize our productivity and reliability: We firmly capital planning and execution are key to fleet, leveraging GPS fleet tracking to more believe in continuous improvement to successfully delivering efficient capital on efficiently deploy and manage our vehicles enhance the efficiency, productivity, behalf of all stakeholders. on the road, support safer and more energy- and reliability of our field operations. efficient driver behaviour and reduce fuel People are most productive when they are Our Performance and maintenance costs, while also extending empowered with the right tools and the In March 2019, we experienced a tragic the life of Hydro One vehicles. These right work in a safe environment free from loss when a Hydro One employee sustained measures helped us achieve $29 million in unnecessary burden. a fatal injury during a forestry incident in fleet productivity savings. the Minden area. The memory of our lost Approximately 500 members of our forestry colleague only strengthens our commitment team began using mobile tablets in the to an injury-free workplace. We have field to efficiently plan their work and to appointed Darlene Bradley to the newly realize the full potential of our vegetation 16 Hydro One Limited | Annual Report 2019
MAKING THINGS BETTER FOR OUR CUSTOMERS AND COMMUNITIES Our state-of-the-art vegetation management program (OCP) has been welcomed by our customers and community partners alike, while delivering major efficiencies and savings. With a three-year maintenance cycle, OCP trims problem trees and vegetation more often to improve the overall safety and reliability of the system. In 2019 our forestry teams completed approximately 31,600 kilometres of work along power lines – with the volume of trees managed at an all- time high. But perhaps the biggest benefit is that OCP has proved to be less disruptive to our community stakeholders, removing less vegetation while being more aesthetically pleasing; being better for the environment with less bio-disruption; creating less noise and improving overall reliability for our customers. management program – Optimal Cycle “Safety is good for 2019 Highlights Protocol (OCP). In support of our growing capital work programs, we partnered with business. A company contractors to improve the predictability of that’s more careful, our project pipeline, with more upfront focus systematic and driven 29.6% on risk assessment and project planning. by proven, repeatable Total Annual Recordable Injury Rate We continued to optimize our shared improvement in 2019 over 2018 services portfolio – which includes our processes will lead supply chain and real estate functions – to being a better- pursuing opportunities to monetize our land holdings and continue to increase managed and more efficiencies in procurement of materials efficient business.” 49.3% and services. Increase in annual total productivity savings (capital and OM&A) in 2019 Mark Poweska, President & CEO Our Future over 2018 In 2020, we plan to develop an integrated reporting system that accounts for near misses; a safety analytics program to gain better insight into safety incidents and mitigate future incidents; and enhance our process to ensure effective response to safety investigation reporting. We will also empower our field operators to focus on the work that matters and streamline their activities in order to improve overall grid reliability. Hydro One Limited | Annual Report 2019 17
Hydro One’s New Strategy Be a Trusted Partner Hydro One will be a trusted partner to Indigenous peoples, industry stakeholders, government, communities, customers and all Ontarians. Our goal is to build and grow relationships to deliver greater value for our customers and shareholders. Our Focus future. Our shared success depends on our could be built to support the growing We are pursuing various strategic initiatives ability to build trust as a reliable partner demand for electricity. This work together to foster trust and improve relationships with and good neighbour. was a success: in June of this year the IESO our key partners: directed us to build a new transmission line Our Performance from Chatham to Lakeshore, to support • Growing relationships with government We consulted with the government on the growing demand for electricity in this area. and industry partners: We want to modernization of the Ontario Energy Board enhance our relationships with industry We advanced various procurement and (OEB), advocating for structure and system employment opportunities with the 104 and government and to advocate for reforms that will reduce red tape while our customers on matters of affordability First Nations communities served by Hydro improving overall transparency, the efficient One Networks Inc. and Hydro One Remote and innovation. As a trusted leader in the delivery of capital and the environmental energy sector, we will continue to advance Communities Inc. In 2019, we increased assessment process. We also advocated with our procurement spending with Indigenous energy-related innovations and policies government on behalf of our customers and that benefit all Ontarians. businesses by 4.8% over 2018 to advanced a number of critical transmission $41.3 million – our highest ever annual • Building strong partnerships with projects during the year, including the spend. We held our first Hydro One Indigenous peoples: We are committed Leamington Area Transmission project. Indigenous Fair as well as nine Indigenous to building respectful and positive In recent years the greenhouse industry in procurement workshops. In recognition of relationships with Indigenous communities. southwestern Ontario has been booming our outreach, the Canadian Council for We firmly believe that this proactive in and around Leamington. We heard from Aboriginal Business selected Hydro One as approach will benefit all communities, as local government and business leaders an Indigenous Procurement Champion. well as enable growth across the province. that this community needed significantly At the community level, we proudly returned • Building trust with customers, communities, more power to support the growth it was as a presenting sponsor of the 2019 Little and all Ontarians: We are committed to experiencing. Through a collaborative Native Hockey League tournament – an serving all Ontarians – now and into the process, we worked together with the IESO annual gathering that brings together and local community leaders to understand over 2,500 competitors from Indigenous needs in the area so that new infrastructure communities across Ontario to compete in a 18 Hydro One Limited | Annual Report 2019
SUPPORTING LONG-TERM ECONOMIC OPPORTUNITIES FOR FIRST NATIONS COMMUNITIES Hydro One operates on traditional territories and as such, we have a responsibility to grow the Indigenous economy while building meaningful relationships based on mutual respect. In 2019 Hydro One completed a major transmission project, the Niagara Reinforcement Line, with two First Nations equity partners, Mississaugas of the Credit First Nation and Six Nations of the Grand River Development Corporation, a community owned corporation of the Six Nations of the Grand River First Nation. This 76-kilometre transmission line was brought to completion by A6N, an Indigenous-owned contractor, and placed in-service in August 2019. This partnership model enables the delivery of critical infrastructure that delivers economic value to the people of Ontario, while ensuring key benefits flow to local First Nation communities such as overall capacity building, along with direct and indirect job opportunities. “The Niagara Reinforcement Line will not only generate millions of dollars of benefit for the Six Nations community, it’s also a step forward for Indigenous participation in the safe environment. With our partner Indspire economy,” said Matt Jamieson, President and Chief we awarded Leonard S. (Tony) Mandamin Executive Officer, Six Nations of the Grand River Scholarships to 20 Indigenous students Development Corporation. “We have proven our ability enrolled in electricity-related programs at to partner and have demonstrated unprecedented colleges and universities across Ontario, capacity to leverage our skilled labour to drive economic who also have the opportunity to apply for development, not only within our community, but across paid work placements with Hydro One. Ontario.” Through our community investment program, Building Safe Communities, Hydro One provided training to about 200,000 youth 2019 Highlights across Ontario to teach them life-saving skills and how to play safe. We also provided 125 donations and sponsorships to over 70 communities across the province. $41.3 million Our Future Indigenous procurement – Hydro One’s highest ever spend We will continue to implement our multi-year Indigenous hiring plan and to develop a comprehensive Indigenous community engagement plan for guiding Indigenous equity partnerships, 104 procurement and employment opportunities. First Nations communities served by Hydro One Networks Inc. and Hydro One Remote Communities Inc. Hydro One Limited | Annual Report 2019 19
Hydro One’s New Strategy Advocate for Our Customers The electricity industry is evolving and so are the needs of our customers. We will continue to advocate for our customers and help them make informed decisions. To enrich the customer experience, we will build and enhance our digital capabilities and offer new products and services to meet their energy needs. Our Focus • Being our customers’ provider of choice: a second transmission station into service in We are pursuing key strategic initiatives Our residential, small business, and Leamington. Capping the year, Hydro One to improve the customer experience and commercial/industrial customers are earned two customer service awards from enhance customer satisfaction: increasingly concerned about affordability, the Ontario Energy Association (OEA) – the reliability, and power quality. As a large 2019 OEA Customer Service Award to the • Making it easier to do business with electric utility, we are uniquely positioned Hydro One Networks Inc. Business Customer Hydro One: More and more, customers to expand their access to third-party Service Team and the 2019 OEA Contributor are relying on mobile technology and products and services. Award to Ryan Boudreau, our Manager of self-service options to simplify their lives Protection and Automation. and improve their customer experience. Our Performance We are expanding our use of digital We are continuing to make it easier to In 2019, we achieved a residential and tools and channels to ensure we remain do business with us by modernizing our small business customer satisfaction score a trusted and cost competitive business Customer Contact Centre and launching a of 85.7% – our highest in over a decade. partner for our customers. dedicated web portal for our commercial and The increase can be attributed to: improved industrial customers, improving their ability to • Helping customers make informed customer experience, reliability, rates, access and manage their usage and billing decisions: As their trusted energy resource, and the strength of the Hydro One brand. information. Digital technology is helping Hydro One is committed to providing Transmission customer satisfaction was us deliver more effectively on key customer its customers with deeper insights and 87.2%, reflecting a new approach to the interactions. We have enrolled approximately tailored solutions for their energy needs. delivery of customer service to this customer 500,000 customers for proactive outage We also help our customers by advocating group. During the year, we increased alerts, allowing them to stay informed with the for them to meet their needs by offering a the number of new connections for our latest information during outages, providing fresh perspective on the most efficient and distribution customers, responding to high convenience for customers. reliable solutions the market offers. volumes and requests for more load, bringing 20 Hydro One Limited | Annual Report 2019
CONNECTING OUR CUSTOMERS WITH REAL-TIME INFORMATION In February, we updated Hydro One’s new customer Outage Map and App, which includes advanced features, such as a weather radar and street level detail. “We know our customers need real-time information when the lights go out and our new Outage Map will make it easier to get the latest information while our crews work to get the power back on,” said Imran Merali, Vice President of Customer Service, Hydro One. The Outage Map now provides customers with enhanced features to track outages in Hydro One’s service area along with the ability to bookmark multiple locations for easy reference. Other new features include: the ability to view outage information for individual homes, cottages or businesses; a weather radar overlay that allows customers to view current weather; updates every 10 minutes as information comes in from crews on-site; and improvements to be compliant with AODA (Accessibility for Ontarians with Disabilities). In March, we hosted an energy conference Hydro One is on a 2019 Highlights for our large industrial customers, helping them keep pace with changes in the multi-year journey to province’s energy landscape. Our dedicated transform the customer account managers continued to provide experience by creating 85.7% these customers with detailed information Residential and small business on their consumption patterns, while we digital channels that customer satisfaction continued to advocate for their needs and enhance existing services, provide guidance on the most efficient and reliable solutions the market offers. introduce new services, and offer innovative solutions to Our Future better anticipate and meet 87. 2 % We will explore opportunities for Transmission customer satisfaction building access to third-party services for the needs of customers. residential customers and creating offerings customized to our commercial and industrial customers’ needs, while providing commercial and industrial customers with 90.0% the tools and technology they need to make Hydro One Telecom Inc. customer informed decisions. satisfaction Hydro One Limited | Annual Report 2019 21
Hydro One’s New Strategy Innovate and Grow the Business Growth and innovation are central to providing value for our customers and our shareholders. With change comes opportunity and Hydro One will innovate to compete in our evolving marketplace. While we will continue to invest responsibly in our core transmission and distribution business, we will pursue regulated and unregulated business opportunities in Ontario. Our Focus Ontario. Ontario currently has 58 LDCs, transmission line wood poles across the We are pursuing various strategic initiatives making this a significant opportunity to find province; $28 million each on the new to drive the sustainable financial growth of efficiencies to drive costs out of the system. Leamington TS #2 (transmission station) and the rebuild of Hanmer TS in northeastern our business and provide innovate offerings • Pursuing innovative unregulated to our customers: Ontario; $27 million to refurbish Bronte opportunities: Unregulated opportunities TS in the western GTA; $26 million on • Responsibly investing in rate base assets: are critical to ensuring our long-term the refurbishment of the D2L circuit in We will continue to invest responsibly sustained growth in an evolving market. We northeastern Ontario; $26 million to build in our core transmission and distribution will pursue these growth opportunities in the new Enfield TS in the Durham region; business to ensure grid safety, efficiency order to diversify our portfolio and respond $25 million as part of a project to rebuild and reliability – and to deliver the services to the changing needs of the market, as well one of the switchyards serving Bruce Power’s our customers depend on for their electricity as to foster a culture of entrepreneurship nuclear generating stations; and finally, needs. With many transmission and and innovation at Hydro One. $119 million in capital additions with the distribution assets aging and degrading, completion of the Niagara Reinforcement investment in grid modernization remains Our Performance Line. We continued to focus on replacing critical to the long-term health of the system. In 2019, we invested approximately aging priority assets using a disciplined $1.7 billion to expand the electricity grid and approach to capital investments, with a • Pursuing new regulated opportunities: renew and modernize existing infrastructure goal to deliver greater value for both our We plan to actively pursue growth – $624 million in our distribution business customers and shareholders. opportunities in the regulated portion of our and $1 billion in our transmission business. business that can benefit ratepayers and Some of the largest transmission capital We pursued new regulated opportunities, shareholders alike – through acquisitions additions included: $73 million on the mainly through the ongoing consolidation of local distribution companies (LDCs) and replacement of transmission line insulators of Ontario’s electricity distributors. competitive transmission projects within and $40 million on the replacement of Hydro One remains committed to its 22 Hydro One Limited | Annual Report 2019
HYDRO ONE TELECOM INC. TRUSTED ENTERPRISE BUSINESS PARTNER In 2019, HOT began pivoting from a focus of providing businesses with commoditized fibre connectivity to offering a suite of value-added services to meet customers’ connectivity and data management needs. These new services complement Hydro One Telecom Inc.’s province-wide fibre-optic network and include an expansion of connectivity options with Secure SD-WAN, as well as cloud based offerings of Backup as a Service (BaaS) and Infrastructure as a Service (IaaS). HOT now provides an enhanced suite of cloud services, data backup tools and secure data storage options for our customers to choose from, ultimately providing managed services and adding to net income growth. $105-million purchase of Peterborough’s We have entered into a partnership with Highlights electrical utility, pending approval from the Ontario Power Generation to provide an Ontario Energy Board. We also continued easier charging experience for Ontario’s to move through the regulatory process to EV drivers. By the end of 2021, the Ivy acquire Orillia Power Distribution Corp – Charging Network is expected to have 7. 3% a $41.3-million purchase, which is expected 73 fast-charger stations across Ontario. Adjusted EPS CAGR since IPO to bring long-term economic value to businesses and residents in Simcoe County. Our Future Additionally, we announced an investment In 2020, we plan to invest approximately of approximately $150 million to build a $1.9 billion in our rate base assets while state-of-the-art grid control centre in Orillia, pursuing opportunities to participate in $10.1billion which will serve as one of our innovative competitive processes for pursuing LDCs In regulated capital investments technology hubs and will ensure the safe, and transmission lines within Ontario. We in the next 5 years reliable delivery of electricity to communities also plan to accelerate the growth of the across all of Ontario for years to come. telecom business. Our pursuit of unregulated growth opportunities is mainly through our telecom subsidiary. With approximately 9,000 route kilometers in fiber optic lines, HOT is seeking to expand on its success, as well as to identify new opportunities for innovative growth within Ontario. Hydro One Limited | Annual Report 2019 23
Corporate Governance Hydro One’s Board of Directors is composed of a diverse and accomplished group of Hydro One’s Progressive, Corporate independent, proven business leaders with Gender-Diverse and Independent deep corporate governance experience. The Board of Directors Governance Board’s primary role is overseeing corporate performance and the quality, depth and We value diversity at all levels of continuity of management required to Hydro One and its commitment extends meet the company’s strategic objectives. to ensuring a gender-diverse Board of Strong corporate governance practices Directors. With the announcement of are at the heart of how we manage our Hydro One is committed to maintaining best corporate governance practices. The Susan Wolburgh Jenah in 2019, the day-to-day operations in the interest composition of our Independent Non- of all stakeholders. Company’s practices are fully aligned with the rules and regulations issued by Executive Board is five women (50%) Hydro One and its independent Board Canadian Securities Administrators and the and five men (50%), making us one of the of Directors recognize the importance Toronto Stock Exchange, including national most gender progressive boards in North of corporate governance in the effective corporate governance guidelines and America. It also reflects best practices in management of the company. Independence, related disclosure requirements. board diversity and surpasses our Catalyst integrity and accountability are the Accord commitment to maintaining at least foundation of Hydro One’s approach to Board Structure 30% female board members. The Catalyst Accord is a global non-profit organization corporate governance. It is in the long-term The Chair is responsible for leading the dedicated to gender parity best interests of shareholders, and promotes Board of Directors in carrying out its duties in the workplace. and strengthens relationships with our and responsibilities effectively, efficiently customers, employees, the communities and independent of management. The Chair where we operate and other stakeholders is nominated and confirmed annually by of the Company. The Board of Directors special resolution of the Board. Consistent Board Gender Diversity1 is firmly supported in these commitments with best practices, Hydro One’s Board Chair by a governance agreement between is separate from the role of President and Hydro One and the province of Ontario, Chief Executive Officer and is independent which was executed in advance of the of Hydro One and the Province of Ontario. November 2015 Initial Public Offering of the Company and ensures that the province’s role To learn more about the Directors, is limited to that of a shareholder and not a committee mandates and composition, go to 50% Female Directors manager of the business. www.HydroOne.com/Investors Board of Directors and Committees (as at January 1, 2020) Female Health, Safety, Male Environmental and Committees Audit Governance Human Resources Indigenous Peoples 1. Hydro One’s Independent Non-Executive Board Timonthy Hodgson of Directors (Chair) 2. Became a director on January 1, 2020 Mark Poweska (President & CEO) Cherie Brant • • Blair Cowper-Smith • Anne Giardini • David Hay • • Jessica McDonald • • Russel Robertson • William Sheffield • • Melissa Sonberg • Susan Wolburgh Pending Appointment Jenah2 Chair • Committee Member 24 Hydro One Limited | Annual Report 2019
Board of Directors 1. Timothy Hodgson, MBA, FCPA, ICD.D Trevali Mining Corporation, Member 1 2 3 Corporate Director, Chair of Hydro Council of Sustainable Development One Ltd, Chair of Sagicor Financial Technology Canada Corporation Limited, Director 7. Russel Robertson, FCPA, FCA, ICD.D Public Sector Pension Investment Corporate Director, Former EVP and Board (PSP Investments), Director Head, Anti-Money Laundering, BMO Alignvest Acquisition II Corporation, Financial Group, Former Vice-Chair, retired Managing Partner Alignvest Deloitte & Touche LLP, Director Bausch Management Corporation, Former Health Companies Inc., Director Special Advisor to Bank of Canada Turquoise Hill Resources Governor Mark Carney, Former CEO 4 5 6 Goldman Sachs Canada 8. William Sheffield, BSC, MBA, ICD.D Corporate Director, Former CEO Sappi 2. Cherie Brant, JD Fine Papers, Director Houston Wire & Partner, Borden Ladner Gervais Cable Company, Director Velan Inc., LLP, Director Anishnawbe Health Former Board Member OPG Foundation, Member Canadian Council for Aboriginal Business, 9. Melissa Sonberg, BSC, MHA, ICD.D Research Advisory Board, Aboriginal Adjunct Professor and Executive-in- Energy Working Group-IESO Residence, McGill University, Desautel Faculty of Management, Director 3. Blair Cowper-Smith, LLM, ICD.D Exchange Income Corporation, Principal and founder Erin Park 7 8 9 Former Senior Vice President, Human Business Solutions, Former Chief Resources & Corporate Affairs and Corporate Affairs Officer OMERS Senior Vice President, Global Brands, 4. Anne Giardini, O.C., O.B.C, Q.C, LLM Communications and External Affairs Chancellor, Simon Fraser University, at AIMIA Former Canadian President 10. Susan Wolburgh Jenah J.D., ICD.D Weyerhaeuser Company Limited, Corporate Director, Director Laurentian Former Director Nevsun Resources LTD Bank, Director Aecon Group Inc, and 5. David Hay, LLB, ICD.D Humber River Hospital. Governor Managing Director Delgatie of the Financial Industry Regulatory 10 11 Incorporated, Former CEO New Authority (FINRA), and member of the Brunswick Power Corporation, Former Independent Review Committee of Vice-Chair and Managing Director Vanguard Investments Canada of CIBC World Markets Inc., Director 11. Mark Poweska, President and CEO of EPCOR, Council Member of the Hydro One Ltd, Former Executive Vice Council for Clean and Reliable Energy President, Operations at BC Hydro, 6. Jessica McDonald, ICD.D Director and Chair of the Operations Corporate Director, Chair, Canada Committee of the Western Energy Post Corporation, Former President Institute, Board Advisor to Yukon & CEO BC Hydro & Power Authority, Energy Corporation Director Coeur Mining Inc., Chair Executive Leadership Team 11. Mark Poweska 12 13 14 15 President and Chief Executive Officer 12. Brad Bowness Chief Information Officer 13. Darlene Bradley Chief Safety Officer 14. Jason Fitzsimmons Chief Corporate Affairs & Customer Care Officer 15. Paul Harricks 16 17 18 Chief Legal Officer 16. David Lebeter Chief Operating Officer, January 2020 17. Chris Lopez Chief Financial Officer 18. Saylor Millitz-Lee Chief Human Resources Officer For detailed biographical information of Hydro One Limited Board members, go to www.HydroOne.com/Investors. The biographical information of Hydro One Limited Board members is based on information available to management as of January 15, 2020. Hydro One Limited | Annual Report 2019 25
Management’sThe Power of Partnership Discussion and Analysis Financial Report Contents Management’s Discussion and Analysis 27 Consolidated Financial Statements 68 Notes to Consolidated Financial Statements 72 Corporate and Shareholder Information 116 26 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Management’s Discussion and Analysis For the years ended December 31, 2019 and 2018 The following Management’s Discussion and Analysis (MD&A) of the 2017 and 2018 transmission revenue requirement, for which the OEB financial condition and results of operations should be read together with previously granted a motion to review and vary (DTA Decision). The the consolidated financial statements and accompanying notes thereto comparative information in this MD&A reflects the amended consolidated (Consolidated Financial Statements) of Hydro One Limited (Hydro One or financial statements and amended MD&A as at and for the year ended the Company) for the year ended December 31, 2019. The Consolidated December 31, 2018. Financial Statements are prepared and presented in Canadian dollars and have been prepared in accordance with United States (US) Generally The Company has prepared this MD&A in accordance with National Accepted Accounting Principles (GAAP). All financial information in this Instrument 51-102 – Continuous Disclosure Obligations of the Canadian MD&A is presented in Canadian dollars, unless otherwise indicated. Securities Administrators. Under the US/Canada Multijurisdictional Disclosure System, the Company is permitted to prepare this MD&A in On March 25, 2019, the Company filed amended consolidated financial accordance with the disclosure requirements of Canadian securities laws statements and amended MD&A as at and for the year ended December 31, and regulations, which can vary from those of the US. This MD&A provides 2018 to reflect the impact of the March 7, 2019 decision issued by the information for the year ended December 31, 2019, based on information Ontario Energy Board (OEB) relating to the deferred tax asset portion of available to management as of February 11, 2020. the OEB’s decision on Hydro One Networks Inc.’s (Hydro One Networks) Consolidated Financial Highlights and Statistics Year ended December 31 (millions of dollars, except as otherwise noted) 2019 2018 Change Revenues 6,480 6,150 5.4% Purchased power 3,111 2,899 7.3% Revenues, net of purchased power1 3,369 3,251 3.6% Operation, maintenance and administration (OM&A) costs 1,181 1,105 6.9% Depreciation, amortization and asset removal costs 878 837 4.9% Financing charges 514 459 12.0% Income tax expense (recovery) (6) 915 (100.7%) Net income (loss) to common shareholders of Hydro One 778 (89) 974.2% Adjusted net income to common shareholders of Hydro One1 918 807 13.8% Basic earnings per common share (EPS) $ 1.30 $ (0.15) 966.7% Diluted EPS $ 1.30 $ (0.15) 966.7% Basic adjusted non-GAAP EPS (Adjusted EPS)1 $ 1.54 $ 1.35 14.1% Diluted Adjusted EPS1 $ 1.53 $ 1.35 13.3% Net cash from operating activities 1,614 1,575 2.5% Funds from operations (FFO)1 1,532 1,572 (2.5%) Capital investments 1,667 1,575 5.8% Assets placed in-service 1,703 1,813 (6.1%) Transmission: Average monthly Ontario 60-minute peak demand (MW) 19,896 20,485 (2.9%) Distribution: Electricity distributed to Hydro One customers (GWh) 27,536 27,338 0.7% 2019 2018 Debt to capitalization ratio2 56.3% 55.6% 1 See section “Non-GAAP Measures” for description and reconciliation of adjusted net income, basic and diluted Adjusted EPS, FFO and revenues, net of purchased power. 2 De bt to capitalization ratio is a non-GAAP measure and has been presented as at December 31, 2019 and 2018, and has been calculated as total debt (including total long-term debt, convertible debentures and short-term borrowings, net of cash and cash equivalents) divided by total debt plus total shareholders’ equity, including preferred shares but excluding any amounts related to noncontrolling interest. Management believes that the debt to capitalization ratio is helpful as a measure of the proportion of debt in the Company’s capital structure. Overview operations are owned by Hydro One Inc. Hydro One delivers electricity safely and reliably to approximately 1.4 million customers across the Through its wholly-owned subsidiary, Hydro One Inc., Hydro One is province of Ontario, and to large industrial customers and municipal utilities. Ontario’s largest electricity transmission and distribution utility. Hydro One Hydro One Inc. owns and operates approximately 30,000 circuit kilometres owns and operates substantially all of Ontario’s electricity transmission of high-voltage transmission lines and approximately 123,000 circuit network and is the largest electricity distributor in Ontario by number kilometres of primary low-voltage distribution lines. Hydro One has three of customers. The Company’s regulated transmission and distribution segments: (i) transmission; (ii) distribution; and (iii) other. Hydro One Limited | Annual Report 2019 27
Management’s Discussion and Analysis For the years ended December 31, 2019 and 2018, Hydro One’s segments accounted for the Company’s total revenues, net of purchased power, as follows: Year ended December 31 2019 2018 Transmission 49% 52% Distribution 50% 47% Other 1% 1% As at December 31, 2019 and 2018, Hydro One’s segments accounted for the Company’s total assets as follows: December 31 2019 2018 Transmission 56% 55% Distribution 37% 36% Othe r 7% 9% Transmission Segment and an approximately 75% interest in Niagara Reinforcement Limited Hydro One’s transmission business owns, operates and maintains Hydro Partnership (NRLP), a limited partnership between Hydro One and Six One’s transmission system, which accounts for approximately 98% of Nations of the Grand River Development Corporation and the Mississaugas Ontario’s transmission capacity based on revenue approved by the OEB. of the Credit First Nation (collectively, the First Nations Partners). The As at December 31, 2019, the Company’s transmission business consists of Company’s 75% interest in NRLP was reduced to 55% in January 2020. the transmission system operated by Hydro One Inc.’s subsidiaries, Hydro See section “Other Developments – NRLP” for additional information. The One Networks and Hydro One Sault Ste. Marie LP (HOSSM), as well as an Company’s transmission business is rate-regulated and earns revenues approximately 66% interest in B2M Limited Partnership (B2M LP), a limited mainly from charging transmission rates that are approved by the OEB. partnership between Hydro One and the Saugeen Ojibway Nation (SON), As at and for the year ended December 31 2019 2018 Electricity transmitted1 (MWh) 135,101,455 137,436,546 Transmission lines spanning the province (circuit-kilometres) 30,122 30,166 Rate base (millions of dollars) 12,609 11,870 Capital investments (millions of dollars) 1,035 985 Assets placed in-service (millions of dollars) 1,082 1,164 1 Electricity transmitted represents total electricity transmitted in Ontario by all transmitters. Distribution Segment Hydro One’s distribution business is the largest in Ontario and consists of the distribution system operated by Hydro One Inc.’s subsidiaries, Hydro One Networks and Hydro One Remote Communities Inc. (Hydro One Remote Communities). The distribution business is rate-regulated and earns revenues mainly by charging distribution rates that are approved by the OEB. As at and for the year ended December 31 2019 2018 Electricity distributed to Hydro One customers (GWh) 27,536 27,338 Electricity distributed through Hydro One lines (GWh)1 38,446 38,265 Distribution lines spanning the province (circuit-kilometres) 123,422 123,441 Distribution customers (number of customers) 1,381,011 1,370,819 Rate base (millions of dollars) 8,101 7,852 Capital investments (millions of dollars) 624 577 Assets placed in-service (millions of dollars) 602 642 1 Units distributed through Hydro One lines represent total distribution system requirements and include electricity distributed to consumers who purchased power directly from the Independent Electricity System Operator (IESO). 28 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis 2019 Distribution Revenues amount of electricity the Company distributes. Distribution revenues also include ancillary distribution service revenues, such as fees related to the Embedded Distributors 8% joint use of Hydro One’s distribution poles by the telecommunications and cable television industries, as well as miscellaneous revenues such Large Users 11 % as charges for late payments. Residential 52% Purchased Power Costs Purchased power costs are incurred by the distribution business and General Service 29% represent the cost of the electricity purchased by the Company for delivery to customers within Hydro One’s distribution service territory. These costs are comprised of: (i) the wholesale commodity cost of energy; (ii) the Global Adjustment, which is the difference between amounts the IESO pays energy Other Segment producers for the electricity they produce and the actual fair market value Hydro One’s other segment consists principally of its telecommunications of this electricity; and (iii) the wholesale market service and transmission business, which provides telecommunications support for the Company’s charges levied by the IESO. Hydro One passes on the cost of electricity transmission and distribution businesses, as well as certain corporate activities. that it delivers to its customers, and is therefore not exposed to wholesale electricity commodity price risk. The telecommunication business is carried out by Hydro One’s wholly- owned subsidiary Hydro One Telecom Inc. (Hydro One Telecom). It also offers comprehensive communications and information technology services Operation, Maintenance and Administration Costs and solutions (for example, cloud services, managed services and security- OM&A costs are incurred to support the operation and maintenance of based services) that extend beyond Hydro One Telecom’s fibre optic the transmission and distribution systems, and include other costs such as network, in a competitive commercial market. Hydro One Telecom is not property taxes related to transmission and distribution stations and buildings, regulated by the OEB. However, Hydro One Telecom is registered with the and the operation of information technology (IT) systems. Transmission Canadian Radio-television and Telecommunications Commission as a non- OM&A costs are required to sustain the Company’s high-voltage dominant, facilities-based carrier, providing broadband telecommunications transmission stations, lines, and rights-of-way, and include preventive services in Ontario with connections to Montreal, Quebec; Buffalo, New and corrective maintenance costs related to power equipment, overhead York; and Detroit, Michigan. transmission lines, transmission station sites, and forestry control to maintain safe distances between line spans and trees. Distribution OM&A costs Corporate activities include the deferred tax asset which arose on the are required to maintain the Company’s low-voltage distribution system transition from the provincial payments in lieu of tax regime to the federal tax to provide safe and reliable electricity to the Company’s residential, small regime at the time of the Company’s initial public offering in 2015 and reflects business, commercial, and industrial customers across the province. These the revaluation of the tax basis of Hydro One’s assets to fair market value. include costs related to distribution line clearing and forestry control to reduce power outages caused by trees, line maintenance and repair, land Primary Factors Affecting Results of Operations assessment and remediation, as well as issuing timely and accurate bills and responding to customer inquiries. Transmission Revenues Transmission revenues primarily consist of regulated transmission rates Hydro One manages its costs through ongoing efficiency and productivity approved by the OEB which are charged based on the monthly peak initiatives, while continuing to complete planned work programs associated with electricity demand across Hydro One’s high-voltage network. Transmission the development and maintenance of its transmission and distribution networks. rates are designed to generate revenues necessary to construct, upgrade, extend and support a transmission system with sufficient capacity to Depreciation, Amortization and Asset Removal Costs accommodate maximum forecasted demand and a regulated return on Depreciation and amortization costs relate primarily to depreciation of the the Company’s investment. Peak electricity demand is primarily influenced Company’s property, plant and equipment, and amortization of certain by weather and economic conditions. Transmission revenues also include intangible assets and regulatory assets. Asset removal costs consist of costs export revenues associated with transmitting electricity to markets outside incurred to remove property, plant and equipment where no asset retirement of Ontario. Ancillary revenues include revenues associated with providing obligations have been recorded on the balance sheet. maintenance services to power generators and from third-party land use. Financing Charges Distribution Revenues Financing charges relate to the Company’s financing activities, and Distribution revenues primarily consist of regulated distribution rates include interest expense on the Company’s long-term debt and short-term approved by the OEB, as well as the recovery of purchased power borrowings, as well as gains and losses on interest rate swap agreements, costs. Distribution rates are designed to generate revenues necessary to contingent foreign exchange or other similar contracts, net of interest construct and support the local distribution system with sufficient capacity earned on short-term investments. A portion of financing charges incurred to accommodate existing and new customer demand and a regulated by the Company is capitalized to the cost of property, plant and equipment return on the Company’s investment. Accordingly, distribution revenues associated with the periods during which such assets are under construction are influenced by distribution rates, the cost of purchased power, and the before being placed in-service. Hydro One Limited | Annual Report 2019 29
Management’s Discussion and Analysis Results of Operations higher financing charges primarily resulting from an increase in interest expense on long-term debt; and increased Merger-related financing Net Income charges; and Net income attributable to common shareholders for the year ended December 31, 2019 of $778 million is an increase of $867 million or lower income tax expense as a result of the prior year charge to deferred 974.2% from the prior year. Significant influences on earnings included: tax expense related to the impairment of Hydro One’s deferred income tax regulatory asset, as well as the deferred tax asset sharing and Accelerated higher revenues, net of purchased power, primarily resulting from: CCA, both of which will flow through to customers and are offset with — an increase in distribution revenues, net of purchased power, due to lower revenues, with no impact on regulated ROE. the OEB’s decision on the 2018 and 2019 distribution rates; partially offset by EPS and Adjusted EPS EPS was $1.30 in 2019, compared to a loss per share of $0.15 in 2018. The — lower average monthly Ontario 60-minute peak demand and energy increase in EPS was driven by higher earnings in 2019, as discussed above. consumption driven by less favourable weather in 2019; and Adjusted EPS, which adjusts for income and costs related to the Merger, — lower revenues as a result of deferred tax asset sharing mandated by including gains and losses on the deal-contingent foreign-exchange forward the OEB and deferred tax regulatory adjustment related to accelerated contract (Foreign-Exchange Contract), as well as the impacts related to the tax depreciation (Accelerated CCA), both of which will flow through to DTA Decision was $1.54 in 2019, compared to $1.35 in 2018. The increase customers and are offset with lower taxes, with no impact on regulated in Adjusted EPS was driven by higher net income in 2019, as discussed return-on-equity (ROE); above, but excluding the impacts of the Merger and the DTA Decision. higher OM&A costs primarily resulting from the payment of the termination See section “Non-GAAP Measures” for description and reconciliation of fee related to the terminated acquisition of Avista Corporation (Merger) Adjusted EPS. and higher vegetation management coverage; partially offset by lower corporate support costs, insurance proceeds received in 2019, and lower spend on station and lines maintenance programs; Revenues Year ended December 31 (millions of dollars, except as otherwise noted) 2019 2018 Change Transmission 1,652 1,686 (2.0%) Distribution 4,788 4,422 8.3% Other 40 42 (4.8%) Total revenues 6,480 6,150 5.4% Transmission 1,652 1,686 (2.0%) Distribution, net of purchased power1 1,677 1,523 10.1% Other 40 42 (4.8%) Total revenues, net of purchased power1 3,369 3,251 3.6% Transmission: Average monthly Ontario 60-minute peak demand (MW) 19,896 20,485 (2.9%) Distribution: Electricity distributed to Hydro One customers (GWh) 27,536 27,338 0.7% 1 See section “Non-GAAP Measures” for description and reconciliation of distribution revenues, net of purchased power, and revenues, net of purchased power. Transmission Revenues Distribution Revenues, Net of Purchased Power Transmission revenues decreased by 2.0% in 2019 primarily due to Distribution revenues, net of purchased power, increased by 10.1% in 2019 the following: primarily due to the following: lower average monthly Ontario 60-minute peak demand driven by less the OEB’s decision on the 2018 and 2019 distribution rates; partially favourable weather in 2019; and offset by deferred tax regulatory adjustment related to Accelerated CCA; partially deferred tax asset sharing mandated by the OEB and deferred tax offset by regulatory adjustment related to Accelerated CCA; and the 2018 impact of the OEB decision in respect of the deferred tax asset; deferred regulatory adjustment related to Earnings Sharing Mechanism in 2019. increased OEB-approved transmission rates for 2019; and revenue related to NRLP assets placed in-service in late August 2019. 30 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis OM&A Costs Year ended December 31 (millions of dollars) 2019 2018 Change Transmission 355 409 (13.2%) Distribution 610 602 1.3% Other 216 94 129.8% 1,181 1,105 6.9% Transmission OM&A Costs Depreciation, Amortization and Asset Removal Costs The decrease of 13.2% in transmission OM&A costs for the year ended The increase of $41 million or 4.9% in depreciation, amortization and December 31, 2019 was primarily due to: asset removal costs in 2019 was mainly due to the growth in capital assets higher insurance proceeds received in 2019; as the Company continues to place new assets in-service, consistent with its ongoing capital investment program. lower spend on station and lines maintenance programs; lower project write-offs in 2019; Financing Charges The increase of $55 million or 12.0% in financing charges for the year lower volume of work on transmission vegetation management coverage; ended December 31, 2019 was primarily due to: lower property taxes due to a reassessment of municipal property taxes; and an increase in interest expense on long-term debt and short-term notes lower corporate support costs; partially offset by payable, primarily driven by higher balances outstanding in 2019; and higher spend related to IT projects as a result of the implementation of new higher Merger-related financing charges, including the write-off of tools to support ongoing operations. deferred financing costs related to the convertible debentures redeemed in February 2019, the reversal of previously recorded unrealized gains on the Distribution OM&A Costs Foreign-Exchange Contract, and unrealized gain on the Foreign-Exchange The increase of 1.3% in distribution OM&A costs for the year ended Contract recorded in 2018, partially offset by a decrease in interest December 31, 2019 was primarily due to: expense related to the convertible debentures. higher volume of work on distribution vegetation management coverage; Income Tax Expense higher emergency power restoration costs due to a higher volume of Income tax recovery was $6 million for the year ended December 31, 2019, non-storm related emergency calls; and compared to an income tax expense of $915 million in 2018. The Company higher spend related to IT projects; partially offset by realized an effective tax rate (ETR) of approximately (0.8%) in 2019, compared to approximately 107.6% in 2018. lower corporate support costs; lower costs resulting from the repatriation of the Call Centre; As prescribed by the regulators, the Company recovers income taxes and is required to accrue its tax expense based on the tax liability determined mutual storm assistance costs in the first quarter of 2018 (net income without accounting for temporary differences recoverable from or neutral); and refundable to customers in the future. lower project write-offs in 2019. The decrease in income tax expense for the year ended December 31, 2019 Other OM&A Costs was primarily attributable to the following: The increase in other OM&A costs for the year ended December 31, 2019 the prior year charge to deferred tax expense related to the impairment was primarily due to the payment of the Merger termination fee and higher of Hydro One’s deferred income tax regulatory asset; project write-offs related to the regulatory decision on the Lake Superior Link project, partially offset by lower corporate support costs. deferred tax asset sharing mandated by the OEB; and Accelerated CCA resulting from the enactment of certain 2019 federal and Ontario budget measures in the second quarter of 2019; partially offset by tax recovery on the termination fee and financing charges related to the Merger. Hydro One Limited | Annual Report 2019 31
Management’s Discussion and Analysis Common Share Dividends In 2019, the Company declared and paid cash dividends to common shareholders as follows: Total Amount Date Declared Record Date Payment Date Amount per Share (millions of dollars) February 20, 2019 March 13, 2019 March 29, 2019 $ 0.2300 137 May 8, 2019 June 12, 2019 June 28, 2019 $ 0.2415 145 August 8, 2019 September 12, 2019 September 30, 2019 $ 0.2415 144 November 6, 2019 December 11, 2019 December 31, 2019 $ 0.2415 144 570 Following the conclusion of the fourth quarter of 2019, the Company declared a cash dividend to common shareholders as follows: Total Amount Date Declared Record Date Payment Date Amount per Share (millions of dollars) February 11, 2020 March 11, 2020 March 31, 2020 $ 0.2415 144 Selected Annual Financial Statistics Year ended December 31 (millions of dollars, except per share amounts) 2019 2018 2017 Revenues 6,480 6,150 5,990 Net income (loss) to common shareholders of Hydro One 778 (89) 658 Basic EPS $ 1.30 $ (0.15) $ 1.11 Diluted EPS $ 1.30 $ (0.15) $ 1.10 Basic Adjusted EPS1 $ 1.54 $ 1.35 $ 1.17 Diluted Adjusted EPS1 $ 1.53 $ 1.35 $ 1.16 Dividends per common share declared $ 0.96 $ 0.91 $ 0.87 Dividends per preferred share declared $ 1.06 $ 1.06 $ 1.06 December 31 (millions of dollars) 2019 2018 2017 Total assets 27,061 25,657 25,701 Total non-current financial liabilities 10,828 10,479 9,815 1 See section “Non-GAAP Measures” for description and reconciliation of basic and diluted Adjusted EPS. higher Merger-related financing charges, including an increase in interest Net Income (Loss) – 2018 compared to 2017 expense incurred on the convertible debentures, partially offset by Net loss attributable to common shareholders for the year ended December 31, revaluation of the Foreign-Exchange Contract; partially offset by 2018 of $89 million represents a $747 million or 113.5% reduction in earnings from the prior year. Significant influences on earnings included: an increase in transmission and distribution revenues primarily due to higher energy consumption resulting from favourable weather; and higher income tax expense primarily attributable to a one-time charge to higher transmission revenues driven by increased OEB-approved deferred tax expense in 2018 related to the impairment of Hydro One’s transmission rates. deferred income tax regulatory asset; higher OM&A costs primarily resulting from higher vegetation EPS and Adjusted EPS – 2018 compared to 2017 management costs, property taxes, project write-offs, and demand EPS was a loss of $0.15 in 2018, compared to earnings of $1.11 in 2017. The maintenance work on power equipment and overhead lines; partially decrease in EPS was driven by lower earnings in 2018, as discussed above. offset by savings related to the renewed IT contract and lower costs Adjusted EPS was $1.35 in 2018, compared to $1.17 in 2017. The increase related to the Merger; and in Adjusted EPS was driven by net income impacts discussed above, but excluding the impacts of the Merger and the DTA Decision. 32 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Quarterly Results of Operations Quarter ended (millions of dollars, except EPS) Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Revenues 1,715 1,593 1,413 1,759 1,491 1,606 1,477 1,576 Purchased power 914 737 653 807 741 733 674 751 Revenues, net of purchased power1 801 856 760 952 750 873 803 825 Net income (loss) to common shareholders 211 241 155 171 (705) 194 200 222 Adjusted net income to common shareholders1 211 241 155 311 176 227 194 210 Basic EPS $ 0.35 $ 0.40 $ 0.26 $ 0.29 $ (1.18) $ 0.33 $ 0.34 $ 0.37 Diluted EPS $ 0.35 $ 0.40 $ 0.26 $ 0.29 $ (1.18) $ 0.32 $ 0.33 $ 0.37 Basic Adjusted EPS1 $ 0.35 $ 0.40 $ 0.26 $ 0.52 $ 0.30 $ 0.38 $ 0.33 $ 0.35 Diluted Adjusted EPS1 $ 0.35 $ 0.40 $ 0.26 $ 0.52 $ 0.29 $ 0.38 $ 0.32 $ 0.35 1 See section “Non-GAAP Measures” for description of revenues, net of purchased power, adjusted net income and Adjusted EPS. Variations in revenues and net income over the quarters are primarily due to the impact of seasonal weather conditions on customer demand and market pricing, as well as timing of regulatory decisions. Capital Investments through a combination of sustaining capital investments, which are required to support the continued operation of Hydro One’s existing assets, and The Company makes capital investments to maintain the safety, reliability development capital investments, which involve both additions to existing and integrity of its transmission and distribution system assets and to provide assets and large-scale projects such as new transmission lines and for the ongoing growth and modernization required to meet the expanding transmission stations. and evolving needs of its customers and the electricity market. This is achieved Assets Placed In-Service The following table presents Hydro One’s assets placed in-service during the year ended December 31, 2019 and 2018: Year ended December 31 (millions of dollars) 2019 2018 Change Transmission 1,082 1,164 (7.0%) Distribution 602 642 (6.2%) Other 19 7 171.4% Total assets placed in-service 1,703 1,813 (6.1%) Transmission Assets Placed In-Service assets placed in-service in 2019 for station sustainment investments Transmission assets placed in-service decreased by $82 million or 7.0% (primarily at Enfield, Hanmer, Elgin transmission stations, as well as line during the year ended December 31, 2019 primarily due to: refurbishment projects); and assets placed in-service in the second quarter of 2018 for the Clarington assets placed in-service for major development project at Leamington transmission station; and transmission station in 2019. assets placed in-service in 2018 for station sustainment investments (primarily at Horning, Centralia, London, and St. Isidore transmission Distribution Assets Placed In-Service stations, as well as the Bruce Special Protection System end-of-life Distribution assets placed in-service decreased by $40 million or 6.2% equipment replacement project); partially offset by during the year ended December 31, 2019 primarily due to lower volume of storm-related asset replacements in 2019, partially offset by higher volume completion of development work at Niagara Reinforcement Project of new residential customer connections. in 2019; Hydro One Limited | Annual Report 2019 33
Management’s Discussion and Analysis Capital Investments The following table presents Hydro One’s capital investments during the years ended December 31, 2019 and 2018: Year ended December 31 (millions of dollars) 2019 2018 Change Transmission Sustaining 811 810 0.1% Development 143 116 23.3% Other 81 59 37.3% 1,035 985 5.1% Distribution Sustaining 272 296 (8.1%) Development 265 217 22.1% Other 87 64 35.9% 624 577 8.1% Other 8 13 (38.5%) Total capital investments 1,667 1,575 5.8% Total 2019 capital investments of $1,667 million were largely in-line with the previously disclosed expected amount of $1,694 million. Transmission Capital Investments Distribution Capital Investments Transmission capital investments increased by $50 million or 5.1% during Distribution capital investments increased by $47 million or 8.1% during the the year ended December 31, 2019. Principal impacts on the levels of year ended December 31, 2019. Principal impacts on the levels of capital capital investments included: investments included: higher volume of transmission overhead lines and station refurbishments timing of investments in distribution system connections (Leamington and and replacements; Enfield transmission stations) and increased investment in distribution modernization initiatives; higher investments in multi-year development projects in 2019 (primarily East-West Tie Expansion), partially offset by the work related to the Lake higher volume of new residential customer connections; Superior Link project and completion of the Clarington transmission higher volume of lines and station refurbishments and replacements; station in 2018; higher volume of emergency power restoration work; and higher volume of load customer connections; and higher volume of IT and work equipment purchases; partially offset by higher volume of IT and work equipment purchases. lower volume of storm-related asset replacements. 34 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Major Transmission Capital Investment Projects The following table summarizes the status of significant transmission projects as at December 31, 2019: Anticipated Capital Cost Project Name Location Type In-Service Date Estimated Cost To Date Development Projects: (year) (millions of dollars) Niagara Niagara area New transmission line and stations 20191 135 135 Reinforcement Project Southwestern Ontario Wataynikaneyap Pickle Lake New stations and transmission connection 20 21 23 1 Power LP Line Connection Northwestern Ontario East-West Tie Northern Ontario New transmission connection 20222 157 62 Station Expansion and station expansion Waasigan Transmission Line Thunder Bay-Atikokan-Dryden New transmission line 20243 353 3 Northwestern Ontario Leamington Area Leamington New transmission line and stations 20264 3254 2 Transmission Reinforcement4 Southwestern Ontario Sustainment Projects: Richview Transmission Station Toronto Southwestern Ontario Station sustainment 20 21 115 109 Circuit Breaker Replacement Bruce A Transmission Station Tiverton Southwestern Ontario Station sustainment 20 21 147 133 Beck #2 Transmission Station Niagara area Station sustainment 2023 135 77 Circuit Breaker Replacement Southwestern Ontario Lennox Transmission Station Napanee Southeastern Station sustainment 2024 116 78 Circuit Breaker Replacement Ontario Middleport Transmission Middleport Station sustainment 2025 116 5 36 Station Circuit Southwestern Ontario Breaker Replacement 1 The Niagara Reinforcement Project was placed in-service in August 2019. Total costs include $119 million for the construction of a new 230 kV transmission line (Niagara Line), as well as $16 million for costs relating to other assets, including stations. In September 2019, the Niagara Line assets were transferred from Hydro One Networks to NRLP. See section Regulation – NRLP for additional information. 2 The majority of the East-West Tie Station Expansion project is expected to be placed in-service in 2021, enabling the connection and energization of the new East-West Tie transmission line. Additional work to complete the upgrades is expected to be placed in-service in 2022. 3 The in-service date and the costs of the Waasigan Transmission Line project (formerly known as Northwest Bulk Transmission Line Development project) relate to the development phase. 4 The Leamington Area Transmission Reinforcement project consists of the construction of a new double-circuit line between Chatham and Leamington and associated transmission stations and connections. The project is currently in the development stage. The anticipated in-service dates for the line and stations are between 2020 and 2026, and the total estimated cost is in the range of $290 million to $325 million, with approximately $249 million of the total estimated cost included in the projected capital investments tables in section “Future Capital Investments” below. 5 Approximately $76 million of the total estimated cost is included in the projected capital investments tables in section “Future Capital Investments” below. Future Capital Investments transmission capital investments and 2023 distribution capital investments Following is a summary of estimated capital investments by Hydro One estimates are lower than the prior year disclosures as the Company has over the years 2020 to 2024. The Company’s estimates are based on updated its plan for timing and pacing of future capital investments, as well management’s expectations of the amount of capital expenditures that as reprioritization of work. Changes in other capital investments are due will be required to provide transmission and distribution services that are to timing and new planned capital investments by Hydro One Telecom, as efficient, reliable, and provide value for customers, consistent with the well as capital investments by Ontario Charging Network LP (OCN LP), a OEB’s Renewed Regulatory Framework. joint venture limited partnership between a subsidiary of Hydro One and Ontario Power Generation Inc. (OPG). The projections and the timing of the The 2020 to 2022 distribution capital investments estimates differ from 2018 transmission 2020–2024 expenditures and the distribution 2023–2024 year end disclosures, representing a decrease to reflect Hydro One’s five- expenditures are subject to approval by the OEB. year rate application for 2018–2022 distribution rates. The 2020 to 2022 Hydro One Limited | Annual Report 2019 35
Management’s Discussion and Analysis The following table summarizes Hydro One’s annual projected capital investments for 2020 to 2024, by business segment: (millions of dollars) 2020 2021 2022 2023 2024 Transmission 1,181 1,307 1,359 1,382 1,380 Distribution 689 666 632 734 750 Other 34 14 16 14 10 Total capital investments1 1,904 1,987 2,007 2,130 2,140 1 Total capital investments for years 2020–2021 include $140 million related to a new Ontario grid control centre with an anticipated in-service date of 2021. The following table summarizes Hydro One’s annual projected capital investments for 2020 to 2024, by category: (millions of dollars) 2020 2021 2022 2023 2024 Sustainment 1,191 1,310 1,412 1,543 1,548 Development 438 479 422 439 459 Other1 275 198 173 148 133 Total capital investments2 1,904 1,987 2,007 2,130 2,140 1 “Other” capital expenditures consist of special projects, such as those relating to IT. 2 Total capital investments for years 2020–2021 include $140 million related to a new Ontario grid control centre with an anticipated in-service date of 2021. Summary of Sources and Uses of Cash Hydro One’s primary sources of cash flows are funds generated from operations, capital market debt issuances and bank credit facilities that are used to satisfy Hydro One’s capital resource requirements, including the Company’s capital expenditures, servicing and repayment of debt, and dividend payments. Year ended December 31 (millions of dollars) 2019 2018 Cash provided by operating activities 1,614 1,575 Cash provided by (used in) financing activities (439) 399 Cash used in investing activities (1,628) (1,516) Increase (decrease) in cash and cash equivalents (453) 458 Cash provided by operating activities Uses of cash Cash from operating activities increased by $39 million for the year ended The Company repaid $4,326 million of short-term notes in 2019, December 31, 2019 compared to 2018. The increase was impacted by compared to $3,916 million repaid in 2018. various factors, including higher cash earnings in 2019, changes in accrued The Company repaid $730 million of long-term debt in 2019, compared to purchased power costs resulting from higher energy rates and lower $753 million repaid in 2018. generation rebates from the IESO, partially offset by a higher receivable from IESO due to introduction of the new Ontario Electricity Rebate in The Company redeemed $513 million of convertible debentures in 2019, November 2019, changes in certain regulatory variance and deferral compared to no convertible debentures redeemed in 2018. accounts, as well as changes in receivable balances mainly due to higher Dividends paid in 2019 were $588 million, consisting of $570 million non-energy revenues in 2019 related to secondary land use. common share dividends and $18 million of preferred share dividends, compared to dividends of $560 million paid in 2018, consisting of Cash provided by (used in) financing activities $542 million common share dividends and $18 million of preferred Sources of cash share dividends. The Company issued $1,500 million of long-term debt in 2019, compared to $1,400 million issued in 2018. Cash used in investing activities Capital expenditures were higher in 2019, primarily due to higher volume The Company received proceeds of $4,217 million from the issuance of and timing of capital investment work. short-term notes in 2019, compared to $4,242 million received in 2018. 36 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Liquidity and Financing Strategy the purposes of, but not limited to, funding a portion of the cash purchase price of the Merger. The US Debt Shelf Prospectus allows HOHL to offer, Short-term liquidity is provided through FFO, Hydro One Inc.’s commercial from time to time in one or more public offerings, up to US$3.0 billion of paper program, and the Company’s consolidated bank credit facilities. debt securities, unconditionally guaranteed by Hydro One, during the Under the commercial paper program, Hydro One Inc. is authorized to 25-month period ending on December 23, 2020. At December 31, 2019, issue up to $2,300 million in short-term notes with a term to maturity of no securities have been issued under the Universal Base Shelf Prospectus up to 365 days. On March 25, 2019, the maximum number of short-term or the US Debt Shelf Prospectus. notes authorized for issuance was increased from $1,500 million to $2,300 million. Acquisition Credit Facilities At December 31, 2019, Hydro One Inc. had $1,143 million in commercial In June 2018, for the purpose of bridge financing for the Merger, the paper borrowings outstanding, compared to $1,252 million outstanding at Company secured a $1.0 billion non-revolving equity bridge credit facility, December 31, 2018. The interest rates on the commercial paper borrowings and a US$2.6 billion non-revolving debt bridge credit facility (Acquisition outstanding at December 31, 2019 ranged from 1.8% to 1.9%. In addition, Credit Facilities). As a result of the termination of the Merger agreement, in the Company has revolving bank credit facilities (Operating Credit Facilities) January 2019, the Company cancelled the Acquisition Credit Facilities, with with total availability of $2,550 million. On June 3, 2019, the maturity dates no amounts drawn. for the Operating Credit Facilities were extended from November 2021 and June 2022 to June 2024. At December 31, 2019 and 2018, no amounts In addition, the Foreign-Exchange Contract entered into in October 2017 that were drawn on the Operating Credit Facilities. The Company may use these was intended to mitigate the foreign currency risk related to the portion of the credit facilities for working capital and general corporate purposes. The Merger purchase price financed by the issuance of convertible debentures short-term liquidity under the commercial paper program, the Operating was terminated and revalued to $nil, resulting in a loss of $22 million Credit Facilities, and anticipated levels of FFO are expected to be sufficient recorded in 2019, compared to an unrealized gain of $25 million recorded to fund the Company’s normal operating requirements. in 2018. No amounts were paid or received by Hydro One. On February 1, 2019, Hydro One entered into a credit agreement for a Compliance $170 million unsecured demand operating credit facility (Demand Facility) At December 31, 2019, the Company was in compliance with all financial which was used to fund the payment of the Merger termination fee and covenants and limitations associated with the outstanding borrowings other Merger-related costs. On June 6, 2019, the $170 million drawn on the and credit facilities. Demand Facility was repaid, and the Demand Facility is no longer available. Credit Ratings At December 31, 2019, the Company had long-term debt outstanding in Various ratings organizations review the Company’s and Hydro One Inc.’s the principal amount of $11,486 million, which included $11,345 million of debt ratings from time to time. These ratings organizations may take various long-term debt issued by Hydro One Inc. and long-term debt in the principal actions, positive or negative. The Company cannot predict what actions amount of $141 million issued by HOSSM. The majority of long-term debt rating agencies may take in the future. The failure to maintain the Company’s issued by Hydro One Inc. has been issued under its Medium Term Note current credit ratings could adversely affect the Company’s financial (MTN) Program. The long-term debt consists of notes and debentures condition and results of operations, and a downgrade in the Company’s that mature between 2020 and 2064, and at December 31, 2019, had credit ratings could restrict the Company’s ability to access debt capital a weighted-average term to maturity of approximately 15.7 years and a markets and increase the Company’s cost of debt. weighted-average coupon rate of 4.2%. The maximum authorized principal amount of notes issuable under the current MTN Program prospectus filed in On November 20, 2019, Moody’s Investors Service (Moody’s) upgraded March 2018 is $4.0 billion. At December 31, 2019, $1,100 million remained Hydro One Inc.’s long-term debt rating to “A3” from “Baa1”, and affirmed available for issuance until April 2020. A new MTN Program prospectus is the short-term rating for commercial paper at “P-2”. Moody’s maintained expected to be filed in the first half of 2020. the stable outlook on the ratings. The upgrade reflects Moody’s view of an increased probability of extraordinary support from the provincial On June 18, 2018, Hydro One filed a short form base shelf prospectus government due to the Company’s exclusive focus on its businesses in (Universal Base Shelf Prospectus) with securities regulatory authorities in Ontario for at least the next five years. Canada. The Universal Base Shelf Prospectus allows Hydro One to offer, from time to time in one or more public offerings, up to $4.0 billion of debt, On November 8, 2019, S&P Global Ratings (S&P) affirmed the Company’s equity or other securities, or any combination thereof, during the 25-month issuer credit rating and Hydro One Inc.’s issuer and issue-level credit period ending on July 18, 2020. On November 23, 2018, Hydro One ratings and revised its ratings outlook on Hydro One and Hydro One Inc. Holdings Limited (HOHL), an indirect wholly-owned subsidiary of to stable from negative, based on expectations that Hydro One’s operating Hydro One, filed a short form base shelf prospectus (US Debt Shelf environment has stabilized and that the Company will focus on regulated Prospectus) with securities regulatory authorities in Canada and the US for operations in Ontario, without expansion outside Ontario. Hydro One Limited | Annual Report 2019 37
Management’s Discussion and Analysis At December 31, 2019, Hydro One’s corporate credit ratings were as follows: Rating Agency Corporate Credit Rating S&P A- At December 31, 2019, Hydro One Inc.’s long-term and short-term debt ratings were as follows: Short-term Debt Long-term Debt Rating Agency Rating Rating DBRS Limited R-1 (low) A (high) Moody’s Prime-2 A3 S&P A-1 (low) A- Hydro One has not obtained a credit rating in respect of any of its securities. Pension Plan An issuer rating from S&P is a forward-looking opinion about an obligor’s In 2019, Hydro One made cash contributions of $61 million to its pension overall creditworthiness. This opinion focuses on the obligor’s capacity and plan, compared to cash contributions of $75 million in 2018, and incurred willingness to meet its financial commitments as they come due but it does $41 million in net periodic pension benefit costs, compared to $75 million not apply to any specific financial obligation. An obligor with a long-term incurred in 2018. credit rating of ’A’ has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances In September 2019, Hydro One filed an actuarial valuation of its pension and economic conditions than obligors in higher-rated categories. plan as at December 31, 2018. Hydro One estimates that total Company pension contributions for 2020, 2021, 2022, 2023 and 2024 are The rating above is not a recommendation to purchase, sell or hold any approximately $66 million, $65 million, $64 million, $64 million, of Hydro One’s securities and does not comment on the market price or and $64 million, respectively. suitability of any of the securities for a particular investor. There can be no assurance that the rating will remain in effect for any given period of time or The Company’s pension benefits obligation is impacted by various that the rating will not be revised or withdrawn entirely by S&P at any time assumptions and estimates, such as discount rate, rate of return on plan in the future. Hydro One has made, and anticipates making, payments to assets, rate of cost of living increase and mortality assumptions. A full S&P pursuant to agreements entered into with S&P in respect of the rating discussion of the significant assumptions and estimates can be found in assigned to Hydro One and expects to make payments to S&P in the future the section “Critical Accounting Estimates – Employee Future Benefits”. to the extent it obtains a rating specific to any of its securities. Other Obligations Effect of Interest Rates Off-Balance Sheet Arrangements The Company is exposed to fluctuations of interest rates as its regulated ROE There are no off-balance sheet arrangements that have, or are reasonably is derived using a formulaic approach that takes into account changes in likely to have, a material current or future effect on the Company’s financial benchmark interest rates for Government of Canada debt and the A-rated condition, changes in financial condition, revenues or expenses, results of utility corporate bond yield spread. The Company issues debt from time to operations, liquidity, capital expenditures or capital resources. time to refinance maturing debt and for general corporate purposes. The Company is therefore exposed to fluctuations in interest rates in relation to such issuances of debt. See section “Risk Management and Risk Factors – Risks Relating to Hydro One’s Business – Market, Financial Instrument and Credit Risk” for more details. 38 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Summary of Contractual Obligations and Other Commercial Commitments The following table presents a summary of Hydro One’s debt and other major contractual obligations and commercial commitments: Less than More than December 31, 2019 (millions of dollars) Total1 1 year 1-3 years 3-5 years 5 years Contractual obligations (due by year) Long-term debt – principal repayments 11,486 653 1,407 831 8,595 Long-term debt – interest payments 8,249 473 891 833 6,052 Short-term notes payable 1,143 1,143 — — — Pension contributions1 323 66 129 128 — Environmental and asset retirement obligations 168 30 60 33 45 Outsourcing and other agreements2 238 162 44 19 13 Lease obligations 93 12 25 20 36 Long-term software/meter agreement 28 22 3 3 — Total contractual obligations 21,728 2,561 2,559 1,867 14,741 Other commercial commitments (by year of expiry) Operating Credit Facilities3 2,550 — — 2,550 — Letters of credit4 195 193 2 — — Guarantees5 332 332 — — — Total other commercial commitments 3,077 525 2 2,550 — 1 Contributions to the Hydro One Pension Fund are generally made one month in arrears. Company and employee contributions to the pension plan are based on actuarial reports, including valuations performed at least every three years, and actual or projected levels of pensionable earnings, as applicable. The most recent actuarial valuation was performed effective December 31, 2018 and filed on September 30, 2019. 2 In September 2019, the agreements with Inergi LP for finance and accounting, and pay operations services were extended to December 31, 2020. 3 In June 2019, the maturity dates for the Operating Credit Facilities were extended from November 2021 and June 2022 to June 2024. 4 Letters of credit consist of $179 million letters of credit related to retirement compensation arrangements, $4 million in letters of credit to satisfy debt service reserve requirements, a $9 million letter of credit provided to the IESO for prudential support, and $3 million in letters of credit for various operating purposes. 5 Guarantees consist of $325 million prudential support provided to the IESO by Hydro One Inc. on behalf of its subsidiaries, and guarantees totalling $7 million provided by Hydro One to the Minister of Natural Resources relating to OCN LP (OCN Guarantee). OPG has provided a $2.5 million guarantee to Hydro One related to the OCN Guarantee. Share Capital The number of additional common shares of Hydro One that would be issued if all outstanding awards under the share grant plans and The common shares of Hydro One are publicly traded on the Toronto Stock the Long-term Incentive Plan (LTIP) were vested and exercised as at Exchange (TSX) under the trading symbol “H”. Hydro One is authorized to February 11, 2020 was 4,450,382. issue an unlimited number of common shares. The amount and timing of any dividends payable by Hydro One is at the discretion of the Hydro One Board of Directors (Board) and is established on the basis of Hydro One’s results of Regulation operations, maintenance of its deemed regulatory capital structure, financial The OEB approves both the revenue requirements and the rates charged condition, cash requirements, the satisfaction of solvency tests imposed by by Hydro One’s regulated transmission and distribution businesses. The corporate laws for the declaration and payment of dividends and other rates are designed to permit the Company’s transmission and distribution factors that the Board may consider relevant. At February 11, 2020, Hydro businesses to recover the allowed costs and to earn a formula-based annual One had 596,936,416 issued and outstanding common shares. rate of return on its deemed 40% equity level invested in the regulated businesses. This is done by applying a specified equity risk premium to The Company is authorized to issue an unlimited number of preferred forecasted interest rates on long-term bonds. In addition, the OEB approves shares, issuable in series. The Company has two series of preferred shares rate riders to allow for the recovery or disposition of specific regulatory authorized for issuance: the Series 1 preferred shares and Series 2 preferred deferral and variance accounts over specified time frames. shares. At February 11, 2020, the Company had 16,720,000 Series 1 preferred shares and no Series 2 preferred shares issued and outstanding. Hydro One Limited | Annual Report 2019 39
Management’s Discussion and Analysis The following table summarizes the status of Hydro One’s major regulatory proceedings with the OEB: Application Years Type Status Electricity Rates Hydro One Networks 2017–2018 Transmission – Cost-of-service OEB decision received1 Hydro One Networks 2019 Transmission – Revenue Cap OEB decision received Hydro One Networks 2020–2022 Transmission – Custom OEB decision pending Hydro One Networks 2018–2022 Distribution – Custom OEB decision received2 B2M LP 2015–2019 Transmission – Cost-of-service OEB decision received B2M LP 2020–2024 Transmission – Revenue Cap OEB decision received HOSSM 2017–2026 Transmission – Revenue Cap OEB decision received NRLP 2020–2024 Transmission – Revenue Cap OEB decision pending Mergers Acquisitions Amalgamations and Divestitures (MAAD) Orillia Power n/a Acquisition OEB decision pending Peterborough Distribution n/a Acquisition OEB decision pending Leave to Construct East-West Tie Station Expansion n/a Section 92 OEB decision received Lake Superior Link Project n/a Section 92 OEB decision received3 1 On March 7, 2019, the OEB upheld its original decision relating to the deferred tax asset. On April 5, 2019, the Company filed an appeal with the Ontario Divisional Court. The appeal was heard by the Ontario Divisional Court on November 21, 2019, and a decision is pending. 2 On March 26, 2019, the Company filed a motion to review and vary the OEB’s decision as it relates to recovery of pension costs. Concurrently, the Company filed an appeal with the Ontario Divisional Court, which was being held in abeyance pending the outcome of the motion. On December 19, 2019, the OEB affirmed its earlier decision with respect to recovery of the pension costs. The Company has decided to discontinue its appeal of the OEB decision with the Ontario Divisional Court. 3 On February 11, 2019, the OEB issued its decision awarding the construction of the East-West Tie Line to NextBridge, as directed by the Province of Ontario (Province) on January 30, 2019. The following table summarizes the key elements and status of Hydro One’s electricity rate applications: ROE Rate Base Allowed (A) Allowed (A) Application Year or Forecast (F) or Forecast (F) Rate Application Status Rate Order Status Transmission Hydro One Networks 2019 n/a1 n/a1 Filed in October 2018 Approved in June 2019 2020 8.52% (F) $12,375 million2 (F) Filed in March 2019 To be filed 2021 8.52% (F) $13,093 million2 (F) Filed in March 2019 To be filed 2022 8.52% (F) $13,917 million2 (F) Filed in March 2019 To be filed B2M LP 2019 8.98% (A) $496 million (A) Approved in December 2015 Approved in December 2018 2020–2024 8.52% (F) $490 million (F) Approved in January 2020 Filed in January 2020 HOSSM 2017–2026 9.19% (A) $218 million (A) Approved in October 2016 Approved in December 20193 NRLP 2020–2024 8.52% (F) $120 million (F) Filed in October 2019 To be filed Distribution Hydro One Networks 2018 9.00% (A) $7,637 million (F) Approved in March 2019 Approved in June 20194 2019 9.00% (A) $7,894 million (F) Approved in March 2019 Approved in June 20194 2020 9.00% (A) $8,175 million (F) Approved in March 2019 Approved in December 2019 2021 9.00% (A) $8,517 million (F) Approved in March 2019 To be filed in 2020 2022 9.00% (A) $8,813 million (F) Approved in March 2019 To be filed in 2021 1 The Revenue Cap application is a formulaic adjustment to the approved revenue requirement and does not consider ROE or rate base. 2 On June 19, 2019, Hydro One filed updates to the application reflecting recent financial results and other adjustments. 3 In October 2016, the OEB approved the 2017–2026 revenue requirements. In June 2019, the OEB approved the request for an inflationary increase (revenue cap escalator index) to the 2019 revenue requirement. On July 18, 2019, the OEB issued the final rate order including a final 2019 revenue requirement of $38 million to be included in the 2019 Uniform Transmission Rates (UTRs). On December 17, 2019, the OEB issued a decision on HOSSM’s request for transmission revenue requirement for 2020. 4 On June 11, 2019, the OEB approved Hydro One Networks’ rate order which included the rate base amounts shown above. 40 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Electricity Rates Applications 2018 revenue requirement as interim for 2019. On April 25, 2019, the OEB Hydro One Networks – Transmission issued its decision on Hydro One’s 2019 transmission rate application, and On September 28, 2017, the OEB issued its decision and order on Hydro set the revenue index at 1.4% on a final basis effective May 1, 2019. One Networks’ 2017 and 2018 transmission rates revenue requirements On March 21, 2019, Hydro One Networks filed a three-year Custom (Original Decision), with 2017 rates effective January 1, 2017. Incentive Rate application with the OEB for 2020–2022 transmission rates. In its Original Decision, the OEB concluded that the net deferred tax asset On June 19, 2019, Hydro One filed updates to the application reflecting resulting from transition from the payments in lieu of tax regime under the recent financial results and other adjustments. The hearing began on Electricity Act, 1998 (Ontario) to tax payments under the federal and October 21, 2019, and concluded on November 4, 2019. The OEB provincial tax regime should not accrue entirely to Hydro One shareholders decision is pending. and that a portion should be shared with ratepayers. On November 9, On December 10, 2019, the OEB approved Hydro One Networks’ 2017, the OEB issued a decision and order that calculated the portion of 2019 transmission revenue requirement and charges as interim effective the tax savings that should be shared with ratepayers. The OEB’s calculation January 1, 2020 until the new transmission revenue requirement and would result in an impairment of a portion of both Hydro One Networks’ charges are approved by the OEB. transmission and distribution deferred income tax regulatory asset. In October 2017, the Company filed a motion to review and vary (Motion) Hydro One Networks – Distribution the Original Decision and filed an appeal with the Ontario Divisional Court On March 31, 2017, Hydro One Networks filed a custom application with (Appeal). In both cases, the Company’s position was that the OEB made the OEB for 2018–2022 distribution rates under the OEB’s incentive-based errors of fact and law in its determination of allocation of the tax savings regulatory framework (2018–2022 Distribution Application), which was between the shareholders and ratepayers. On December 19, 2017, the subsequently updated on June 7 and December 21, 2017. The application OEB granted a hearing of the merits of the Motion which was held on reflects the level of capital investments required to minimize degradation February 12, 2018. On August 31, 2018, the OEB granted the Motion in overall system asset condition, to meet regulatory requirements, and to and returned the portion of the Original Decision relating to the deferred maintain current reliability levels. tax asset to an OEB panel for reconsideration. On March 7, 2019, the OEB rendered its decision on the 2018–2022 On March 7, 2019, the OEB issued its reconsideration decision (DTA Distribution Application (2018-2022 Distribution Decision). In accordance Decision) and concluded that their Original Decision was reasonable with the 2018-2022 Distribution Decision, as well as the DTA Decision as and should be upheld. Also, on March 7, 2019, the OEB issued its noted above in “Hydro One Networks – Transmission”, the Company filed decision for Hydro One Networks’ 2018–2022 distribution rates, in which its draft rate order reflecting updated revenue requirements of $1,459 million it directed the Company to apply the Original Decision to Hydro One for 2018, $1,498 million for 2019, $1,532 million for 2020, $1,578 million Networks’ distribution rates. As a result, as at December 31, 2018, the for 2021, and $1,624 million for 2022. On June 11, 2019, the OEB approved Company recognized an impairment charge of Hydro One Networks’ the rate order confirming these updated revenue requirements, which include distribution deferred income tax regulatory asset of $474 million and impacts of both the 2018–2022 Distribution Decision and the DTA Decision. Hydro One Networks’ transmission deferred income tax regulatory asset of $558 million, an increase in deferred income tax regulatory liability of On March 26, 2019, the Company filed a motion to review and vary $81 million, and a decrease in the foregone revenue deferral regulatory the OEB’s decision as it relates to rates revenue requirement recovery of asset of $68 million. After recognition of the related $314 million deferred employer pension costs. Concurrently, the Company filed an appeal with tax asset, the Company recorded an $867 million one-time decrease in net the Ontario Divisional Court. The appeal was held in abeyance pending income as a reversal of revenues of $68 million, and charge to deferred tax the outcome of the motion made before the OEB. During the year, the expense of $799 million, which is expected to result in an annual decrease Company reflected a portion of pension costs incurred in the Hydro to FFO in the range of $50 million to $60 million in the near term, and this One Networks’ distribution Pension Cost Differential regulatory account, range will decline over time. Notwithstanding the recognition of the effects pending the outcome of the motion before the OEB. On December 19, of the DTA Decision in the 2018 financial statements, on April 5, 2019, the 2019, the OEB affirmed its earlier decision with respect to recovery of the Company filed an appeal with the Ontario Divisional Court with respect to revenue requirement associated with pension costs. As a result, Hydro One the OEB’s DTA Decision. The appeal was heard on November 21, 2019, derecognized the portion relating to pension costs charged to operations as and a decision is pending. a reversal of revenues of $13 million as this amount is no longer probable for recovery. Hydro One also transferred to property, plant and equipment On October 26, 2018, Hydro One filed a one-year inflation-based and intangible assets the portion attributable to capital expenditures in the application with the OEB for the 2019 transmission revenue requirement. amount of $37 million. Hydro One has decided to discontinue its appeal On December 20, 2018, the OEB issued a decision approving Hydro One’s of the OEB decision with the Ontario Divisional Court. Hydro One Limited | Annual Report 2019 41
Management’s Discussion and Analysis Hydro One Remote Communities HOSSM On November 5, 2018, Hydro One Remote Communities filed an HOSSM is under a 10-year deferred rebasing period for years 2017–2026, application with the OEB seeking approval for increased base rates of as approved in the OEB MAAD decision dated October 13, 2016. In July 1.8% effective May 1, 2019. On February 11, 2019, the OEB issued a draft 2018, HOSSM filed a 2019 application to allow for inflationary increase decision approving the requested increase, which was later finalized on (revenue cap escalator index) to its previously approved revenue requirement. March 28, 2019. On November 15, 2019, Hydro One Remote Communities The revenue cap escalator index is designed to add inflationary increases filed an application with the OEB seeking approval for increased base rates to the revenue requirement on an annual basis. On June 20, 2019, the OEB of 2.0% effective May 1, 2020. A decision from the OEB is pending. approved the revenue cap escalator index at 1.1% (net) which was applied to HOSSM’s base revenue requirement for 2019, effective February 1, 2019, Hydro One Remote Communities is fully financed by debt and is operated and also approved the 2019–2026 revenue cap framework. as a break-even entity with no ROE. On December 17, 2019, the OEB issued a decision on HOSSM’s request for NRLP transmission revenue requirement for 2020. The OEB approved the revenue On September 19, 2018, NRLP was formed to own and operate a new cap adjustment requesting an increase to the 2020 revenue requirement of 230 kV transmission line (Niagara Line) in the Niagara region. The Niagara 1.5% (inflation factor 1.8% less stretch factor 0.3%). Line enables generators in the Niagara area to connect to the load centres of the Greater Toronto and Hamilton areas. B2M LP On July 31, 2019, B2M LP filed a transmission rate application for 2020– On September 27, 2018, Hydro One filed a transmission licence application 2024, seeking a base revenue requirement of $36 million for 2020, and with the OEB for NRLP. On October 25, 2018, Hydro One filed two other a 1.4% revenue cap escalator index for 2021 to 2024. On December 9, applications with the OEB relating to NRLP requesting approval for Hydro 2019, B2M LP reached a settlement on all issues with OEB staff and One Networks to sell the applicable Niagara Line assets to NRLP, and Intervenors on the 5-year revenue cap rate application for 2020–2024 approval of interim rates to include in the 2019 Uniform Transmission Rates to be effective January 1, 2020. The settlement accepts all of B2M LP’s (UTRs). On December 20, 2018, the OEB issued a decision finding that the cost submissions, but includes additional reliability reporting and a capital request for approval for an interim revenue requirement effective January 1, adjustment (reduction) factor of 0.6% to account for the lower rate base 2019 was premature but indicated that there would be an opportunity to value. On January 6, 2020, the settlement agreement was filed with the adjudicate the matter at a later date. OEB for approval, and was approved on January 16, 2020. In January 2019, construction on the project was halted due to a land MAAD Applications dispute with the Haudenosaunee Confederacy Chiefs Council (HCCC). On March 1, 2019, Hydro One filed a letter with the OEB requesting that the Orillia Power MAAD Application three previously filed applications be heard together once the land dispute In 2016, Hydro One filed a MAAD application (2016 Application) with the was resolved. On March 15, 2019, the OEB put the NRLP applications in OEB to acquire Orillia Power Distribution Corporation (Orillia Power) from the abeyance per Hydro One’s request. Hydro One filed a Statement of Claim City of Orillia, Ontario. On April 12, 2018, the OEB issued a decision denying with the Ontario Superior Court of Justice for injunctive relief (injunction) Hydro One’s proposed acquisition of Orillia Power. On September 26, 2018, against members of the HCCC among others. On July 15, 2019, Hydro One Hydro One filed a new MAAD application (2018 Application) with the OEB was granted the injunction. Hydro One resumed construction shortly thereafter. to acquire Orillia Power. The evidence in the 2018 Application is similar to that provided in the 2016 Application. However, it includes additional On August 1, 2019, Hydro One filed an update to the three previously information that was not available at the time Hydro One filed its 2016 filed OEB applications and asked that the OEB resume adjudication of the Application, including updates to reflect current variables to costs and other applications. On August 30, 2019, the construction of the Niagara Line metrics, as well as future cost structures pertaining to the acquired entity. was completed, and on September 12, 2019, the OEB granted NRLP a transmission licence and granted Hydro One Networks leave to sell the On October 16, 2018, the School Energy Coalition (SEC) filed a motion applicable Niagara Line assets to NRLP. On September 18, 2019, the with the OEB seeking an order dismissing the 2018 Application. On applicable Niagara Line assets were transferred from Hydro One Networks January 16, 2019, Hydro One and Orillia Power filed submissions on the to NRLP. See section “Other Developments - NRLP” for additional information. SEC motion, maintaining that the motion should be dismissed, and that the 2018 Application should be heard by the OEB. On March 12, 2019, the On September 26, 2019, the OEB approved NRLP’s request to establish OEB dismissed SEC’s motion. At the request of Hydro One, on March 21, a deferral account to record NRLP’s 2019 revenue requirement prior to its 2019, the OEB cancelled the deadlines for interrogatories to allow Hydro inclusion in the UTRs. On October 25, 2019, NRLP filed its revenue cap One to file amended or supplemental evidence in response to the OEB incentive rate application for 2020–2024. The OEB decision is pending. decision on Hydro One’s 2018–2022 Distribution Application. Hydro One filed the supplemental evidence on April 26, 2019. A transcribed technical On December 19, 2019, the OEB approved NRLP’s proposed 2020 conference was held on October 3–4, 2019, followed by an oral hearing revenue requirement of $9 million as interim effective January 1, 2020. on December 2–3, 2019. A decision by the OEB is pending. 42 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Peterborough Distribution MAAD Application 5. INNOVATE AND GROW THE BUSINESS On October 12, 2018, the Company filed an application with the OEB We will continue to invest responsibly in our core transmission and for approval of the acquisition of the business and distribution assets of distribution business. In addition, we will pursue incremental regulated Peterborough Distribution Inc. (Peterborough Distribution). On October 25, and unregulated business opportunities through innovation and our 2018, an advance ruling certification application was filed with the focused presence in Ontario. Competition Bureau. On November 14, 2018, the Competition Bureau issued a no action letter, meaning that the transaction can proceed from Litigation the Competition Bureau’s perspective. At the request of Hydro One, Hydro One Inc., Hydro One Networks, Hydro One Remote Communities, on March 21, 2019, the OEB allowed Hydro One to file amended or and Norfolk Power Distribution Inc. were defendants in a class action suit supplemental evidence in response to the OEB decision on Hydro One’s commenced in 2015 in which the representative plaintiff was seeking up to 2018–2022 Distribution Application. Hydro One filed the supplemental $125 million in damages related to allegations of improper billing practices. evidence on April 26, 2019. A transcribed technical conference was held The plaintiff’s application for leave to appeal the lower court’s refusal to certify on October 3–4, 2019, followed by an oral hearing on December 2–3, the lawsuit as a class action was denied by the Ontario Court of Appeal on 2019. A decision by the OEB is pending. March 26, 2019, which means that the lawsuit has effectively ended. Other Developments There were four putative class action lawsuits filed by Avista Corporation shareholders in relation to the Merger. The plaintiffs in the four lawsuits were, Strategy respectively, Fink, Jenß, Samuel and Sharpenter. All of these class action In November 2019, Hydro One released its updated corporate strategy lawsuits have now been dismissed. which reaffirms the Company’s commitment to Ontario and the provision of safe, reliable and affordable electricity. The strategy focuses on five key 2019 Federal and Ontario Budgets aspirational priorities: Certain 2019 federal and Ontario budget measures enacted during the year ended December 31, 2019 provide certain time-limited investment incentives 1. PLAN, DESIGN AND BUILD A GRID FOR THE FUTURE permitting Hydro One to deduct Accelerated CCA of up to three times the We will plan, design and build a reliable grid taking into account first-year rate for eligible capital investments acquired after November 20, changing technologies to prevent future outages. There will be increased 2018 and placed in-service before January 1, 2028. In 2019, the Accelerated focus on grid resilience in order to restore power after events. Climate CCA resulted in a temporary reduction in the Company’s ETR and the change and sustainability factors will be taken into consideration in our recognition of a tax regulatory liability relating to the Accelerated CCA that planning processes to increase resilience and lower our environmental has not been reflected in the OEB approved rates. The timing of the disposition footprint. We will incorporate distributed energy resources to enable of the tax regulatory liability is subject to OEB approval, and may have a customer choice while delivering exceptional value to customers through material impact on Hydro One’s future cash flows in the near term. best-in-class asset management practices. 2. BE THE SAFEST AND MOST EFFICIENT UTILITY Impact We will transform and improve our safety culture through robust safety Hydro One expects that the OEB’s March 7, 2019 decision relating to the analytics as well as grass-roots engagement with our employees. Field sharing of the Company’s deferred tax asset, the Merger-related costs, operations will be more empowered to drive efficiency, productivity and and the Accelerated CCA will lower the Company’s ETR to a range of reliability and provided with efficient corporate support. There will be approximately 6% to 13% in the next five years. a focus on efficient capital delivery to support an ongoing growing work program. Exemptive Relief Disclosure of Ownership by the Province 3. BE A TRUSTED PARTNER On June 6, 2017, the Canadian securities regulatory authorities granted We will make concerted efforts to build and grow relationships with (i) the Minister of Energy, (ii) OPG (on behalf of itself and the segregated Indigenous peoples, government and industry partners. We will proactively funds established as required by the Nuclear Fuel Waste Act (Canada)) address community concerns and establish strong partnerships with our and (iii) agencies of the Crown, provincial Crown corporations and other customers through local investment and economic development for the provincial entities (collectively, the Non-Aggregated Holders) exemptive benefit of Ontarians. relief, subject to certain conditions, to enable each Non-Aggregated Holder to treat securities of Hydro One that it owns or controls separately from 4. ADVOCATE FOR OUR CUSTOMERS AND HELP THEM MAKE securities of Hydro One owned or controlled by the other Non-Aggregated INFORMED DECISIONS Holders for purposes of certain take-over bid, early warning reporting, We will make it easier to do business with Hydro One by strengthening insider reporting and control person distribution rules and certain distribution the customer experience through innovative customer- centric practices. restrictions under Canadian securities laws. Hydro One was also granted We will help our customers make informed decisions with deeper insights relief permitting it to rely solely on insider reports and early warning reports and leverage our position as energy experts. We will expand access to filed by Non-Aggregated Holders when reporting beneficial ownership energy offerings to become the provider of choice to our customers. Hydro One Limited | Annual Report 2019 43
Management’s Discussion and Analysis or control or direction over securities in an information circular or annual Avista Corporation information form in respect of securities beneficially owned or controlled In July 2017, Hydro One reached an agreement to acquire Avista by any Non-Aggregated Holder subject to certain conditions. Corporation. On January 23, 2019, Hydro One and Avista Corporation announced that the companies had mutually agreed to terminate the Merger US GAAP agreement. As a result of the termination of the Merger agreement, on On March 27, 2018, Hydro One was granted exemptive relief by securities January 24, 2019, Hydro One paid a US$103 million termination fee to regulators in each province and territory of Canada which allows Hydro Avista Corporation as required by the Merger agreement. In January 2019, One to continue to report its financial results in accordance with US GAAP the Company cancelled the Acquisition Credit Facilities, with no amounts (Exemptive Relief). The Exemptive Relief will remain in effect until the drawn. On February 1, 2019, Hydro One entered into the Demand Facility earlier of: (i) January 1, 2024; (ii) the first day of Hydro One’s financial which was used to fund the payment of the Merger termination fee and year that commences after Hydro One ceases to have activities subject to other Merger-related costs. On June 6, 2019, the $170 million drawn on the rate regulation; and (iii) the effective date prescribed by the International Demand Facility was repaid, and the Demand Facility is no longer available. Accounting Standards Board for the mandatory application of a standard On February 8, 2019, Hydro One redeemed the convertible debentures within International Financial Reporting Standards specific to entities with issued in 2017 and paid the holders of the instalment receipts $513 million activities subject to rate regulation. ($333 per $1,000 principal amount) plus accrued and unpaid interest of $7 million. The redemption of the convertible debentures was paid with NRLP cash on hand. As a result of the termination of the Merger agreement, the In 2018, Hydro One entered into an agreement with the First Nations Foreign-Exchange Contract terminated, with no amounts paid or received Partners, wherein a noncontrolling equity interest in Hydro One’s limited by Hydro One. partnership, NRLP, would be made available for purchase at fair value by the First Nations Partners. On September 19, 2018, NRLP was formed to The following amounts related to the termination of the Merger agreement own the Niagara Line in the Niagara region. The Niagara Line enables were recorded by the Company during the year ended December 31, 2019. generators in the Niagara area to connect to the load centres of the Greater All amounts were recognized in the first quarter. Toronto and Hamilton areas. Hydro One Networks maintains and operates $138 million for payment of the US$103 million Merger termination fee the Niagara Line in accordance with an operation and management recorded in OM&A costs; services agreement. $22 million financing charges, due to reversal of previously recorded On September 18, 2019, the applicable Niagara Line assets were unrealized gains upon termination of the Foreign-Exchange Contract; transferred from Hydro One Networks to NRLP for $119 million and redemption of $513 million convertible debentures and payment of operation of the line was contracted to Hydro One Networks. This transfer related interest of $7 million; and was financed with 60% debt ($71 million) and 40% equity ($48 million). $24 million financing charges, due to derecognition of the deferred The cash payment of $71 million was financed by debt sourced by NRLP financing costs elatedr to convertible debentures. from a Hydro One subsidiary, and the $48 million equity comprised of partnership units issued by NRLP to Hydro One Networks. Subsequently, on the same date, Hydro One Networks sold to the Six Nations of Hydro One Board of Directors and Executive Officers the Grand River Development Corporation and, through a trust, to the Board of Directors Mississaugas of the Credit First Nation a 25.0% and 0.1%, respectively, On July 31, 2019, former Board Chair Tom Woods stepped down from the equity interest in NRLP for total consideration of $12 million, representing Board. On July 2, 2019, Hydro One announced that Tim Hodgson has the fair value of the equity interest acquired. been appointed by the Board to serve as the Board Chair commencing August 1, 2019. On December 23, 2019, Hydro One announced that Susan In addition, the Mississaugas of the Credit First Nation had an option to Wolburgh Jenah has been appointed to the Board effective January 1, 2020. purchase an additional 19.9% equity interest in NRLP from Hydro One Networks at a price based on the value of the Niagara Line assets on the Executive Officers date of the closing, subject to certain conditions. On December 31, 2019, On March 28, 2019, Hydro One announced the appointment of Mark the Mississaugas of the Credit First Nation exercised the option. Poweska as President and Chief Executive Officer (CEO) of Hydro One On January 31, 2020, the Mississaugas of the Credit First Nation purchased and Hydro One Inc., effective May 10, 2019. an additional 19.9% equity interest in NRLP. On this date, Hydro One In April 2019, Greg Kiraly, Chief Operating Officer, and Jamie Scarlett, Networks sold to the Mississaugas of the Credit First Nation, through a Executive Vice President and Chief Legal Officer, left the Company following trust, a 19.9% equity interest in NRLP for total consideration of $9 million. a period of planned leadership transition. Following this transaction, Hydro One’s interest in NRLP was reduced to 55%, with the Six Nations of the Grand River Development Corporation and the Mississaugas of the Credit First Nation owning 25% and 20%, respectively, of equity interest in NRLP. 44 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis On May 8, 2019, Chris Lopez was appointed as the Chief Financial Officer Executive Compensation (CFO) of Hydro One and Hydro One Inc., effective May 9, 2019. On March 8, 2019, Hydro One released a revised executive compensation framework for its Board, the CEO and other executives that was approved On July 10, 2019, Hydro One announced the appointment of Saylor by the Management Board of Cabinet of the Province. Millitz-Lee, as Executive Vice President and Chief Human Resources Officer, effective immediately. Hydro One Work Force On August 9, 2019, Hydro One announced the appointment of Paul At December 31, 2019, Hydro One had a skilled and flexible work force Harricks, as Executive Vice President and Chief Legal Officer, effective of approximately 5,700 regular employees and 2,300 non- regular September 9, 2019. employees province-wide, comprising a mix of skilled trades, engineering, professional, managerial and executive personnel. Hydro One’s regular Effective October 1, 2019, Darlene Bradley was appointed as the Chief employees are supplemented primarily by accessing a large external labour Safety Officer of Hydro One and Hydro One Inc. force available through arrangements with the Company’s trade unions for contingent workers, sometimes referred to as “hiring halls”, and also by Effective January 2, 2020, David Lebeter was appointed as the Chief access to contract personnel. The hiring halls offer Hydro One the ability to Operating Officer of Hydro One and Hydro One Inc. flexibly use highly trained and appropriately skilled workers on a project- by-project and seasonal basis. The following table sets out the number of Hydro One employees as at December 31, 2019: Regular Non-Regular Employees Employees Total Power Workers’ Union (PWU)1 3,591 780 4,371 Society of United Professionals (Society) 1,479 38 1,517 Canadian Union of Skilled Workers (CUSW) and construction building trade unions — 1,422 1,422 Total employees represented by unions 5,070 2,240 7,310 Management and non-represented employees 660 19 679 Total employees2 5,730 2,259 7,989 1 Includes 675 non-regular “hiring hall” employees covered by the PWU agreement. 2 The average number of Hydro One employees in 2019 was approximately 8,800, consisting of approximately 5,800 regular employees and approximately 3,000 non-regular employees. Collective Agreements Hydro One’s five-year collective agreement with the CUSW expires on The current collective agreement with the PWU (for classifications other April 30, 2022. than Customer Service Operations (CSO)) expires on March 31, 2020. The collective agreement with the PWU for CSO was set to expire on The construction building trade unions have collective agreements with September 30, 2019; however, it was extended to allow for bargaining at the Electrical Power Systems Construction Association (EPSCA). EPSCA is the same time as the non-CSO agreement. In January 2020, Hydro One an employers’ association of which Hydro One is a member. A number and the PWU commenced collective bargaining with the official exchange of the EPSCA construction collective agreements, which bind Hydro One, of bargaining agendas. Both sides acknowledged their commitment to expire on April 30, 2020. Ratified five-year renewal collective agreements, working towards the timely completion of collective bargaining. covering May 1, 2020 to April 30, 2025, have been reached with The Carpenters, The Boilermakers, The United Association of Plumbers and In March 2019, Hydro One reached an agreement with the Society for Pipefitters, The Painters, and The Sheet Metal Workers. EPSCA is currently a renewal of the collective agreement covering approximately 1,500 in the process of negotiating agreements or scheduling negotiating dates employees in critical engineering, supervisory and administrative roles. with the other building trades. The agreement is for a two-year term, covering April 1, 2019 to March 31, 2021. The agreement was ratified by the Society on April 30, 2019. Hydro One Limited | Annual Report 2019 45
Management’s Discussion and Analysis Stock-based Compensation The Company granted awards under its LTIP, consisting of Performance Share Units (PSUs), Restricted Share Units (RSUs), and Stock Options. At December 31, 2019 and 2018, the following LTIP awards were outstanding: December 31 (number of units) 2019 2018 PSUs 171,344 605,180 RSUs 206,993 442,470 Stock Options 403,550 949,910 Non-GAAP Measures FFO FFO, basic and diluted Adjusted EPS, adjusted net income, revenues, net of FFO is defined as net cash from operating activities, adjusted for (i) changes purchased power, and distribution revenues, net of purchased power are in non-cash balances related to operations, (ii) dividends paid on preferred not recognized measures under US GAAP and do not have a standardized shares, and (iii) distributions to noncontrolling interest. Management believes meaning prescribed by US GAAP. They are therefore unlikely to be directly that FFO is helpful as a supplemental measure of the Company’s operating comparable to similar measures presented by other companies. They should cash flows as it excludes timing-related fluctuations in non-cash operating not be considered in isolation nor as a substitute for analysis of the Company’s working capital and cash flows not attributable to common shareholders. financial information reported under US GAAP. As such, FFO provides a consistent measure of the cash generating performance of the Company’s assets. Year ended December 31 (millions of dollars) 2019 2018 Net cash from operating activities 1,614 1,575 Changes in non-cash balances related to operations (55) 23 Preferred share dividends (18) (18) Distributions to noncontrolling interest (9) (8) FFO 1,532 1,572 Adjusted Net Income and Adjusted EPS they exclude the impact of Merger-related costs, including gains and losses The following adjusted net income, and basic and diluted Adjusted EPS have on the Foreign-Exchange Contract, as well as the impacts related to the been calculated by management on a supplementary basis which adjusts OEB’s DTA Decision on Hydro One Networks’ distribution and transmission net income under US GAAP for income and costs related to the Merger. businesses. Adjusted net income and Adjusted EPS provide users with Adjusted net income and Adjusted EPS are used internally by management a comparative basis to evaluate the current ongoing operations of the to assess the Company’s performance and are considered useful because Company compared to prior year. Year ended December 31 (millions of dollars, except number of shares and EPS) 2019 2018 2017 Net income (loss) attributable to common shareholders 778 (89) 658 Impacts related to the Merger: OM&A – Merger-related costs (before tax) 138 11 20 Financing charges – Merger-related costs (before tax) 31 58 22 Financing charges – loss (gain) on Foreign-Exchange Contract (before tax) 22 (25) 3 Tax impact (51) (15) (9) Merger-related impacts (after tax) 140 29 36 Impacts related to OEB’s DTA Decision on Hydro One Networks’ distribution and transmission businesses: Reversal of revenues — 68 — Deferred tax expense — 799 — OEB’s DTA Decision on Hydro One Networks’ distribution and transmission businesses impacts (after tax) — 867 — Adjusted net income attributable to common shareholders 918 807 694 Weighted average number of shares Basic 596,437,577 595,756,470 595,287,586 Effect of dilutive stock-based compensation plans 2,410,860 2,147,473 2,234,665 Diluted 598,848,437 597,903,943 597,522,251 Adjusted EPS Basic $ 1.54 $ 1.35 $ 1.17 Diluted $ 1.53 $ 1.35 $ 1.16 46 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Quarter ended (millions of dollars, except number of shares and EPS) Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Net income attributable to common shareholders 211 241 155 171 Impacts related to the Merger: OM&A – Merger-related costs (before tax) — — — 138 Financing charges – Merger-related costs (before tax) — — — 31 Financing charges – loss on Foreign-Exchange Contract (before tax) — — — 22 Tax impact — — — (51) Merger-related impacts (after tax) — — — 140 Adjusted net income attributable to common shareholders 211 241 155 311 Weighted average number of shares Basic 596,670,374 596,605,054 596,503,988 595,961,260 Effect of dilutive stock-based compensation plans 2,564,789 2,420,792 2,442,181 2,354,970 Diluted 599,235,163 599,025,846 598,946,169 598,316,230 Adjusted EPS Basic $ 0.35 $ 0.40 $ 0.26 $ 0.52 Diluted $ 0.35 $ 0.40 $ 0.26 $ 0.52 Quarter ended (millions of dollars, except number of shares and EPS) Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Net income (loss) attributable to common shareholders (705) 194 200 222 Impacts related to the Merger: OM&A – Merger-related costs (before tax) 6 1 2 2 Financing charges – Merger-related costs (before tax) 14 15 15 14 Financing charges – loss (gain) on Foreign-Exchange Contract (before tax) — 24 (22) (27) Tax impact (6) (7) (1) (1) Merger-related impacts (after tax) 14 33 (6) (12) Impacts related to OEB’s DTA Decision on Hydro One Networks’ distribution and transmission businesses: Reversal of revenues 68 — — — Deferred tax expense 799 — — — OEB’s DTA Decision on Hydro One Networks’ distribution and transmission businesses impacts (after tax) 867 — — — Adjusted net income attributable to common shareholders 176 227 194 210 Weighted average number of shares Basic 595,882,447 595,882,438 595,867,452 595,386,711 Effect of dilutive stock-based compensation plans 2,122,782 1,968,856 2,130,394 2,322,393 Diluted 598,005,229 597,851,294 597,997,846 597,709,104 Adjusted EPS Basic $ 0.30 $ 0.38 $ 0.33 $ 0.35 Diluted $ 0.29 $ 0.38 $ 0.32 $ 0.35 Hydro One Limited | Annual Report 2019 47
Management’s Discussion and Analysis Revenues, Net of Purchased Power Revenues, net of purchased power is defined as revenues less the cost of purchased power. Management believes that revenue, net of purchased power is helpful as a measure of net revenues for the distribution segment, as purchased power is fully recovered through revenues. Year ended December 31 (millions of dollars) 2019 2018 Revenues 6,480 6,150 Less: Purchased power 3,111 2,899 Revenues, net of purchased power 3,369 3,251 Year ended December 31 (millions of dollars) 2019 2018 Distribution revenues 4,788 4,422 Less: Purchased power 3,111 2,899 Distribution revenues, net of purchased power 1,677 1,523 Quarter ended (millions of dollars) Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Revenues 1,715 1,593 1,413 1,759 1,491 1,606 1,477 1,576 Less: Purchased power 914 737 653 807 741 733 674 751 Revenues, net of purchased power 801 856 760 952 750 873 803 825 Quarter ended (millions of dollars) Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Distribution revenues 1,298 1,140 1,029 1,321 1,138 1,103 1,036 1,145 Less: Purchased power 914 737 653 807 741 733 674 751 Distribution revenues, net of purchased power 384 403 376 514 397 370 362 394 Related Party Transactions The Province is a shareholder of Hydro One with approximately 47.3% ownership at December 31, 2019. The IESO, OPG, Ontario Electricity Financial Corporation (OEFC), and the OEB are related parties to Hydro One because they are controlled or significantly influenced by the Ministry of Energy. OCN LP is a joint-venture limited partnership between a subsidiary of Hydro One and OPG. The following is a summary of the Company’s related party transactions during the years ended December 31, 2019 and 2018: Year ended December 31 (millions of dollars) Related Party Transaction 2019 2018 Province Dividends paid 288 275 IESO Power purchased 1,808 1,636 Revenues for transmission services 1,636 1,672 Amounts related to electricity rebates 692 477 Distribution revenues related to rural rate protection 240 239 Distribution revenues related to the supply of electricity to remote northern communities 35 35 Funding received related to Conservation and Demand Management (CDM) programs 42 62 OPG1 Power purchased 8 10 Revenues related to provision of services and supply of electricity 9 9 Costs related to the purchase of services 1 — OEFC Power purchased from power contracts administered by the OEFC 2 2 OEB OEB fees 9 8 OCN LP2 Investment in OCN LP 2 — 1 The OPG has provided a $2.5 million guarantee to Hydro One related to the OCN Guarantee. See Other Obligations – Summary of Contractual Obligations and Other Commercial Commitments for details related to the OCN Guarantee. 2 OCN LP owns and operates electric vehicle fast charging stations across Ontario, under the Ivy Charging Network brand. 48 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Risk Management and Risk Factors Further, the OEB approves the Company’s transmission and distribution rates based on projected electricity load and consumption levels, among Hydro One is subject to numerous risks and uncertainties. Critical to Hydro other factors. If actual load or consumption materially falls below projected One’s success is the identification, management, and to the extent possible, levels, the Company’s revenue and net income for either, or both, of these mitigation of these risks. Hydro One’s Chief Risk Officer has accountability businesses could be materially adversely affected. Also, the Company’s for the Company’s Enterprise Risk Management (ERM) program, which current revenue requirements for these businesses are based on cost and assists decision-makers throughout the organization with the management other assumptions that may not materialize. There is no assurance that the of key business risks, including new and emerging risks and opportunities. OEB would allow rate increases sufficient to offset unfavourable financial The material risks relating to Hydro One and its business that the Company impacts from unanticipated changes in electricity demand or in the believes would be the most likely to influence an investor’s decision to Company’s costs. purchase Hydro One’s securities are set out in the risk factors below. These The Company is subject to risk of revenue loss from other factors, such as risks could have a materially adverse effect on the Company or its business, economic trends and conditions, changes in service territory, and weather financial condition, or operations. This list is not a comprehensive list of all conditions that influence the demand for electricity. The Company’s overall the risks to the Company, and the actual effect of any of the risks cited below operating results may fluctuate substantially on a seasonal and year-to-year could be materially different from what is described below. Additionally, basis based on these trends and weather conditions. For instance, a cooler other risks may arise or risks currently not considered material may become than normal summer or warmer than normal winter can be expected to reduce material in the future. demand for electricity below that forecast by the Company, causing a decrease in the Company’s revenues from the same period of the previous year. Risks Relating to Hydro One’s Business Regulatory Risks and Risks Relating to Hydro One’s Revenues The Company’s load could also be negatively affected by successful CDM Risks Relating to Obtaining Rate Orders programs whose results exceed forecasted expectations. The Company is subject to the risk that the OEB will not approve the Company’s transmission and distribution revenue requirements requested in Risks Relating to Other Applications to the OEB outstanding or future applications for rates. Rate applications for revenue Hydro One may face increased competition with other transmitters for requirements are subject to the OEB’s review process, usually involving opportunities to build new, large-scale transmission facilities in Ontario. participation from intervenors and a public hearing process. There can be The Company is subject to the risk that it will not be selected to build new no assurance that resulting decisions or rate orders issued by the OEB will transmission in Ontario, which could impair growth, disrupt operations permit Hydro One to recover all costs actually incurred, costs of debt and and/or development, or have other adverse impacts. The Company is also income taxes, or to earn a particular ROE. A failure to obtain acceptable subject to the risk that it will not obtain, or will not obtain in a timely manner, rate orders, or approvals of appropriate returns on equity and costs actually required regulatory approvals for other matters, such as leave to construct incurred, may materially adversely affect: Hydro One’s transmission or applications, applications for mergers, acquisitions, amalgamations distribution businesses, the undertaking or timing of capital expenditures, and divestitures, and environmental approvals. Decisions to acquire or ratings assigned by credit rating agencies, the cost and issuance of long- divest other regulated businesses licensed by the OEB are subject to term debt, and other matters, any of which may in turn have a material OEB approval. Accordingly, there is the risk that such matters may not be adverse effect on the Company. In addition, there is no assurance that approved, that the Company may not be selected to build new transmission the Company will receive regulatory decisions in a timely manner and, as part of the competitive process, or that unfavourable conditions will be therefore, the Company may incur costs before having an approved imposed by the OEB. revenue requirement and cash flows could be impacted. Risks Relating to Rate-Setting Models for Transmission and Distribution Risks Relating to Actual Performance Against Forecasts The OEB approves and periodically changes the rate-setting models and The Company’s ability to recover the actual costs of providing service and methodology for the transmission and distribution businesses. Changes to earn the allowed ROE depends on the Company achieving its forecasts the application type, filing requirements, rate-setting model or methodology, established and approved in the rate-setting process. Actual costs could or revenue requirement determination may have a material negative impact exceed the approved forecasts if, for example, the Company incurs on Hydro One’s revenue and net income. For example, the OEB may in operations, maintenance, administration, capital and financing costs above the future decide to reduce the allowed ROE for either of these businesses, those included in the Company’s approved revenue requirement. The modify the formula or methodology it uses to determine the ROE, or reduce inability to obtain acceptable rate decisions or to recover any significant the weighting of the equity component of the deemed capital structure. Any difference between forecast and actual expenses could materially adversely such reduction could reduce the net income of the Company. Similarly, the affect the Company’s financial condition and results of operations. OEB is currently considering other utility remuneration models, and any such change could affect Hydro One’s revenue and net income. Hydro One Limited | Annual Report 2019 49
Management’s Discussion and Analysis The OEB’s recent Custom Incentive Rate-setting model requires that the restrictions and requirements imposed by the collective bargaining process term of a custom rate application be for multi-year periods. There are risks and legislative requirements. Any element of total compensation costs which associated with forecasting key inputs such as revenues, operating expenses is disallowed in whole or part by the OEB and therefore not recoverable and capital over such a long period. For instance, if unanticipated capital from customers in rates could result in costs which could be material and expenditures arise that were not contemplated in the Company’s most recent could decrease net income, which could have a material adverse effect on rate decision, the Company may be required to incur costs that may not be the Company. Legislation restricts Hydro One from recovering specified recoverable until a future period or not recoverable at all in future rates. This executive compensation costs from the OEB. could have a material adverse effect on the Company. The Company provides OPEBs, including workers compensation benefits and When rates are set for a multi-year period, including under a Custom long-term disability benefits to qualifying employees. Hydro One currently Incentive Rate application, the OEB expects there to be no further rate maintains the accrual accounting method with respect to OPEBs. If the applications for annual updates within the multi-year period, unless there OEB directed Hydro One to transition to a different accounting method are exceptional circumstances, with the exception of the clearance of for OPEBs or otherwise adjusted the basis of recovery for OPEB costs, this established deferral and variance accounts. For example, the OEB does could result in income volatility, due to an inability of the Company to book not expect to address annual rate applications for updates for cost of the difference between the accrual and cash as a regulatory asset, and the capital (including ROE), working capital allowance or sales volumes. If Company might not be able to recover some costs. A determination that there were an increase in interest rates over the period of a rate decision some of the Company’s post-employment and post- retirement benefit costs and no corresponding changes were permitted to the Company’s allowed are not recoverable could have a material adverse effect on the Company. cost of capital (including ROE), then the result could be a decrease in the Company’s financial performance. Risks Relating to Regulatory Treatment of Deferred Tax Asset As a result of leaving the payments in lieu of corporate income taxes (PILs) To the extent that the OEB approves an In-Service Variance Account for the regime and entering the federal tax regime in connection with the 2015 transmission and/or distribution businesses, and should the Company fail initial public offering (IPO) of the Company, Hydro One recorded additional to meet the threshold levels of in-service capital, the OEB may reclaim a deferred tax assets due to the revaluation of the tax basis of Hydro One’s corresponding portion of the Company’s revenues. fixed assets at their fair market value and recognition of eligible capital expenditures. At the time of the IPO, the Company determined the tax Risks Relating to Capital Expenditures savings derived from the additional deferred tax assets should accrue to In order to be recoverable in rates, capital expenditures require the approval the shareholders of Hydro One Limited. The OEB’s September 28, 2017 of the OEB. There can be no assurance that all capital expenditures, Original Decision (see details above in “Regulation – Electricity Rates including any imposed by or resulting from government or regulatory Applications – Hydro One Networks – Transmission”) altered Hydro bodies, incurred by Hydro One will be approved by the OEB. For example, One’s allocation of the tax savings derived from the additional deferred capital cost overruns, unexpected capital expenditures in maintaining or tax assets and determined that a portion of the tax savings should accrue improving the Company’s assets, unexpected costs as a result of proposed to ratepayers. In October 2017, the Company filed a motion to review and legislation, including that relating to the expansion of broadband service vary (Motion) the Original Decision and filed an appeal with the Ontario in Canada, may not be recoverable in transmission or distribution rates. Divisional Court (Appeal) which was stayed pending the outcome of the To the extent possible, Hydro One aims to mitigate this risk by ensuring Motion. In both cases, the Company’s position was that the OEB made expenditures are reasonable and prudent, and also by seeking from the errors of fact and law in its determination of the allocation of the tax regulator clear policy direction on cost responsibility, and by obtaining savings between shareholders and ratepayers. pre-approval of the need for capital expenditures. On March 7, 2019, the OEB issued a decision upholding its Original Decision Any regulatory decision by the OEB to disallow or limit the recovery of on the handling of the deferred tax asset. Also, on March 7, 2019, the OEB any capital expenditures would lead to a lower-than-expected approved issued its decision for Hydro One Networks’ 2018–2022 distribution rates revenue requirement or rate base, potential asset impairment or charges to in which it directed the Company to apply the Original Decision to Hydro the Company’s results of operations, any of which could have a material One Networks’ distribution rates. Based on these decisions, the Company adverse effect on the Company. recognized a total one-time $867 million decrease to net income. On April 5, 2019, the Company filed a motion to commence a new appeal Risk of Recoverability of Total Compensation Costs with respect to the OEB’s deferred tax asset decision. The appeal was heard Hydro One manages all of its total compensation costs, including pension on November 21, 2019, and a decision is pending. Loss of the appeal, in and other post-employment and post-retirement benefits (OPEBs), subject to whole or in part, could have a material adverse effect on the Company. 50 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Risks Relating to Government Action The Company’s operations and activities may give rise to the Crown’s The Province is, and is likely to remain, the largest shareholder in Hydro duty to consult and potentially accommodate Indigenous communities. One Limited. The Province may be in a position of conflict from time to time Procedural aspects of the duty to consult may be delegated to the Company as a result of being an investor in Hydro One Limited and also being a by the Province or the federal government. A perceived failure by the Crown government actor setting broad policy objectives in the electricity industry. to sufficiently consult an Indigenous community, including communities with Government actions may not be in the interests of the Company or investors. a traditional governance model not recognized under the Indian Act, or a perceived failure by the Company in relation to delegated consultation Governments may pass legislation or issue regulations at any time, including obligations, could result in legal challenges against the Crown or the legislation or regulation impacting Hydro One, which could have potential Company, including judicial review or injunction proceedings, or could material adverse effects on Hydro One and its business. Such government potentially result in direct action against the Company by a community or actions may include, but are not limited to, legislation, regulation, directives its citizens. If this occurs, it could disrupt or delay the Company’s operations or shareholder action intended to reduce electricity rates, place constraints and activities, including current and future projects, and have a material on compensation, or affect the governance of Hydro One. Such government adverse effect on the Company. actions could adversely affect the Company’s financial condition and results of operations, as well as public opinion and the Company’s reputation. Risk from Transfer of Assets Located on Reserves Government action may also hinder Hydro One’s ability to pursue its The transfer orders by which the Company acquired certain of Ontario strategy and/or objectives. Hydro’s businesses as of April 1, 1999 did not transfer title to assets located on Reserves. The transfer of title to these assets did not occur Additionally, involvement by the Province in placing constraints on executive because authorizations originally granted by the federal government for compensation (through the compensation framework implemented as a the construction and operation of these assets on Reserves could not be result of the Hydro One Accountability Act, 2018) may inhibit the Company’s transferred without required consent. In several cases, the authorizations ability to attract and retain qualified executive talent, which may also impact had either expired or had never been issued. the Company’s performance, strategy and/or objectives. The failure to attract and retain qualified executives could have a material adverse effect Currently, OEFC holds legal title to these assets and it is expected that the on the Company. Company will manage them until it has obtained permits to complete the title transfer. To occupy Reserves, the Company must have valid permits. Government action may also impact the Company’s credit ratings as the For each permit, the Company must negotiate an agreement (in the form Company’s credit ratings reflect, in part, the rating agencies’ assessment of a memorandum of understanding) with the First Nation, OEFC and any of government involvement in the business of Hydro One. The Company members of the First Nation who have occupancy rights. The agreement cannot predict what actions rating agencies may take in the future, positive includes provisions whereby the First Nation consents to the issuance of or negative, including in response to government action or inaction relating a permit. For transmission assets, the Company must negotiate terms of to or impacting Hydro One. The failure to maintain the Company’s current payment. It is difficult to predict the aggregate amount that the Company credit ratings could adversely affect the Company’s financial condition and may have to pay to obtain the required agreements from First Nations. If results of operations, and a downgrade in the Company’s credit ratings the Company cannot reach satisfactory agreements with the relevant First could restrict the Company’s ability to access debt capital markets and Nation to obtain federal permits, it may have to relocate these assets to increase the Company’s cost of debt. other locations and restore the lands at a cost that could be substantial. In a limited number of cases, it may be necessary to abandon a line and Indigenous Claims Risk replace it with diesel generation facilities. In either case, the costs relating Some of the Company’s current and proposed transmission and to these assets could have a material adverse effect on the Company if distribution assets are or may be located on reserve (as defined in the the costs are not recoverable in future rate orders. Indian Act (Canada)) (Reserve) lands, or lands over which Indigenous people have Aboriginal, treaty, or other legal claims. Some Indigenous Executive Recruitment and Retention Risk leaders, communities, and their members have made assertions related to Involvement by the Province relating to executive compensation, and Hydro sovereignty and jurisdiction over Reserve lands and traditional territories One executive compensation constraints flowing from the Hydro One (land traditionally occupied or used by a First Nation, Métis or Inuit group) Accountability Act, 2018, may inhibit the Company’s ability to attract and and are increasingly willing to assert their claims through the courts, retain qualified executive talent. The Company’s strategy is tied to its ability tribunals, or direct action. These claims, and/or the settlement or resolution to continue to attract and retain qualified executives. The failure to attract of these claims could have a material adverse effect on the Company or and retain qualified executives could have a material adverse effect on otherwise materially adversely impact the Company’s operations, including the Company. the development of current and future projects. Hydro One Limited | Annual Report 2019 51
Management’s Discussion and Analysis Compliance with Laws and Regulations Environment Risk Hydro One must comply with numerous laws and regulations affecting its The Company is subject to extensive Canadian federal, provincial and business, including requirements relating to transmission and distribution municipal environmental regulation. Failure to comply could subject the companies, environmental laws, employment laws and health and safety Company to fines or other penalties. In addition, the presence or release of laws. The failure of the Company to comply with these laws could have a hazardous or other harmful substances could lead to claims by third parties material adverse effect on the Company’s business. See also “– Environment or governmental orders requiring the Company to take specific actions such Risk” and “– Health and Safety Risk”. as investigating, controlling and remediating the effects of these substances. Although Hydro One is not a large emitter of greenhouse gases, the For example, Hydro One’s licensed transmission and distribution businesses Company monitors its emissions to track and report on all sources, including are required to comply with the terms of their licences, with codes and rules sulphur hexafluoride or “SF6”. The Company could be subject to costs and issued by the OEB, and with other regulatory requirements. In Ontario, the other risks related to emissions. Contamination of the Company’s properties Market Rules issued by the IESO require the Company to, among other could limit its ability to sell or lease these assets in the future. things, comply with applicable reliability standards established by the North American Electric Reliability Corporation (NERC) and Northeast Power In addition, actual future environmental expenditures may vary materially Coordinating Council, Inc. (NPCC). The costs associated with compliance from the estimates used in the calculation of the environmental liabilities with these reliability standards are expected to be recovered through rates, provided for in the Company’s financial statements. The Company does but there can be no assurance that the OEB will approve the recovery of not have insurance coverage for these environmental expenditures. all of such costs. Failure to obtain such approvals could have a material adverse effect on the Company. There is also risk associated with obtaining governmental approvals, permits, or renewals of existing approvals and permits related to constructing or There is the risk that new legislation, regulations, requirements or policies operating facilities. This may require environmental assessment or result in will be introduced in the future. These may reduce Hydro One’s revenue, the imposition of conditions, or both, which could result in delays and cost or may require Hydro One to incur additional costs, which may or may increases. Failure to obtain necessary approvals or permits could result in not be recovered in future transmission and distribution rates. an inability to complete projects which may have a material adverse effect on the Company. Risk of Natural and Other Unexpected Occurrences The Company’s facilities are exposed to the effects of severe weather The Company’s facilities are exposed to the effects of severe weather conditions, natural disasters, man-made events including, but not limited conditions and natural disasters. The Company recognizes the risks to, cyber and physical terrorist type attacks, events which originate from associated with potential climate change and has developed plans to third-party connected systems, and any other potentially catastrophic respond as appropriate. Climate change may have the effect of shifting events. The Company’s facilities may not withstand occurrences of these weather patterns and increasing the severity and frequency of extreme types in all circumstances. weather events and natural disasters, which could impact Hydro One’s business. The Company’s facilities may not withstand occurrences of these The Company could also be subject to claims for damages from events types in all circumstances. Notwithstanding Hydro One’s efforts to adapt which may be proximately connected with the Company’s assets (for and increase grid resilience, the Company’s facilities are exposed to example, forest fires), claims for damages caused by its failure to transmit risks which may have an adverse effect on grid resilience. The Company or distribute electricity or costs related to ensuring its continued ability to could also be subject to claims for damages from events which may be transmit or distribute electricity. proximately connected with the Company’s assets (for example, forest fires), claims for damages caused by its failure to transmit or distribute The Company does not have insurance for damage to its transmission and electricity or costs related to ensuring its continued ability to transmit or distribution wires, poles and towers located outside its transmission and distribute electricity. The Company does not have insurance for damage to distribution stations resulting from these or other events. Where insurance its transmission and distribution wires, poles and towers located outside its is available for the Company’s other assets and for damage claims, such transmission and distribution stations resulting from these or other events. insurance coverage may have deductibles, limits and/or exclusions that Where insurance is available for the Company’s other assets and for may still expose the Company to material losses. Losses from lost revenues damage claims, such insurance coverage may have deductibles, limits and repair costs could be substantial, especially for many of the Company’s and/or exclusions that may still expose the Company to material losses. facilities that are located in remote areas. Losses from lost revenues and repair costs could be substantial, especially for many of the Company’s facilities that are located in remote areas. In the event that the Company is unable to recover such costs, this could have a material adverse effect on the Company. In the event that the Company is unable to recover such costs, this could have a material adverse effect on the Company. 52 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Risk Associated with Information Technology (IT), Operational a number of building trade unions have agreements, to which Hydro One Technology (OT) Infrastructure and Data Security is bound, covering the period from May 1, 2015 to April 30, 2020, some The Company’s ability to operate effectively in the Ontario electricity market of which have been renewed to cover the period from May 1, 2020 to is, in part, dependent upon it developing, modernizing, maintaining and April 30, 2025 (see “Hydro One Work Force – Collective Agreements” managing complex IT and OT systems which are employed to operate for details). Agreements were also reached with the Society and the PWU and monitor its transmission and distribution facilities, financial and billing to facilitate the insourcing of CSO services effective March 1, 2018. Future systems and other business systems. The Company’s increasing reliance negotiations with unions present the risk of a labour disruption or dispute, on information systems and expanding data networks, as well as growing risk to the Company’s ability to sustain the continued supply of energy to volume and complexity of data, increases its vulnerability, and exposure to customers, as well as potential risks to public safety. The Company also information security threats. The Company’s transmission business is required faces financial risks related to its ability to negotiate collective agreements to comply with various rules and standards for transmission reliability, consistent with its rate orders. Any of these could have a material adverse including mandatory standards established by the NERC and the NPCC. effect on the Company. Collective agreements requiring renewal in 2020 These include standards relating to cyber-security and OT, which only apply include the PWU and PWU CSO agreements, as well as the agreements to certain of the Company’s assets (generally being those whose failure between EPSCA and the building trades (see “Hydro One Work Force – could impact the functioning of the bulk electricity system). The Company Collective Agreements” for details). Failure to renew these agreements on may maintain different or lower levels of security for its assets that are not terms acceptable to Hydro One could have a material adverse effect on subject to these mandatory standards. The Company must also comply with its business and results of operations and expose Hydro One to the risks various cyber-security and privacy-related regulatory requirements under notes above. the OEB’s Ontario Cyber Security Framework and legislative and licence requirements relating to the collection, use and disclosure of personal Work Force Demographic Risk information and information regarding consumers, wholesalers, generators By the end of 2019, approximately 15% of the Company’s employees who and retailers. are members of the Company’s defined benefit and defined contribution pension plans were eligible for retirement, and by the end of 2020, Cyber-attacks or unauthorized access to corporate IT and OT systems could approximately 17% could be eligible. These percentages are not evenly result in service disruptions and system failures, which could have a material spread across the Company’s work force, but tend to be most significant in adverse effect on the Company, including as a result of a failure to provide the most senior levels of the Company’s staff and among management staff. electricity to customers. Because it operates critical infrastructure, Hydro One During 2019, approximately 3% of the Company’s work force (down from may be at greater risk of cyber-attacks from third parties (including state run 4% in 2018) elected to retire. Accordingly, the Company’s continued success or controlled parties) that could impair or incapacitate its assets. In addition, will be tied to its ability to continue to attract and retain sufficient qualified in the course of its operations, the Company collects, uses, processes and staff to replace the capability lost through retirements and meet the demands stores information which could be exposed in the event of a cyber-security of the Company’s work programs. incident or other unauthorized access or disclosure, such as information about customers, suppliers, counterparties, employees and other third parties. In addition, the Company expects the skilled labour market for its industry will remain highly competitive. Many of the Company’s current and potential Security and system disaster recovery controls are in place; however, employees being sought after possess skills and experience that are also there can be no assurance that there will not be system failures or security highly coveted by other organizations inside and outside the electricity breaches or that such threats would be detected or mitigated on a timely sector. The failure to attract, retain and deploy qualified personnel for Hydro basis. Upon occurrence and detection, the focus would shift from prevention One’s business could have a material adverse effect on the Company. to isolation, remediation and recovery until the incident has been fully addressed. Any such system failures or security breaches could have a Risk Associated with Arranging Debt Financing material adverse effect on the Company. The Company expects to borrow to repay its existing indebtedness and to fund a portion of capital expenditures. Hydro One has substantial Labour Relations Risk debt principal repayments, including $653 million in 2020, $803 million The substantial majority of the Company’s employees are represented in 2021, and $604 million in 2022. In addition, from time to time, the by either the PWU or the Society. Over the past several years, significant Company may draw on its syndicated bank lines and/or issue short- effort has been expended to increase Hydro One’s flexibility to conduct term debt under Hydro One Inc.’s $2,300 million commercial paper operations in a more cost-efficient manner. Although the Company has program which would mature within one year of issuance. The Company achieved improved flexibility in its collective agreements, the Company also plans to incur continued material capital expenditures for each of may not be able to achieve further improvements. The Company reached 2020 and 2021. Cash generated from operations, after the payment of an agreement with the Society for a collective agreement, covering the expected dividends, will not be sufficient to fund the repayment of the period from April 1, 2019 to March 31, 2021. The Company also reached a Company’s existing indebtedness and capital expenditures. The Company’s collective agreement with the PWU, covering the period from April 1, 2018 ability to arrange sufficient and cost-effective debt financing could be to March 31, 2020, and a collective agreement with the CUSW, covering materially adversely affected by numerous factors, including the regulatory the period from May 1, 2017 to April 30, 2022. Additionally, EPSCA and environment in Ontario, the Company’s results of operations and financial Hydro One Limited | Annual Report 2019 53
Management’s Discussion and Analysis position, market conditions, the ratings assigned to its debt securities by risk of equipment failures and to determine the need for and timing credit rating agencies, an inability of the Company to comply with its of major refurbishments and replacements of its transmission and debt covenants, and general economic conditions. A downgrade in the distribution infrastructure. Company’s credit ratings could restrict the Company’s ability to access debt capital markets and increase the Company’s cost of debt. Any failure or While traditionally a mature and stable industry, the electricity industry inability on the Company’s part to borrow the required amounts of debt on is facing significant technological change and increasing innovation, satisfactory terms could impair its ability to repay maturing debt, fund capital the consequences of which could have a material adverse effect on expenditures and meet other obligations and requirements and, as a result, the Company. could have a material adverse effect on the Company. Execution of the Company’s capital expenditure programs is partially dependent on external factors, such as environmental approvals, municipal Market, Financial Instrument and Credit Risk permits, equipment outage schedules that accommodate the IESO, Market risk refers primarily to the risk of loss that results from changes in generators and transmission-connected customers, and supply chain costs, foreign exchange rates and interest rates. The Company is exposed to availability for equipment suppliers and consulting services. There may fluctuations in interest rates as its regulated ROE is derived using a formulaic also be a need for, among other things, Environmental Assessment Act approach that takes into account anticipated interest rates. The Company (Ontario) approvals, approvals which require public meetings, appropriate issues debt from time to time to refinance maturing debt and for general engagement with Indigenous communities, OEB approvals of expropriation corporate purposes. The Company is therefore exposed to fluctuations or early access to property, and other activities. Obtaining approvals in interest rates in relation to such issuances of debt. The Company is not and carrying out these processes may also be impacted by opposition to currently exposed to material commodity price risk or material foreign the proposed site of the capital investments. Delays in obtaining required exchange risk. approvals or failure to complete capital projects on a timely basis could The OEB-approved adjustment formula for calculating ROE in a deemed materially adversely affect transmission reliability or customers’ service regulatory capital structure of 60% debt and 40% equity provides for quality or increase maintenance costs which could have a material adverse increases and decreases depending on changes in benchmark interest rates effect on the Company. Failure to receive approvals for projects when for Government of Canada debt and the A-rated utility corporate bond spending has already occurred would result in the inability of the Company yield spread. For the transmission and distribution businesses in 2021, after to recover the investment in the project as well as forfeit the anticipated transmission rates are set as part of a Custom Incentive Rate application, return on investment. The assets involved may be considered impaired and the OEB does not expect to address annual rate applications for updates result in the write off of the value of the asset, negatively impacting net to allowed ROE, so fluctuations will have no impact to net income. The income. External factors are considered in the Company’s planning process. Company has interest rate exposure on issuances of short- and long-term If the Company is unable to carry out capital expenditure plans in a timely debt maturing in 2020 and beyond. The Company periodically uses interest manner, equipment performance may degrade, which may reduce network rate swap agreements to mitigate elements of interest rate risk. capacity, result in customer interruptions, compromise the reliability of the Company’s networks or increase the costs of operating and maintaining Financial assets create a risk that a counterparty will fail to discharge an these assets. Any of these consequences could have a material adverse obligation, causing a financial loss. Derivative financial instruments result effect on the Company. in exposure to credit risk, since there is a risk of counterparty default. Hydro One monitors and minimizes credit risk through various techniques, Increased competition for the development of large transmission projects including dealing with highly rated counterparties, limiting total exposure and legislative changes relating to the selection of transmitters could impact levels with individual counterparties, entering into agreements which enable the Company’s ability to expand its existing transmission system, which may net settlement, and by monitoring the financial condition of counterparties. have an adverse effect on the Company. To the extent that other parties The Company does not trade in any energy derivatives. The Company is are selected to construct, own and operate new transmission assets, the required to procure electricity on behalf of competitive retailers and certain Company’s share of Ontario’s transmission network would be reduced. local distribution companies for resale to their customers. The resulting concentrations of credit risk are mitigated through the use of various security Health and Safety Risk arrangements, including letters of credit, which are incorporated into the Hydro One’s work environment can be inherently dangerous and there is Company’s service agreements with these retailers in accordance with the a risk to health and safety of both the public and our employees, as well OEB’s Retail Settlement Code. as possible resultant operational and/or financial impacts. The Company is subject to federal and provincial legislation and regulations relating to The failure to properly manage these risks could have a material adverse health and safety. Findings of a failure to comply with these requirements effect on the Company. could result in penalties and reputational risk, which could negatively impact the Company. Failure to comply could subject the Company to fines or other Risks Relating to Asset Condition, Capital Projects and Innovation penalties. Any regulatory decision to disallow or limit the recovery of such The Company continually incurs sustainment and development capital costs could have a material adverse effect on the Company. expenditures and monitors the condition of its assets to manage the 54 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Pension Plan Risk adverse effect on the Company. Even if the Company prevails in any such Hydro One has the Hydro One Defined Benefit Pension Plan in place for the legal proceeding, the proceedings could be costly and time-consuming majority of its employees. Contributions to the pension plan are established and would divert the attention of management and key personnel from the by actuarial valuations which are required to be filed with the Financial Company’s business operations, which could adversely affect the Company. Services Regulatory Authority of Ontario on a triennial basis. The most See also “Other Developments – Litigation”. recently filed valuation was prepared as at December 31, 2018, and was filed in September 2019, covering a three-year period from 2019 to 2021. Transmission Assets on Third-Party Lands Risk Hydro One’s contributions to its pension plan satisfy, and are expected to Some of the lands on which the Company’s transmission assets are located continue to satisfy, minimum funding requirements. Contributions beyond are owned by third parties, including the Province and federal Crown, and 2021 will depend on the funded position of the plan, which is determined are or may become subject to land claims by First Nations. The Company by investment returns, interest rates and changes in benefits and actuarial requires valid occupation rights to occupy such lands (which may take the assumptions at that time. A determination by the OEB that some of the form of land use permits, easements or otherwise). If the Company does not Company’s pension expenditures are not recoverable through rates could have valid occupational rights on third-party owned or controlled lands or have a material adverse effect on the Company, and this risk may be has occupational rights that are subject to expiry, it may incur material costs exacerbated if the amount of required pension contributions increases. to obtain or renew such occupational rights, or if such occupational rights cannot be renewed or obtained it may incur material costs to remove and Hydro One currently reports and recovers its pension costs on a cash basis, relocate its assets and restore the subject land. If the Company does not and maintains the accrual method with respect to OPEBs. Transitioning from have valid occupational rights and must incur costs as a result, this could the cash basis to an accrual method for pension may have material negative have a material adverse effect on the Company or otherwise materially rate impacts for customers or material negative impacts on the Company adversely impact the Company’s operations. should recovery of costs be disallowed by the OEB. Reputational, Public Opinion and Political Risk See also “– Regulatory Risks and Risks Relating to Hydro One’s Revenues Reputation risk is the risk of a negative impact to Hydro One’s business, – Risk of Recoverability of Total Compensation Costs” for risks relating to operations or financial condition that could result from a deterioration recovery of pension costs. of Hydro One’s reputation. Hydro One’s reputation could be negatively impacted by changes in public opinion, attitudes towards the Company’s Risk Associated with Outsourcing Arrangements privatization, failure to deliver on its customer promises and other external Hydro One has entered into an outsourcing arrangement with a third party forces. Adverse reputational events or political actions could have negative for the provision of back office and IT services. If the services are disrupted, impacts on Hydro One’s business and prospects including, but not limited to, it could have a material adverse effect on the Company. Additionally, if the delays or denials of requisite approvals, such as denial of requested rates, outsourcing arrangement or statements of work thereunder are terminated and accommodations for Hydro One’s planned projects, escalated costs, for any reason or expire before a new supplier is selected and fully legal or regulatory action, and damage to stakeholder relationships. transitioned, the Company could be required to transfer to another service provider or insource, which could have a material adverse effect on the Risks Associated with Acquisitions Company’s business, operating results, financial condition or prospects. Acquisitions include inherent risks that some or all of the expected benefits may fail to materialize, or may not occur within the time periods anticipated, Risk from Provincial Ownership of Transmission Corridors and Hydro One may incur material unexpected costs. Realization of the The Province owns some of the corridor lands underlying the Company’s anticipated benefits would depend, in part, on the Company’s ability to transmission system. Although the Company has the statutory right to use successfully integrate the acquired business, including the requirement these transmission corridors, the Company may be limited in its options to to devote management attention and resources to integrating business expand or operate its systems. Also, other uses of the transmission corridors practices and support functions. The failure to realize the anticipated by third parties in conjunction with the operation of the Company’s systems benefits, the diversion of management’s attention, or any delays or may increase safety or environmental risks, which could have a material difficulties encountered in connection with the integration could have an adverse effect on the Company. adverse effect on the Company’s business, results of operations, financial condition or cash flows. Litigation Risks In the normal course of the Company’s operations, it becomes involved Risks Relating to the Company’s Relationship with the Province in, is named as a party to and is the subject of, various legal proceedings, including regulatory proceedings, tax proceedings and legal actions, Ownership and Continued Influence by the Province and Voting relating to actual or alleged violations of law, common law damages Power; Share Ownership Restrictions claims, personal injuries, property damage, property taxes, land rights, the The Province currently owns approximately 47.3% of the outstanding environment and contract disputes. The outcome of outstanding, pending common shares of Hydro One. The Electricity Act restricts the Province from or future proceedings cannot be predicted with certainty and may be selling voting securities of Hydro One (including common shares) of any determined adversely to the Company, which could have a material class or series if it would own less than 40% of the outstanding number Hydro One Limited | Annual Report 2019 55
Management’s Discussion and Analysis of voting securities of that class or series after the sale and in certain More Extensive Regulation circumstances also requires the Province to take steps to maintain that level Although under the Governance Agreement, the Province has agreed to of ownership. Accordingly, the Province is expected to continue to maintain engage in the business and affairs of Hydro One as an investor and not as a significant ownership interest in voting securities of Hydro One for an a manager and has stated that its intention is to achieve its policy objectives indefinite period. through legislation and regulation as it would with respect to any other utility operating in Ontario, there is a risk that the Province will exercise its As a result of its significant ownership of the common shares of Hydro legislative and regulatory power to achieve policy objectives in a manner One, the Province has, and is expected indefinitely to have, the ability that has a material adverse effect on the Company. See “Risks Relating to to determine or significantly influence the outcome of shareholder votes, Government Action” above. subject to the restrictions in the Governance Agreement. Despite the terms of the Governance Agreement in which the Province has agreed to engage Prohibitions on Selling the Company’s Transmission in the business and affairs of the Company as an investor and not as a or Distribution Business manager, there is a risk that the Province’s engagement in the business The Electricity Act prohibits the Company from selling all or substantially and affairs of the Company as an investor will be informed by its policy all of the business, property or assets related to its transmission system objectives and may influence the conduct of the business and affairs of or distribution system that is regulated by the OEB. There is a risk that the Company in ways that may not be aligned with the interests of other these prohibitions may limit the ability of the Company to engage in sale investors. Notwithstanding the Governance Agreement, and in light of transactions involving a substantial portion of either system, even where such actions historically taken by the Province, there can be no assurance that the a transaction may otherwise be considered to provide substantial benefits to Province will not take other actions in the future that could be detrimental to the Company and the holders of the common shares. the interests of investors in Hydro One. See “Risks Relating to Government Action” above. Future Sales of Common Shares by the Province Although the Province has indicated that it does not intend to sell further The share ownership restrictions in the Electricity Act (Share Ownership common shares of Hydro One, the registration rights agreement between Restrictions) and the Province’s significant ownership of common shares of Hydro One and the Province dated November 5, 2015 (available on Hydro One together effectively prohibit one or more persons acting together SEDAR at www.sedar.com) grants the Province the right to request that from acquiring control of Hydro One. They also may limit or discourage Hydro One file one or more prospectuses and take other procedural steps transactions involving other fundamental changes to Hydro One and to facilitate secondary offerings by the Province of the common shares of the ability of other shareholders to successfully contest the election of the Hydro One. Future sales of common shares of Hydro One by the Province, directors proposed for election pursuant to the Governance Agreement. or the perception that such sales could occur, may materially adversely The Share Ownership Restrictions may also discourage trading in, and affect market prices for these common shares and impede Hydro One’s may limit the market for, the common shares and other voting securities. ability to raise capital through the issuance of additional common shares, including the number of common shares that Hydro One may be able to Nomination of Directors and Confirmation of CEO and Chair sell at a particular time or the total proceeds that may be realized. Although director nominees (other than the CEO) are required to be independent of both the Company and the Province pursuant to the Limitations on Enforcing the Governance Agreement Governance Agreement, there is a risk that the Province will nominate or The Governance Agreement includes commitments by the Province restricting confirm individuals who satisfy the independence requirements but who it the exercise of its rights as a holder of voting securities, including with considers are disposed to support and advance its policy objectives and respect to the maximum number of directors that the Province may nominate give disproportionate weight to the Province’s interests in exercising their and on how the Province will vote with respect to other director nominees. business judgment and balancing the interests of the stakeholders of Hydro Hydro One’s ability to obtain an effective remedy against the Province, if the One. This, combined with the fact certain matters require a two-thirds vote Province were not to comply with these commitments, is limited as a result of of the Board, could allow the Province to unduly influence certain Board the Proceedings Against the Crown Act (Ontario). This legislation provides actions such as confirmation of the Chair and confirmation of the CEO. that the remedies of injunction and specific performance are not available against the Province, although a court may make an order declaratory of the Board Removal Rights rights of the parties, which may influence the Province’s actions. A remedy of Under the Governance Agreement, the Province has the right to withhold damages would be available to Hydro One, but damages may not be an from voting in favour of all director nominees and has the right to seek to effective remedy, depending on the nature of the Province’s non-compliance remove and replace the entire Board, including in each case its own director with the Governance Agreement. nominees but excluding the CEO and, at the Province’s discretion, the Chair. In exercising these rights in any particular circumstance, the Province is entitled to vote in its sole interest, which may not be aligned with the interests of other stakeholders of Hydro One. 56 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Critical Accounting Estimates and Judgments in remediation technologies. In determining the amounts to be recorded as environmental liabilities, the Company estimates the current cost of The preparation of Hydro One Consolidated Financial Statements requires completing required work and makes assumptions as to when the future the Company to make key estimates and critical judgments that affect the expenditures will actually be incurred, in order to generate future cash flow reported amounts of assets, liabilities, revenues and costs, and related information. All factors used in estimating the Company’s environmental disclosures of contingencies. Hydro One bases its estimates and judgments liabilities represent management’s best estimates of the present value of costs on historical experience, current conditions and various other assumptions required to meet existing legislation or regulations. However, it is reasonably that are believed to be reasonable under the circumstances, the results of possible that numbers or volumes of contaminated assets, cost estimates which form the basis for making judgments about the carrying values of to perform work, inflation assumptions and the assumed pattern of annual assets and liabilities, as well as identifying and assessing the Company’s cash flows may differ significantly from the Company’s current assumptions. accounting treatment with respect to commitments and contingencies. Actual Environmental liabilities are reviewed annually or more frequently if results may differ from these estimates and judgments. Hydro One has significant changes in regulations or other relevant factors occur. Estimate identified the following critical accounting estimates used in the preparation changes are accounted for prospectively. of its Consolidated Financial Statements: Revenues Employee Future Benefits Hydro One’s employee future benefits consist of pension and post-retirement Distribution revenues attributable to the delivery of electricity are based on and post-employment plans, and include pension, group life insurance, OEB-approved distribution rates and are recognized on an accrual basis health care, and long-term disability benefits provided to the Company’s and include billed and unbilled revenues. Billed revenues are based on current and retired employees. Employee future benefits costs are included electricity delivered as measured from customer meters. At the end of each in Hydro One’s labour costs that are either charged to results of operations month, electricity delivered to customers since the date of the last billed or capitalized as part of the cost of property, plant and equipment and meter reading is estimated, and the corresponding unbilled revenue is intangible assets. Changes in assumptions affect the benefit obligation recorded. The unbilled revenue estimate is affected by energy consumption, of the employee future benefits and the amounts that will be charged to weather, and changes in the composition of customer classes. results of operations or capitalized in future years. The following significant assumptions and estimates are used to determine employee future benefit Regulatory Assets and Liabilities costs and obligations: Hydro One’s regulatory assets represent certain amounts receivable from future electricity customers and costs that have been deferred for Weighted Average Discount Rate accounting purposes because it is probable that they will be recovered The weighted average discount rate used to calculate the employee future in future rates. The regulatory assets mainly include amounts related to benefits obligation is determined at each year end by referring to the most the deferred income taxes, pension benefit liability, post-retirement and recently available market interest rates based on “AA”-rated corporate bond post-employment benefits, post-retirement and post-employment non- yields reflecting the duration of the applicable employee future benefit plan. service costs, share-based compensation costs, foregone revenue, and The discount rate at December 31, 2019 decreased to 3.10% (from 3.90% environmental liabilities. The Company’s regulatory liabilities represent at December 31, 2018) for pension benefits and decreased to 3.10% (from certain amounts that are refundable to future electricity customers. They 4.00% at December 31, 2018) for the post-retirement and post-employment pertain primarily to deferral and variance accounts. The regulatory assets plans. The decrease in the discount rate has resulted in a corresponding and liabilities can be recognized for rate-setting and financial reporting increase in employee future benefits liabilities for the pension, post-retirement purposes only if the amounts have been approved for inclusion in the and post-employment plans for accounting purposes. The liabilities are electricity rates by the OEB, or if such approval is judged to be probable determined by independent actuaries using the projected benefit method by management. If, at some future date, management judges that it is prorated on service and based on assumptions that reflect management’s no longer probable that the OEB will allow the inclusion of a regulatory best estimates. asset or liability in future electricity rates, the appropriate carrying amount would be reflected in results of operations prospectively from the date the Company’s assessment is made, unless the change meets the requirements Expected Rate of Return on Plan Assets for a subsequent event adjustment. The expected rate of return on pension plan assets of 5.75% is based on expectations of long-term rates of return at the beginning of the year and reflects the current pension plan asset mix. A new investment policy was Environmental Liabilities adopted by Hydro One effective May 14, 2018 and is being implemented Hydro One records a liability for the estimated future expenditures over several years. Hydro One’s current expectation is that the new associated with the removal and destruction of polychlorinated biphenyl investment policy will not be fully implemented until 2021–2022. As such, (PCB)-contaminated insulating oils and related electrical equipment, and with the implementation timing noted above, the actual asset mix as at for the assessment and remediation of chemically contaminated lands. There November 1, 2019 is appropriate for the December 31, 2019 disclosures are uncertainties in estimating future environmental costs due to potential and the 2020 registered pension plan costs. external events such as changes in legislation or regulations and advances Hydro One Limited | Annual Report 2019 57
Management’s Discussion and Analysis Rates of return on the respective portfolios are determined with reference to Valuation of Deferred Tax Assets respective published market indices. The expected rate of return on pension Hydro One assesses the likelihood of realizing deferred tax assets by plan assets reflects the Company’s long-term expectations. The Company reviewing all readily available current and historical information, including believes that this assumption is reasonable because, with the pension plan’s a forecast of future taxable income. To the extent management considers balanced investment approach, the higher volatility of equity investment it is more likely than not that some portion or all of the deferred tax assets returns is intended to be offset by the greater stability of fixed-income and will not be realized, a valuation allowance is recognized. short-term investment returns. The net result, on a long-term basis, is a lower return than might be expected by investing in equities alone. In the short Asset Impairment term, the pension plan can experience fluctuations in actual rates of return. Within Hydro One’s regulated businesses, the carrying costs of most of the long-lived assets are included in the rate base where they earn an Rate of Cost of Living Increase OEB-approved rate of return. Asset carrying values and the related return The rate of cost of living increase is determined by considering differences are recovered through OEB-approved rates. As a result, such assets are between long-term Government of Canada nominal bonds and real return only tested for impairment in the event that the OEB disallows recovery, bonds, which decreased from 1.40% per annum as at December 31, 2018 in whole or in part, or if such a disallowance is judged to be probable. to approximately 1.30% per annum as at December 31, 2019. Given the The Company regularly monitors the assets of its unregulated Hydro One Bank of Canada’s commitment to keep long-term inflation between 1.00% Telecom subsidiary for indications of impairment. As at December 31, 2019, and 3.00%, management believes that the current rate is reasonable to no asset impairment had been recorded for assets within Hydro One’s use as a long-term assumption and as such, has used a 2.0% per annum regulated or unregulated businesses. inflation rate for employee future benefits liability valuation purposes as at December 31, 2019. Goodwill is evaluated for impairment on an annual basis, or more frequently if circumstances require. Hydro One has concluded that goodwill was not Salary Increase Assumptions impaired at December 31, 2019. Goodwill represents the cost of acquired Salary increases should reflect general wage increases plus an allowance distribution and transmission companies that is in excess of the fair value of for merit and promotional increases for current members of the plan, and the net identifiable assets acquired at the acquisition date. should be consistent with the assumptions for consumer price inflation and real wage growth in the economy. The merit and promotion scale was Disclosure Controls and Procedures and Internal developed based on the salary increase assumption review performed in Control over Financial Reporting 2017. The review considers actual salary experience from 2002 to 2016 Disclosure controls and procedures are the processes designed to ensure using valuation data for all active members as at December 31, 2016, based that information is recorded, processed, summarized and reported on a on age and service and Hydro One’s expectation of future salary increases. timely basis to the Company’s management, including its CEO and CFO, Additionally, the salary scale reflects negotiated salary increases over the as appropriate, to make timely decisions regarding required disclosure in contract period. the MD&A and financial statements. At the direction of the Company’s CEO and CFO, management evaluated disclosure controls and procedures as Mortality Assumptions of the end of the period covered by this report. Based on that evaluation, The Company’s employee future benefits liability is also impacted by management concluded that the Company’s disclosure controls and changes in life expectancies used in mortality assumptions. Increases in life procedures were effective as at December 31, 2019. expectancies of plan members result in increases in the employee future benefits liability. The mortality assumption used at December 31, 2019 is Internal control over financial reporting is designed by, or under the direction 95% of 2014 Canadian Pensioners Mortality Private Sector table projected of the CEO and CFO to provide reasonable assurance regarding the generationally using improvement Scale B. reliability of financial reporting and the preparation of financial statements for external purposes in accordance with US GAAP. The Company’s internal Rate of Increase in Health Care Cost Trends control over financial reporting framework includes those policies and The costs of post-retirement and post-employment benefits are determined at procedures that (i) pertain to the maintenance of records that, in reasonable the beginning of the year and are based on assumptions for expected claims detail, accurately and fairly reflect the transactions and disposition of the experience and future health care cost inflation. For the post-retirement benefit assets of the Company; (ii) provide reasonable assurance that transactions plans, a trend study of historical Hydro One experience was conducted are recorded as necessary to permit preparation of financial statements in 2017, which resulted in a change in the prescription drug, dental and in accordance with US GAAP, and that receipts and expenditures of hospital trends used for 2018 and 2019 year-end reporting purposes. the Company are being made only in accordance with authorization of A 1% increase in the health care cost trends would result in a $21 million management and directors of the Company; and (iii) provide reasonable increase in 2019 interest cost plus service cost, and a $280 million increase assurance regarding prevention or timely detection of unauthorized in the benefit liability at December 31, 2019. acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements. 58 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis The Company’s management, at the direction of the CEO and CFO, affected by change and subject to the risk that internal control effectiveness evaluated the effectiveness of the design and operation of internal control may change over time. over financial reporting based on the criteria established in the Internal Control – Integrated Framework (2013) issued by the Committee of There were no changes in the design of the Company’s internal control over Sponsoring Organizations of the Treadway Commission (COSO). Based financial reporting during the three months ended December 31, 2019 that on that evaluation, management concluded that the Company’s internal have materially affected, or are reasonably likely to materially affect, the control over financial reporting was effective as at December 31, 2019. operation of the Company’s internal control over financial reporting. Internal control, no matter how well designed and operated, can Management will continue to monitor its systems of internal control over provide only reasonable assurance of achieving the desired control reporting and disclosure and may make modifications from time to time objectives and due to its inherent limitations, may not prevent or detect as considered necessary. all misrepresentations. Furthermore, the effectiveness of internal control is New Accounting Pronouncements The following tables present Accounting Standards Codification (ASC) and Accounting Standards Updates (ASUs) issued by the Financial Accounting Standards Board (FASB) that are applicable to Hydro One: Recently Adopted Accounting Guidance Guidance Date issued Description Effective date Impact on Hydro One ASC 842 February 2016 Lessees are required to recognize the rights and January 1, 2019 Hydro One adopted ASC 842 on – January 2019 obligations resulting from operating leases as assets January 1, 2019 using the modified (right to use the underlying asset for the term of the retrospective transition approach using lease) and liabilities (obligation to make future lease the effective date of January 1, 2019 payments) on the balance sheet. as its date of initial application. See Note 2 to the Consolidated Financial Statements for impact of adoption. The Company has included the disclosure requirements of ASC 842 in Note 23 to the Consolidated Financial Statements. ASU August 2017 Amendments will better align an entity’s risk January 1, 2019 No impact upon adoption 2017-12 management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and presentation of hedge results. ASU June 2018 Expansion in the scope of ASC 718 to include share- January 1, 2019 No impact upon adoption 2018-07 based payment transactions for acquiring goods and services from non-employees. Previously, ASC 718 was only applicable to share-based payment transactions for acquiring goods and services from employees. ASU August 2018 The amendment aligns the requirements for capitalizing January 1, 2019 Hydro One early-adopted this ASU 2018-15 implementation costs incurred in a hosting arrangement with a transition date of January 1, that is a service contract with the requirements for 2019. The ASU was applied capitalizing implementation costs incurred to develop prospectively and there was no or obtain internal-use software. The accounting for the material impact upon adoption. service element of a hosting arrangement is not affected by the amendment. ASU June 2016 – The amendments provide users with more decision- January 1, 2019 Hydro One early-adopted these ASUs 2016-13 November 2019 useful information about the expected credit losses on with a transition date of January 1, 2018-19 financial instruments and other commitments to extend 2019 using the modified retrospective 2019-04 credit held by a reporting entity at each reporting date. transition approach. See Note 2 to the 2019-05 Consolidated Financial Statements for 2019-11 impact of adoption. Hydro One Limited | Annual Report 2019 59
Management’s Discussion and Analysis Recently Issued Accounting Guidance Not Yet Adopted Guidance Date issued Description Effective date Anticipated Impact on Hydro One ASU January 2017 The amendment removes the second step of the current January 1, 2020 No impact upon adoption 2017-04 two-step goodwill impairment test to simplify the process of testing goodwill. ASU August 2018 Disclosure requirements on fair value measurements in January 1, 2020 No impact upon adoption 2018-13 ASC 820 are modified to improve the effectiveness of disclosures in financial statement notes. ASU August 2018 Disclosure requirements related to single-employer January 1, 2021 Under assessment 2018-14 defined benefit pension or other post-retirement benefit plans are added, removed or clarified to improve the effectiveness of disclosures in financial statement notes. ASU March 2019 This amendment carries forward the exemption January 1, 2020 No impact upon adoption 2019-01 previously provided under ASC 840 relating to the determination of the fair value of underlying assets by lessors that are not manufacturers or dealers. It also provides for clarification on cash-flow presentation of sales-type and financing leases and clarifies that transition disclosures under Topic 250 are not applicable in the adoption of ASC 842. ASU December 2019 The amendments simplify the accounting for income January 1, 2021 Under assessment 2019-12 taxes by removing certain exceptions to the general principles and improving consistent application of Topic 740 by clarifying and amending existing guidance. ASU January 2020 The amendments clarify the interaction of the accounting January 1, 2021 Under assessment 2020-01 for equity securities under Topic 321, investments under the equity method of accounting in Topic 323 and the accounting for certain forward contracts and purchased options accounted for under Topic 815. 60 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Summary of Fourth Quarter Results of Operations Three months ended December 31 (millions of dollars, except EPS) 2019 2018 Change Revenues Distribution 1,298 1,138 14.1% Transmission 407 342 19.0% Other 10 11 (9.1%) 1,715 1,491 15.0% Costs Purchased power 914 741 23.3% OM&A Distribution 162 167 (3.0%) Transmission 59 114 (48.2%) Other 18 27 (33.3%) 239 308 (22.4%) Depreciation, amortization and asset removal costs 226 217 4.1% 1,379 1,266 8.9% Income before financing charges and income tax expense 336 225 49.3% Financing charges 116 123 (5.7%) Income before income tax expense 220 102 115.7% Income tax expense 2 800 (99.8%) Net income (loss) 218 (698) 131.2% Net income (loss) to common shareholders of Hydro One 211 (705) 129.9% Adjusted net income to common shareholders of Hydro One1 211 176 19.9% Basic EPS $ 0.35 $ (1.18) 129.7% Diluted EPS $ 0.35 $ (1.18) 129.7% Basic Adjusted EPS1 $ 0.35 $ 0.30 16.7% Diluted Adjusted EPS1 $ 0.35 $ 0.29 20.7% Assets Placed In-Service Distribution 271 253 7.1% Transmission 573 698 (17.9%) Other 5 1 400.0% 849 952 (10.8%) Capital Investments Distribution 249 168 48.2% Transmission 311 292 6.5% Other 2 7 (71.4%) 562 467 20.3% 1 See section “Non-GAAP Measures” for description and reconciliation of adjusted net income, and basic and diluted Adjusted EPS. Net Income lower OM&A costs primarily resulting from lower corporate support costs Net income attributable to common shareholders for the quarter ended and higher insurance proceeds, as well as the timing of work performed with December 31, 2019 of $211 million is an increase of $916 million or respect to stations and lines maintenance and vegetation management 129.9% from the prior year. Significant influences on earnings included: compared to the prior year; partially offset by higher IT expenditures; and higher revenues, net of purchased power, primarily resulting from the lower income tax expense primarily attributable to the prior year charge 2018 impact of the OEB decision in respect of the sharing of the deferred to deferred tax expense related to the impairment of Hydro One’s deferred tax asset; income tax regulatory asset, as well as Accelerated CCA and deferred tax asset sharing mandated by the OEB, both of which will flow through to customers and are offset with lower revenues, with no impact on regulated ROE. Hydro One Limited | Annual Report 2019 61
Management’s Discussion and Analysis EPS and Adjusted EPS The quarterly decrease of $5 million or 3.0% in distribution OM&A costs EPS was $0.35 in the fourth quarter of 2019, compared to a loss per share was primarily due to the following: of $1.18 in the fourth quarter of 2018. The increase in EPS was driven by lower corporate support costs; and higher earnings for the fourth quarter of 2019, as discussed above. Adjusted EPS was $0.35 in the fourth quarter of 2019, compared to $0.30 in the fourth lower operating costs resulting from the repatriation of the Call Centre; quarter of 2018 which was driven by higher net income for the fourth quarter partially offset by of 2019, but excluding the impacts of the Merger and the DTA Decision. higher spend related to IT projects. Revenues A further decrease of $9 million in other OM&A is driven primarily by lower The quarterly increase of $65 million or 19.0% in transmission revenues was support costs. primarily due to the following: Financing Charges the 2018 impact of the OEB decision in respect of the sharing of the The quarterly decrease of $7 million or 5.7% in financing charges was deferred tax asset; primarily due to lower Merger-related interest expense on the convertible increased OEB-approved transmission rates for 2019; debentures, partially offset by an increase in interest expense on long- higher average monthly Ontario 60-minute peak demand driven by term debt driven by higher weighted-average long-term debt balance favourable weather in the fourth quarter of 2019; and outstanding in 2019. revenue related to NRLP assets placed in-service in late August 2019; Income Taxes partially offset by Income tax expense for the fourth quarter of 2019 decreased by $798 million deferred tax regulatory adjustment related to Accelerated CCA. compared to 2018. This resulted in a realized ETR of approximately 0.9% in the fourth quarter of 2019, compared to approximately 784.3% in the fourth The quarterly decrease of $13 million or 3.3% in distribution revenues, quarter of the prior year. The lower tax expense was primarily attributable net of purchased power, was primarily due to the following: to the prior year charge to deferred tax expense related to the impairment deferred regulatory adjustment related to Earnings Sharing Mechanism; and of Hydro One’s deferred income tax regulatory asset. Taxes were further lowered by the Accelerated CCA, deferred tax asset sharing mandated by deferred tax asset sharing mandated by the OEB and deferred tax the OEB, and changes in income before taxes in 2019 compared to 2018. regulatory adjustment related to Accelerated CCA; partially offset by increased OEB-approved distribution rates for 2019; and Assets Placed In-Service higher energy consumption resulting from favourable weather in the The decrease in transmission assets placed in-service during the fourth fourth quarter of 2019. quarter was primarily due to the following: assets placed in-service in the fourth quarter of 2018 for station See section “Non-GAAP Measures” for description and reconciliation sustainment investments (Horning, Centralia, London, and St. Isidore of revenues, net of purchased power. transmission stations, as well as the Bruce Special Protection System end-of-life equipment replacement project); partially offset by OM&A Costs The quarterly decrease of $55 million or 48.2% in transmission OM&A assets placed in-service for major development project at Leamington costs was primarily due to the following: transmission station in 2019; and higher insurance proceeds received in the fourth quarter of 2019; higher volume of IT and work equipment purchases. lower spend on station and lines maintenance programs; The increase in distribution assets placed in-service during the fourth quarter lower volume of work on vegetation management coverage, as certain was primarily due to the following: work was done earlier in 2019 as a result of favourable weather conditions; higher volume of IT and work equipment purchases; and lower corporate support costs; higher volume of storm-related asset replacements in the fourth quarter lower project write-offs; and of 2019. lower property taxes due to a reassessment of municipal property taxes; partially offset by higher spend related to IT projects. 62 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis Capital Investments Hydro One Holdings Limited – Consolidating The increase in transmission capital investments during the fourth quarter Summary Financial Information was primarily due to the following: Hydro One Limited fully and unconditionally guarantees the payment higher volume of IT and work equipment purchases; obligations of its wholly-owned subsidiary Hydro One Holdings Limited higher volume of transmission station refurbishments and replacements; and (HOHL) issuable under the short form base shelf prospectus dated November 23, 2018. Accordingly, the following consolidating summary higher investments in multi-year development projects in the fourth quarter financial information is provided in compliance with the requirements of 2019 (primarily East-West Tie Expansion), partially offset by the work of section 13.4 of National Instrument 51-102 – Continuous Disclosure related to the Lake Superior Link project and completion of the Clarington Obligations providing for an exemption for certain credit support issuers. transmission station in 2018. The tables below contain consolidating summary financial information as at and for the years ended December 31, 2019 and December 31, 2018 for: The increase in distribution capital investments during the fourth quarter was (i) Hydro One Limited; (ii) HOHL; (iii) the subsidiaries of Hydro One Limited, primarily due to the following: other than HOHL, on a combined basis, (iv) consolidating adjustments, and transfer of pension costs from the Pension Cost Differential regulatory (v) Hydro One Limited and all of its subsidiaries on a consolidated basis, account subsequent to the OEB’s decision on the motion to review and in each case for the periods indicated. Such summary financial information vary its decision as it relates to the recovery of pension costs; is intended to provide investors with meaningful and comparable financial higher investments in distribution system connections (Leamington and information about Hydro One Limited and its subsidiaries. This summary Enfield transmission stations) and increased investment in distribution financial information should be read in conjunction with Hydro One Limited’s modernization initiatives; most recently issued annual financial statements. This summary financial information has been prepared in accordance with US GAAP, as issued by higher volume of IT and work equipment purchases; and the FASB. higher volume of storm-related asset replacements. Subsidiaries of Total Consolidated Year ended December 31 Hydro One Hydro One Limited, Consolidating Amounts of Hydro (millions of dollars) Limited HOHL other than HOHL Adjustments One Limited 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 Revenue 17 12 — — 6,775 6,243 (312) (105) 6,480 6,150 Net Income (Loss) Attributable to Common Shareholders (133) (74) (19) 22 1,188 47 (258) (84) 778 (89) Subsidiaries of Total Consolidated At December 31 Hydro One Hydro One Limited, Consolidating Amounts of Hydro (millions of dollars) Limited HOHL other than HOHL Adjustments One Limited 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 Current Assets 84 159 — 22 2,440 2,054 (1,256) (744) 1,268 1,491 Non-Current Assets 3,979 5,799 — — 41,188 41,597 (19,374) (23,230) 25,793 24,166 Current Liabilities 408 97 — — 3,925 4,391 (1,246) (1,460) 3,087 3,028 Non-Current Liabilities — 1,516 — 3 25,201 22,373 (11,096) (10,906) 14,105 12,986 Forward-Looking Statements and Information expected timing and investment plans; contractual obligations and other commercial commitments; expected impacts relating to the deferred tax The Company’s oral and written public communications, including this asset; Hydro One’s appeal of the OEB’s deferred tax asset decision; the document, often contain forward-looking statements that are based OEB; the Exemptive Relief; the number of Hydro One common shares on current expectations, estimates, forecasts and projections about issuable in connection with outstanding awards under the share grant plans the Company’s business and the industry, regulatory and economic and the LTIP; collective agreements; labour relations risks; the pension plan, environments in which it operates, and include beliefs and assumptions future pension contributions, valuations and expected impacts; dividends; made by the management of the Company. Such statements include, the anticipated impacts of the Accelerated CCA on Hydro One, including but are not limited to, statements regarding: the Company’s transmission timing of such impacts; the Company’s expectations relating to its ETR; and distribution rate applications, including resulting decisions, rates and credit ratings and related risks; Hydro One’s strategy; effect of interest rates; expected impacts and timing; the Company’s liquidity and capital resources non-GAAP measures; critical accounting estimates, including environmental and operational requirements; the Operating Credit Facilities; expectations liabilities, regulatory assets and liabilities, and employee future benefits; regarding the Company’s financing activities; the Company’s maturing risk management and risk factors; risks relating to other applications to debt; ongoing and planned projects and initiatives, including expected the OEB; rate-setting models for transmission and distribution, including results and completion dates; expected future capital investments, including Hydro One Limited | Annual Report 2019 63
Management’s Discussion and Analysis potential impacts on Hydro One; risk of recoverability of total compensation risks associated with the Province’s share ownership of Hydro One costs, including in relation to pension and OPEBs; occupational rights; risks and other relationships with the Province, including potential conflicts relating to Indigenous claims; risks relating to natural and other unexpected of interest that may arise between Hydro One, the Province and occurrences; internal control over financial reporting and disclosure; recent related parties, risks associated with the Province’s exercise of further accounting-related guidance; expectations relating to filing of a new MTN legislative and regulatory powers in the implementation of the Hydro Program prospectus; the Universal Base Shelf Prospectus; the US Debt Shelf One Accountability Act, risks relating to the ability of the Company to Prospectus; the Company’s acquisitions and mergers, including Orillia Power attract and retain qualified executive talent or the risk of a credit rating and Peterborough Distribution; the Company’s ability to attract and retain downgrade for Hydro One Inc. and its impact on the Company’s qualified executives; risks associated with acquisitions; environment risk, funding and liquidity; including climate change; risks associated with IT, OT infrastructure and data risks relating to the location of the Company’s assets on Reserve lands security; technological change and innovation in the electricity industry and and the risk that Hydro One may incur significant costs associated with potential impacts; health and safety risk and potential impacts; expectations transferring assets located on Reserves; related to work force demographics; the Province’s ownership of Hydro the risk that the Company may be unable to comply with regulatory and One, and conflicts that may arise between the Province and Hydro One legislative requirements or that the Company may incur additional costs from time to time; government actions and the potential impacts on Hydro for compliance that are not recoverable through rates; One and its business; future sales of shares of Hydro One; and reputational, public opinion and political risk. Words such as “expect”, “anticipate”, the risk of exposure of the Company’s facilities to the effects of severe “intend”, “attempt”, “may”, “plan”, “will”, “believe”, “seek”, “estimate”, weather conditions, natural disasters, man-made events or other “goal”, “aim”, “target”, and variations of such words and similar expressions unexpected occurrences for which the Company is uninsured or for are intended to identify such forward-looking statements. These statements which the Company could be subject to claims for damage; are not guarantees of future performance and involve assumptions and risks the risk of non-compliance with environmental regulations and inability to and uncertainties that are difficult to predict. Therefore, actual outcomes and recover environmental expenditures in rate applications; results may differ materially from what is expressed, implied or forecasted risks associated with information system security and maintaining complex in such forward-looking statements. Hydro One does not intend, and it IT and OT system infrastructure, including system failures or risks of cyber- disclaims any obligation, to update any forward-looking statements, except attacks or unauthorized access to corporate IT and OT systems; as required by law. the risk of labour disputes and inability to negotiate or renew appropriate These forward-looking statements are based on a variety of factors and collective agreements on acceptable terms consistent with the Company’s assumptions including, but not limited to, the following: no unforeseen rate decisions; changes in the legislative and operating framework for Ontario’s risks related to the Company’s work force demographic and its potential electricity market or for Hydro One specifically; favourable decisions inability to attract and retain qualified personnel; from the OEB and other regulatory bodies concerning outstanding and future rate and other applications; no unexpected delays in obtaining the risk that the Company is not able to arrange sufficient cost-effective the required approvals; no unforeseen changes in rate orders or rate financing to epayr maturing debt and to fund capital expenditures; setting methodologies for the Company’s distribution and transmission risks associated with fluctuations in interest atesr and failure to manage businesses; continued use of US GAAP; a stable regulatory environment; exposure to credit and financial instrument risk; no unfavourable changes in environmental regulation; no significant risks associated with economic uncertainty and financial market volatility; changes to the Company’s current credit ratings; no unforeseen impacts of new accounting pronouncements; and no significant event occurring the risk that the Company may not be able to execute plans for capital outside the ordinary course of business. These assumptions are based on projects necessary to maintain the performance of the Company’s information currently available to the Company, including information assets or to carry out projects in a timely manner or the risk of increased obtained from third-party sources. Actual results may differ materially competition for the development of large transmission projects or from those predicted by such forward-looking statements. While Hydro legislative changes affecting the selection of transmitters; One does not know what impact any of these differences may have, the risks associated with public opposition to or delays or denials of the requisite Company’s business, results of operations, financial condition and credit approvals and accommodations for the Company’s planned projects; stability may be materially adversely affected. Factors that could cause the risk that assumptions that form the basis of the Company’s recorded actual results or outcomes to differ materially from the results expressed environmental liabilities and related regulatory assets may change; or implied by forward-looking statements include, among other things: the risk of failure to mitigate significant health and safety risks; regulatory risks and risks relating to Hydro One’s revenues, including risks relating to rate orders and the rate-setting models for transmission the risk of not being able to recover the Company’s pension expenditures and distribution, actual performance against forecasts and capital in future rates and uncertainty regarding the future regulatory treatment of expenditures, the regulatory treatment of the deferred tax asset, the pension, other post-employment benefits and post-retirement benefits costs; recoverability of total compensation costs or denials of applications; 64 Hydro One Limited | Annual Report 2019
Management’s Discussion and Analysis the potential that Hydro One may incur significant expenses to replace Hydro One cautions the reader that the above list of factors is not functions currently outsourced if agreements are terminated or expire exhaustive. Some of these and other factors are discussed in more detail before a new service provider is selected; in the section “Risk Management and Risk Factors” in this MD&A. the impact of the ownership by the Province of lands underlying the In addition, Hydro One cautions the reader that information provided in this Company’s transmission system; MD&A regarding the Company’s outlook on certain matters, including potential the risk associated with legal proceedings that could be costly, time- future investments, is provided in order to give context to the nature of some consuming or divert the attention of management and key personnel of the Company’s future plans and may not be appropriate for other purposes. from the Company’s business operations; Additional information about Hydro One, including the Company’s Annual the impact if the Company does not have valid occupational rights on Information Form, is available on SEDAR at www.sedar.com, the US third-party owned or controlled lands and the risks associated with Securities and Exchange Commission’s EDGAR website at www.sec.gov/ occupational rights of the Company that may be subject to expiry; edgar.shtml, and the Company’s website at www.HydroOne.com/Investors. risks relating to adverse reputational events or political actions; the inability to prepare financial statements using US GAAP; and the risk related to the impact of the new accounting pronouncements. Hydro One Limited | Annual Report 2019 65
Management’s Report The Consolidated Financial Statements, Management’s Discussion and The Consolidated Financial Statements have been audited by KPMG LLP, Analysis (MD&A) and related financial information have been prepared independent external auditors appointed by the shareholders of the by the management of Hydro One Limited (Hydro One or the Company). Company. The external auditors’ responsibility is to express their opinion Management is responsible for the integrity, consistency and reliability on whether the Consolidated Financial Statements are fairly presented in of all such information presented. The Consolidated Financial Statements all material respects in accordance with United States Generally Accepted have been prepared in accordance with United States Generally Accepted Accounting Principles. The Independent Auditors’ Report outlines the scope Accounting Principles and applicable securities legislation. The MD&A of their examination and their opinion. has been prepared in accordance with National Instrument 51–102. The Hydro One Board of Directors, through its Audit Committee, is The preparation of the Consolidated Financial Statements and information responsible for ensuring that management fulfils its responsibilities for in the MD&A involves the use of estimates and assumptions based on financial reporting and internal control over reporting and disclosure. The management’s judgment, particularly when transactions affecting the current Audit Committee of Hydro One met periodically with management, the accounting period cannot be finalized with certainty until future periods. internal auditors and the external auditors to satisfy itself that each group Estimates and assumptions are based on historical experience, current had properly discharged its respective responsibility and to review the conditions and various other assumptions believed to be reasonable in the Consolidated Financial Statements before recommending approval by the circumstances, with critical analysis of the significant accounting policies Board of Directors. The external auditors had direct and full access to the followed by the Company as described in Note 2 to the Consolidated Audit Committee, with and without the presence of management, to discuss Financial Statements. The preparation of the Consolidated Financial their audit findings. Statements and the MD&A includes information regarding the estimated impact of future events and transactions. The MD&A also includes On behalf of Hydro One’s management: information regarding sources of liquidity and capital resources, operating trends, risks and uncertainties. Actual results in the future may differ materially from the present assessment of this information because future events and circumstances may not occur as expected. Management is responsible for establishing and maintaining adequate disclosure controls and procedures and internal control over financial Mark Poweska Christopher Lopez reporting as described in the annual MD&A. Management evaluated the President and Chief Executive Officer Chief Financial Officer effectiveness of the design and operation of disclosure controls and procedures and internal control over financial reporting based on the framework and criteria established in the Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, management concluded that the Company’s internal control over financial reporting was effective at a reasonable level of assurance as of December 31, 2019. As required, the results of that evaluation were reported to the Audit Committee of the Hydro One Board of Directors and the external auditors. 66 Hydro One Limited | Annual Report 2019
Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors of Hydro One Limited the critical audit matters below, providing separate opinions on the critical Opinion on the Consolidated Financial Statements audit matters or on the accounts or disclosures to which they relate. We have audited the accompanying consolidated balance sheets of Hydro One Limited (the Company) as of December 31, 2019 and 2018, the related Evaluation of Regulatory Assets and Liabilities and the Impact consolidated statements of operations and comprehensive income (loss), of Rate Regulation on the Financial Statements changes in equity, and cash flows for each of the years in the two-year As discussed in Notes 2 and 12 to the consolidated financial statements, the period ended December 31, 2019, and the related notes (collectively, the Company accounts for its regulated operations in accordance with Financial consolidated financial statements). In our opinion, the consolidated financial Accounting Standards Board Accounting Standard Codification Topic 980, statements present fairly, in all material respects, the financial position of Regulated Operations (ASC 980). Under ASC 980, the actions of the the Company as of December 31, 2019 and 2018, and the results of its Company’s regulator may result in the recognition of revenue and costs in operations and its cash flows for each of the years in the two-year period time periods that are different than non-rate-regulated enterprises. When ended December 31, 2019, in conformity with US generally accepted this occurs, the Company records incurred and accrued costs that it has accounting principles. assessed are probable of recovery in future electricity rates as regulatory assets. Obligations imposed or probable to be imposed by the regulator Basis for Opinion to refund previously collected revenue or to spend revenue collected from These consolidated financial statements are the responsibility of the Company’s customers on future costs are recorded as regulatory liabilities. Under ASC management. Our responsibility is to express an opinion on these 980, the carrying amounts of property, plant and equipment are impacted consolidated financial statements based on our audits. We are a public by the regulator’s actions to the extent that incurred costs are allowed or accounting firm registered with the Public Company Accounting Oversight disallowed to be recovered for rate-making purposes. As at December 31, Board (United States) (PCAOB) and are required to be independent with 2019, the Company’s regulatory assets were $2,728 million and regulatory respect to the Company in accordance with the US federal securities laws liabilities were $212 million. and the applicable rules and regulations of the Securities and Exchange We identified the evaluation of regulatory assets and liabilities and the Commission and the PCAOB. impact of rate regulation as a critical audit matter. Accounting for regulated We conducted our audits in accordance with the standards of the PCAOB. operations under ASC 980 affects multiple financial statement accounts and Those standards require that we plan and perform the audits to obtain disclosures in the Company’s consolidated financial statements. Assessing reasonable assurance about whether the consolidated financial statements the accounting for regulated operations requires significant knowledge are free of material misstatement, whether due to error or fraud. The Company thereof and auditor judgment due to interpretations of regulatory decisions is not required to have, nor were we engaged to perform, an audit of its and judgments involved in evaluating the Company’s assessment of the internal control over financial reporting. As part of our audits, we are required probability associated with recovery of regulatory assets and property, to obtain an understanding of internal control over financial reporting plant and equipment and disposition of regulatory liabilities. but not for the purpose of expressing an opinion on the effectiveness of The primary procedures we performed to address the critical audit matter the Company’s internal control over financial reporting. Accordingly, we included the following. We tested certain internal controls over the express no such opinion. initial recognition of amounts as regulatory assets and liabilities and the Our audits included performing procedures to assess the risks of material monitoring and evaluation of regulatory developments that may affect the misstatement of the consolidated financial statements, whether due to likelihood of recovering costs in future rates or obligations for disposition error or fraud, and performing procedures that respond to those risks. of regulatory liabilities. We evaluated the Company’s assessment of the Such procedures included examining, on a test basis, evidence regarding probability of recovery of the carrying amount of regulatory assets and the amounts and disclosures in the consolidated financial statements. property, plant and equipment and the disposition of regulatory liabilities, Our audits also included evaluating the accounting principles used and through consideration of on-going regulatory proceedings and decisions, significant estimates made by management, as well as evaluating the overall assessment of the Company’s interpretations of regulatory decisions and presentation of the consolidated financial statements. We believe that our reading the opinion of the Company’s external legal counsel. We evaluated audits provide a reasonable basis for our opinion. the impacts of rate regulation on the financial statements, including the amounts recorded and the related disclosures. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material Chartered Professional Accountants, Licensed Public Accountants to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical We have served as the Company’s auditor since 2008 audit matters does not alter in any way our opinion on the consolidated Toronto, Canada financial statements, taken as a whole, and we are not, by communicating February 11, 2020 Hydro One Limited | Annual Report 2019 67
Consolidated Statements of Operations and Comprehensive Income (Loss) Year ended December 31 (millions of Canadian dollars, except per share amounts) 2019 2018 Revenues Distribution (includes $282 related party revenues; 2018 – $280) (Note 29) 4,788 4,422 Transmission (includes $1,637 related party revenues; 2018 – $1,674) (Note 29) 1,652 1,686 Other 40 42 6,480 6,150 Costs Purchased power (includes $1,818 related party costs; 2018 – $1,648) (Note 29) 3,111 2,899 Operation, maintenance and administration (Notes 4, 29) 1,181 1,105 Depreciation, amortization and asset removal costs (Note 5) 878 837 5,170 4,841 Income before financing charges and income tax expense 1,310 1,309 Financing charges (Note 6) 514 459 Income before income tax expense 796 850 Income tax expense (recovery) (Note 7) (6) 915 Net income (loss) 802 (65) Other comprehensive income (loss) (2) 4 Comprehensive income (loss) 800 (61) Net income (loss) attributable to: Noncontrolling interest (Note 28) 6 6 Preferred shareholders 18 18 Common shareholders 778 (89) 802 (65) Comprehensive income (loss) attributable to: Noncontrolling interest (Note 28) 6 6 Preferred shareholders 18 18 Common shareholders 776 (85) 800 (61) Earnings per common share (Note 26) Basic $ 1.30 $ (0.15) Diluted $ 1.30 $ (0.15) Dividends per common share declared (Note 25) $ 0.96 $ 0.91 See accompanying notes to Consolidated Financial Statements. 68 Hydro One Limited | Annual Report 2019
Consolidated Balance Sheets December 31 (millions of Canadian dollars) 2019 2018 Assets Current assets: Cash and cash equivalents 30 483 Accounts receivable (Note 8) 701 628 Due from related parties (Note 29) 415 255 Other current assets (Note 9) 122 125 1,268 1,491 Property, plant and equipment (Note 10) 21,501 20,687 Other long-term assets: Regulatory assets (Note 12) 2,676 1,721 Deferred income tax assets (Note 7) 748 1,018 Intangible assets (Note 11) 456 410 Goodwill 325 325 Other assets 87 5 4,292 3,479 Total assets 27,061 25,657 Liabilities Current liabilities: Short-term notes payable (Note 16) 1,143 1,252 Long-term debt payable within one year (Notes 16, 18) 653 731 Accounts payable and other current liabilities (Note 14) 989 956 Due to related parties (Note 29) 302 89 3,087 3,028 Long-term liabilities: Long-term debt (includes $351 measured at fair value; 2018 – $845) (Notes 16, 18) 10,822 9,978 Convertible debentures (Notes 17, 18) — 489 Regulatory liabilities (Note 12) 167 326 Deferred income tax liabilities (Note 7) 61 58 Other long-term liabilities (Note 15) 3,055 2,135 14,105 12,986 Total liabilities 17,192 16,014 Contingencies and Commitments (Notes 31, 32) Subsequent Events (Note 34) Noncontrolling interest subject to redemption (Note 28) 20 21 Equity Common shares (Note 24) 5,661 5,643 Preferred shares (Note 24) 418 418 Additional paid-in capital (Note 27) 49 56 Retained earnings 3,667 3,459 Accumulated other comprehensive loss (5) (3) Hydro One shareholders’ equity 9,790 9,573 Noncontrolling interest (Note 28) 59 49 Total equity 9,849 9,622 27,061 25,657 See accompanying notes to Consolidated Financial Statements. On behalf of the Board of Directors: Timothy Hodgson Russel Robertson Chair Chair, Audit Committee Hydro One Limited | Annual Report 2019 69
Consolidated Statements of Changes in Equity Accumulated Non- Additional Other Hydro One controlling Year ended December 31, 2019 Common Preferred Paid-in Retained Comprehensive Shareholders’ Interest Total (millions of Canadian dollars) Shares Shares Capital Earnings Income (Loss) Equity (Note 28) Equity January 1, 2019 5,643 418 56 3,459 (3) 9,573 49 9,622 Net income — — — 796 — 796 4 800 Other comprehensive income (loss) — — — — (2) (2) — (2) Distributions to noncontrolling interest — — — — — — (6) (6) Contributions from sale of noncontrolling interest (Note 4) — — — — — — 12 12 Dividends on preferred shares — — — (18) — (18) — (18) Dividends on common shares — — — (570) — (570) — (570) Common shares issued 18 — (12) — — 6 — 6 Stock-based compensation (Note 27) — — 5 — — 5 — 5 December 31, 2019 5,661 418 49 3,667 (5) 9,790 59 9,849 Accumulated Non- Additional Other Hydro One controlling Year ended December 31, 2018 Common Preferred Paid-in Retained Comprehensive Shareholders’ Interest Total (millions of Canadian dollars) Shares Shares Capital Earnings Income (Loss) Equity (Note 28) Equity January 1, 2018 5,631 418 49 4,090 (7) 10,181 50 10,231 Net income (loss) — — — (71) — (71) 4 (67) Other comprehensive income — — — — 4 4 — 4 Distributions to noncontrolling interest — — — — — — (5) (5) Dividends on preferred shares — — — (18) — (18) — (18) Dividends on common shares — — — (542) — (542) — (542) Common shares issued 12 — (12) — — — — — Stock-based compensation (Note 27) — — 19 — — 19 — 19 December 31, 2018 5,643 418 56 3,459 (3) 9,573 49 9,622 See accompanying notes to Consolidated Financial Statements. 70 Hydro One Limited | Annual Report 2019
Consolidated Statements of Cash Flows Year ended December 31 (millions of Canadian dollars) 2019 2018 Operating activities Net income (loss) 802 (65) Environmental expenditures (25) (22) Adjustments for non-cash items: Depreciation and amortization (Note 5) 777 747 Regulatory assets and liabilities (48) 35 Deferred income tax expense (recovery) (30) 890 Unrealized loss (gain) on Foreign-Exchange Contract (Note 4) 22 (25) Derecognition of deferred financing costs(Note 4) 24 — Other 37 38 Changes in non-cash balances related to operations (Note 30) 55 (23) Net cash from operating activities 1,614 1,575 Financing activities Long-term debt issued 1,500 1,400 Long-term debt repaid (730) (753) Short-term notes issued 4,217 4,242 Short-term notes repaid (4,326) (3,916) Convertible debentures redeemed (513) — Dividends paid (588) (560) Distributions paid to noncontrolling interest (9) (8) Contributions received from sale of noncontrolling interest (Note 4) 12 — Common shares issued 6 — Costs to obtain financing (8) (6) Net cash from (used in) financing activities (439) 399 Investing activities Capital expenditures (Note 30) Property, plant and equipment (1,513) (1,418) Intangible assets (115) (120) Capital contributions received (Note 30) 3 7 Other (3) 15 Net cash used in investing activities (1,628) (1,516) Net change in cash and cash equivalents (453) 458 Cash and cash equivalents, beginning of year 483 25 Cash and cash equivalents, end of year 30 483 See accompanying notes to Consolidated Financial Statements. Hydro One Limited | Annual Report 2019 71
Notes to Consolidated Financial Statements For the years ended December 31, 2019 and 2018 1. DESCRIPTION OF THE BUSINESS HOSSM is under a 10-year deferred rebasing period for years 2017– 2026, as approved in the OEB Mergers Acquisitions Amalgamations Hydro One Limited (Hydro One or the Company) was incorporated on and Divestitures (MAAD) decision dated October 13, 2016. In July 2018, August 31, 2015, under the Business Corporations Act (Ontario). On HOSSM filed a 2019 application for permission to include a revenue October 31, 2015, the Company acquired Hydro One Inc., a company cap escalator index, which would allow for inflationary increases to its previously wholly-owned by the Province of Ontario (Province). The previously approved revenue requirement. On June 20, 2019, the OEB acquisition of Hydro One Inc. by Hydro One was accounted for as a approved the revenue cap escalator index at 1.1% (net) which was applied common control transaction and Hydro One is a continuation of business to HOSSM’s base revenue requirement for 2019, effective February 1, 2019, operations of Hydro One Inc. At December 31, 2019, the Province held and also approved the 2019–2026 revenue cap framework. approximately 47.3% (2018 – 47.4%) of the common shares of Hydro One. The principal businesses of Hydro One are the transmission and distribution On September 26, 2019, the OEB approved NRLP’s request to establish of electricity to customers within Ontario. a deferral account to record NRLP’s 2019 revenue requirement prior to its inclusion in the Uniform Transmission Rates (UTRs). Rate Setting The Company’s transmission business consists of the transmission system Distribution operated by Hydro One Inc.’s subsidiaries, Hydro One Networks Inc. In March 2017, Hydro One Networks filed an application with the OEB (Hydro One Networks) and Hydro One Sault Ste. Marie LP (HOSSM), for 2018–2022 distribution rates. On March 7, 2019, the OEB rendered as well as an approximately 66% interest in B2M Limited Partnership its decision on the distribution rates application. In accordance with the (B2M LP), a limited partnership between Hydro One and the Saugeen OEB decision, the Company filed its draft rate order reflecting updated Ojibway Nation (SON), and an approximately 75% interest in Niagara revenue requirements of $1,459 million for 2018, $1,498 million for 2019, Reinforcement Limited Partnership (NRLP), a limited partnership between $1,532 million for 2020, $1,578 million for 2021, and $1,624 million Hydro One and Six Nations of the Grand River Development Corporation for 2022. On June 11, 2019, the OEB approved the rate order confirming and the Mississaugas of the Credit First Nation (collectively, the First Nations these updated revenue requirements. See Note 12 – Regulatory Assets Partners). See Note 4 – Business Combinations and Note 34 – Subsequent and Liabilities for additional information. Events for additional information. Hydro One’s distribution business consists of the distribution system operated by Hydro One Inc.’s subsidiaries, Hydro On March 26, 2019, the Company filed a motion to review and vary One Networks and Hydro One Remote Communities Inc. (Hydro One the OEB’s decision with respect to recovery of pension costs. On Remote Communities). December 19, 2019, the OEB affirmed its earlier decision with respect to recovery of the pension costs. See Note 12 – Regulatory Assets and Transmission Liabilities for additional information. On March 7, 2019, the Ontario Energy Board (OEB) issued a decision on its reconsideration of its decision and order on Hydro One Networks’ 2017 On November 5, 2018, Hydro One Remote Communities filed an and 2018 transmission rates revenue requirement dated September 28, application with the OEB seeking approval for increased base rates 2017 (Original Decision) with respect to the rate-setting treatment of the of 1.8% effective May 1, 2019. On March 28, 2019, the OEB issued benefits of the deferred tax asset resulting from the transition from the a decision approving the requested increase. payments in lieu of tax regime under the Electricity Act, 1998 (Ontario) to tax payments under the federal and provincial tax regimes which occurred 2. SIGNIFICANT ACCOUNTING POLICIES when Hydro One became a public company listed on the Toronto Stock Exchange. See Note 12 – Regulatory Assets and Liabilities for additional Basis of Consolidation and Presentation These Consolidated Financial Statements (Consolidated Financial information. On October 26, 2018, Hydro One filed a one-year inflation- Statements) include the accounts of the Company and its subsidiaries. based application with the OEB for 2019 transmission revenue requirement. Inter-company transactions and balances have been eliminated. On April 25, 2019, the OEB issued its decision on Hydro One Networks’ 2019 transmission rate application, and set the revenue index at 1.4% on On March 25, 2019, the Company filed amended consolidated financial a final basis effective May 1, 2019. statements as at and for the year ended December 31, 2018 to reflect the impact of the March 7, 2019 decision issued by the OEB relating to the In December 2015, the OEB approved B2M LP’s 2015–2019 rates revenue Deferred Tax Asset portion of the OEB’s decision on Hydro One requirements of $39 million, $36 million, $37 million, $38 million and Networks’ 2017 and 2018 transmission revenue requirement, for which $37 million for the respective years. On November 23, 2018, B2M LP filed the OEB previously granted a Motion to Review and Vary. The comparative a revised 2019 revenue requirement with the OEB using the updated cost information in these Consolidated Financial Statements reflects the of capital parameters. On December 20, 2018, the OEB issued its decision amended consolidated financial statements as at and for the year approving the requested 2019 revenue requirement of $33 million, effective ended December 31, 2018. January 1, 2019. 72 Hydro One Limited | Annual Report 2019
Basis of Accounting transmission system with sufficient capacity to accommodate the maximum These Consolidated Financial Statements are prepared and presented expected demand which is influenced by weather and economic conditions. in accordance with United States (US) Generally Accepted Accounting Transmission revenues are recognized as electricity is transmitted and Principles (GAAP) and in Canadian dollars. delivered to customers. Use of Management Estimates Distribution revenues attributable to the delivery of electricity are based on The preparation of financial statements requires management to make OEB-approved distribution rates and are recognized on an accrual basis estimates and assumptions that affect the reported amounts of assets and and include billed and unbilled revenues. Billed revenues are based on liabilities at the date of the financial statements and the reported amounts electricity delivered as measured from customer meters. At the end of each of revenues, expenses, gains and losses during the reporting periods. month, electricity delivered to customers since the date of the last billed Management evaluates these estimates on an ongoing basis based upon meter reading is estimated, and the corresponding unbilled revenue is historical experience, current conditions, and assumptions believed to be recorded. The unbilled revenue estimate is affected by energy consumption, reasonable at the time the assumptions are made, with any adjustments weather, and changes in the composition of customer classes. being recognized in results of operations in the period they arise. Significant Revenues also include amounts related to sales of other services and estimates relate to regulatory assets and regulatory liabilities, environmental equipment. Such revenue is recognized as services are rendered or as liabilities, pension benefits, post-retirement and post-employment benefits, equipment is delivered. Revenues are recorded net of indirect taxes. asset retirement obligations, goodwill and asset impairments, contingencies, unbilled revenues, and deferred income tax assets and liabilities. Actual Accounts Receivable and Allowance for Doubtful Accounts results may differ significantly from these estimates. The Company early-adopted Accounting Standard Update (ASU) 2016-13 Financial Instruments – Credit Losses (along with related ASUs as disclosed Regulatory Accounting in Note 3 – New Accounting Pronouncements) with a transition date of The OEB has the general power to include or exclude revenues, costs, gains January 1, 2019 using the modified retrospective method. Upon adoption, or losses in the rates of a specific period, resulting in a change in the timing there was no material impact to the Consolidated Financial Statements, of accounting recognition from that which would have been applied in and no adjustments were made to prior period financial statements. an unregulated company. Such change in timing involves the application of rate-regulated accounting, giving rise to the recognition of regulatory Billed accounts receivable are recorded at the invoiced amount, net of assets and liabilities. The Company’s regulatory assets represent amounts allowance for doubtful accounts. Unbilled accounts receivable are recorded receivable from future customers and costs that have been deferred for at their estimated value, net of allowance for doubtful accounts. Overdue accounting purposes because it is probable that they will be recovered in amounts related to regulated billings bear interest at OEB-approved rates. future rates. In addition, the Company has recorded regulatory liabilities The allowance for doubtful accounts reflects the Company’s current lifetime that generally represent amounts that are refundable to future customers. expected credit losses (CECL) for all accounts receivable balances. The The Company continually assesses the likelihood of recovery of each of its Company estimates the CECL by applying internally developed loss rates to regulatory assets and continues to believe that it is probable that the OEB all outstanding receivable balances by aging category. Loss rates applied will include its regulatory assets and liabilities in setting future rates. If, at to the accounts receivable balances are based on historical overdue some future date, the Company judges that it is no longer probable that balances, customer payments and write-offs. Accounts receivable are the OEB will include a regulatory asset or liability in setting future rates, written-off against the allowance when they are deemed uncollectible. The the appropriate carrying amount would be reflected in results of operations allowance for doubtful accounts is affected by changes in volume, prices prospectively from the date the Company’s assessment is made, unless the and economic conditions. change meets the requirements for a subsequent event adjustment. Noncontrolling Interest Cash and Cash Equivalents Noncontrolling interest represents the portion of equity ownership Cash and cash equivalents include cash and short-term investments with in subsidiaries that is not attributable to shareholders of Hydro One. an original maturity of three months or less. Noncontrolling interest is initially recorded at fair value and subsequently the amount is adjusted for the proportionate share of net income and other Revenue Recognition comprehensive income (OCI) attributable to the noncontrolling interest and Nature of Revenues any dividends or distributions paid to the noncontrolling interest. Transmission revenues predominantly consist of transmission tariffs, which are collected through OEB-approved UTRs which are applied If a transaction results in the acquisition of all, or part, of a noncontrolling against the monthly peak demand for electricity across Hydro One’s interest in a subsidiary, the acquisition of the noncontrolling interest is high-voltage network. OEB-approved UTRs are based on an approved accounted for as an equity transaction. No gain or loss is recognized in revenue requirement that includes a rate of return. The transmission tariffs consolidated net income or comprehensive income as a result of changes in are designed to recover revenues necessary to support the Company’s the noncontrolling interest, unless a change results in the loss of control by the Company. Hydro One Limited | Annual Report 2019 73
Notes to Consolidated Financial Statements Income Taxes Property, Plant and Equipment Current and deferred income taxes are computed based on the tax rates Property, plant and equipment is recorded at original cost, net of customer and tax laws enacted as at the balance sheet date. Tax benefits associated contributions, and any accumulated impairment losses. The cost of additions, with income tax positions are recorded only when the more-likely-than-not including betterments and replacement asset components, is included on the recognition threshold is satisfied and are measured at the largest amount Consolidated Balance Sheets as property, plant and equipment. of benefit that has a greater than 50% likelihood of being realized upon settlement. Management evaluates each position based solely on the The original cost of property, plant and equipment includes direct materials, technical merits and facts and circumstances of the position, assuming the direct labour (including employee benefits), contracted services, attributable position will be examined by a taxing authority having full knowledge of capitalized financing costs, asset retirement costs, and direct and indirect all relevant information. Significant management judgment is required to overheads that are related to the capital project or program. Indirect determine recognition thresholds and the related amount of tax benefits overheads include a portion of corporate costs such as finance, treasury, to be recognized in the Consolidated Financial Statements. Management human resources, and information technology (IT). Overhead costs, re-evaluates tax positions each period using new information about including corporate functions and field services costs, are capitalized on recognition or measurement as it becomes available. a fully allocated basis, consistent with an OEB-approved methodology. Property, plant and equipment in service consists of transmission, distribution, Deferred Income Taxes communication, administration and service assets and land easements. Deferred income taxes are provided for using the liability method. Under Property, plant and equipment also includes future use assets, such as land, this method, deferred income tax assets and liabilities are recognized on major components and spare parts, and capitalized project development all temporary differences between the tax bases and carrying amounts of costs associated with deferred capital projects. assets and liabilities, including the carry forward unused tax credits and tax losses to the extent that it is more-likely-than-not that these deductions, Transmission credits, and losses can be utilized. Deferred income tax assets and liabilities Transmission assets include assets used for the transmission of high-voltage are measured at the tax rates that are expected to apply in the period electricity, such as transmission lines, support structures, foundations, when the liability is settled or the asset is realized, based on the tax rates insulators, connecting hardware and grounding systems, and assets used and tax laws that have been enacted as at the balance sheet date. to step up the voltage of electricity from generating stations for transmission Deferred income taxes that are not included in the rate-setting process and to step down voltages for distribution, including transformers, circuit are charged or credited to the consolidated statements of operations breakers and switches. and comprehensive income. Management reassesses the deferred income tax assets at each balance Distribution sheet date and reduces the amount to the extent that it is more likely than Distribution assets include assets related to the distribution of low-voltage not that the deferred income tax asset will not be realized. Previously electricity, including lines, poles, switches, transformers, protective devices unrecognized deferred income tax assets are reassessed at each balance and metering systems. sheet date and are recognized to the extent that it has become more likely than not that the tax benefit will be realized. Communication Communication assets include fibre optic and microwave radio systems, The Company recognizes deferred income taxes associated with its optical ground wire, towers, telephone equipment and associated buildings. regulated operations and records offsetting regulatory assets and liabilities for the deferred income taxes that are expected to be recovered or refunded Administration and Service in future regulated rates charged to customers. Administration and service assets include administrative buildings, personal computers, transport and work equipment, tools and other minor assets. Investment tax credits are recorded as a reduction of the related expenses or income tax expense in the current or future period to the extent it is more Easements likely than not that the credits can be utilized. Easements include statutory rights of use for transmission corridors and abutting lands granted under the Reliable Energy and Consumer Protection Materials and Supplies Act, 2002, as well as other land access rights. Materials and supplies represent consumables, small spare parts and construction materials held for internal construction and maintenance of Intangible Assets property, plant and equipment. These assets are carried at average cost Intangible assets separately acquired or internally developed are measured less any impairments recorded. on initial recognition at cost, which comprises purchased software, direct labour (including employee benefits), consulting, engineering, overheads and attributable capitalized financing charges. Following initial recognition, intangible assets are carried at cost, net of any accumulated amortization and accumulated impairment losses. The Company’s intangible assets primarily represent major computer applications. 74 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements Capitalized Financing Costs Depreciation and Amortization Capitalized financing costs represent interest costs attributable to the The cost of property, plant and equipment and intangible assets is construction of property, plant and equipment or development of intangible depreciated or amortized on a straight-line basis based on the estimated assets. The financing cost of attributable borrowed funds is capitalized as remaining service life of each asset category, except for transport and work part of the acquisition cost of such assets. The capitalized financing costs are equipment, which is depreciated on a declining balance basis. a reduction of financing charges recognized in the Consolidated Statements of Operations and Comprehensive Income. Capitalized financing costs are The Company periodically initiates an external independent review of calculated using the Company’s weighted average effective cost of debt. its property, plant and equipment and intangible asset depreciation and amortization rates, as required by the OEB. Any changes arising from Construction and Development in Progress OEB approval of such a review are implemented on a remaining service Construction and development in progress consists of the capitalized cost of life basis, consistent with their inclusion in electricity rates. The most recent constructed assets that are not yet complete and which have not yet been reviews resulted in changes to rates effective January 1, 2015 and January 1, placed in service. 2017 for Hydro One Networks’ distribution and transmission businesses, respectively. A summary of average service lives and depreciation and amortization rates for the various classes of assets is included below: Average Rate Service Life Range Average Property, plant and equipment: Transmission 55 years 1% – 3% 2% Distribution 46 years 1% – 7% 2% Communication 16 years 1% – 15% 5% Administration and service 21 years 1% – 20% 5% Intangible assets 10 years 10% 10% In accordance with group depreciation practices, the original cost of The second step requires an allocation of fair value to the individual assets property, plant and equipment, or major components thereof, and intangible and liabilities using purchase price allocation in order to determine the assets that are normally retired, is charged to accumulated depreciation, implied fair value of goodwill. If the implied fair value of goodwill is less with no gain or loss being reflected in results of operations. Where a than the carrying amount, an impairment loss is recorded as a reduction disposition of property, plant and equipment occurs through sale, a gain or to goodwill and as a charge to results of operations. loss is calculated based on proceeds and such gain or loss is included in depreciation expense. Based on assessment performed as at September 30, 2019, the Company has concluded that goodwill was not impaired at December 31, 2019. Acquisitions and Goodwill The Company accounts for business acquisitions using the acquisition Long-Lived Asset Impairment method of accounting and, accordingly, the assets and liabilities of the When circumstances indicate the carrying value of long-lived assets may acquired entities are primarily measured at their estimated fair value at not be recoverable, the Company evaluates whether the carrying value of the date of acquisition. Costs associated with pending acquisitions are such assets, excluding goodwill, has been impaired. For such long-lived expensed as incurred. Goodwill represents the cost of acquired companies assets, the Company evaluates whether impairment may exist by estimating that is in excess of the fair value of the net identifiable assets acquired at future estimated undiscounted cash flows expected to result from the use the acquisition date. Goodwill is not included in rate base. and eventual disposition of the asset. When alternative courses of action to recover the carrying amount of a long-lived asset are under consideration, Goodwill is evaluated for impairment on an annual basis, or more frequently a probability-weighted approach is used to develop estimates of future if circumstances require. The Company performs a qualitative assessment undiscounted cash flows. If the carrying value of the long-lived asset is not to determine whether it is more likely than not that the fair value of the recoverable based on the estimated future undiscounted cash flows, an applicable reporting unit is less than its carrying amount. If the Company impairment loss is recorded, measured as the excess of the carrying value determines, as a result of its qualitative assessment, that it is not more likely of the asset over its fair value. As a result, the asset’s carrying value is than not that the fair value of the applicable reporting unit is less than its adjusted to its estimated fair value. carrying amount, no further testing is required. If the Company determines, as a result of its qualitative assessment, that it is more likely than not that the Within its regulated business, the carrying costs of most of Hydro One’s fair value of the applicable reporting unit is less than its carrying amount, a long-lived assets are included in rate base where they earn an OEB- goodwill impairment assessment is performed using a two-step, fair value- approved rate of return. Asset carrying values and the related return are based test. The first step compares the fair value of the applicable reporting recovered through approved rates. As a result, such assets are only tested unit to its carrying amount, including goodwill. If the carrying amount of the for impairment in the event that the OEB disallows recovery, in whole or in applicable reporting unit exceeds its fair value, a second step is performed. part, or if such a disallowance is judged to be probable. Hydro One Limited | Annual Report 2019 75
Notes to Consolidated Financial Statements Hydro One regularly monitors the assets of its unregulated Hydro One Derivative Instruments and Hedge Accounting Telecom Inc. subsidiary for indications of impairment. Management The Company closely monitors the risks associated with changes in interest assesses the fair value of such long-lived assets using commonly accepted rates on its operations and, where appropriate, uses various instruments to techniques. Techniques used to determine fair value include, but are not hedge these risks. Certain of these derivative instruments qualify for hedge limited to, the use of recent third-party comparable sales for reference accounting and are designated as accounting hedges, while others either and internally developed discounted cash flow analysis. Significant do not qualify as hedges or have not been designated as hedges changes in market conditions, changes to the condition of an asset, or a (hereinafter referred to as undesignated contracts) as they are part of change in management’s intent to utilize the asset are generally viewed by economic hedging relationships. management as triggering events to reassess the cash flows related to these long-lived assets. As at December 31, 2019 and 2018, no asset impairment The accounting guidance for derivative instruments requires the recognition had been recorded for assets within either the Company’s regulated or of all derivative instruments not identified as meeting the normal purchase unregulated businesses. and sale exemption as either assets or liabilities recorded at fair value on the consolidated balance sheets. For derivative instruments that qualify for Costs of Arranging Debt Financing hedge accounting, the Company may elect to designate such derivative For financial liabilities classified as other than held-for-trading and for instruments as either cash flow hedges or fair value hedges. The Company convertible debentures, the Company defers the external transaction costs offsets fair value amounts recognized on its consolidated balance sheets related to obtaining financing and presents such amounts net of related debt related to derivative instruments executed with the same counterparty under or convertible debentures on the Consolidated Balance Sheets. Deferred the same master netting agreement. issuance costs are amortized over the contractual life of the related debt or For derivative instruments that qualify for hedge accounting and which are convertible debentures on an effective-interest basis and the amortization designated as cash flow hedges, any unrealized gain or loss, net of tax, is is included within financing charges in the Consolidated Statements of recorded as a component of accumulated OCI (AOCI). Amounts in AOCI Operations and Comprehensive Income. Transaction costs for items are reclassified to results of operations in the same period or periods during classified as held-for-trading are expensed immediately. which the hedged transaction affects results of operations and presented in the same line item as the earnings effect of the hedged item. Any gains Comprehensive Income or losses on the derivative instrument that represent hedge components Comprehensive income is comprised of net income and OCI. Hydro One excluded from the assessment of effectiveness are recognized in the same presents net income and OCI in a single continuous Consolidated Statement line item of the consolidated statements of operations as the hedged item. of Operations and Comprehensive Income. For fair value hedges, changes in fair value of both the derivative instrument and the underlying hedged exposure are recognized in the consolidated Financial Assets and Liabilities statements of operations and comprehensive income in the current period. All financial assets and liabilities are classified into one of the following five The gain or loss on the derivative instrument is included in the same line categories: held-to-maturity; loans and receivables; held-for-trading; other item as the offsetting gain or loss on the hedged item in the consolidated liabilities; or available-for-sale. Financial assets and liabilities classified statements of operations and comprehensive income. The changes in fair as held-for-trading are measured at fair value. All other financial assets value of the undesignated derivative instruments are reflected in results and liabilities are measured at amortized cost, except accounts receivable of operations. and amounts due from related parties, which are measured at the lower of cost or fair value. Accounts receivable and amounts due from related Embedded derivative instruments are separated from their host contracts parties are classified as loans and receivables. The Company considers the and are carried at fair value on the consolidated balance sheets when: carrying amounts of accounts receivable and amounts due from related (a) the economic characteristics and risks of the embedded derivative parties to be reasonable estimates of fair value because of the short time are not clearly and closely related to the economic characteristics and to maturity of these instruments. The Company estimates the CECL for all risks of the host contract; (b) the hybrid instrument is not measured at accounts receivable balances which are recognized as adjustments to the fair value, with changes in fair value recognized in results of operations allowance for doubtful accounts. Accounts receivable are written-off against each period; and (c) the embedded derivative itself meets the definition the allowance when they are deemed uncollectible. All financial instrument of a derivative. The Company does not engage in derivative trading or transactions are recorded at trade date. speculative activities and had no embedded derivatives that required bifurcation at December 31, 2019 or 2018. The Company determines the classification of its financial assets and liabilities at the date of initial recognition. The Company designates Hydro One periodically develops hedging strategies taking into account certain of its financial assets and liabilities to be held at fair value, when risk management objectives. At the inception of a hedging relationship it is consistent with the Company’s risk management policy disclosed in where the Company has elected to apply hedge accounting, Hydro One Note 18 – Fair Value of Financial Instruments and Risk Management. formally documents the relationship between the hedged item and the hedging instrument, the related risk management objective, the nature of 76 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements the specific risk exposure being hedged, and the method for assessing the Post-retirement and Post-employment Benefits effectiveness of the hedging relationship. The Company also assesses, both Post-retirement and post-employment benefits are recorded and included in at the inception of the hedge and on a quarterly basis, whether the hedging rates on an accrual basis. Costs are determined by independent actuaries instruments are effective in offsetting changes in fair values or cash flows of using the projected benefit method prorated on service and based on the hedged items. assumptions that reflect management’s best estimates. Past service costs from plan amendments are amortized to results of operations based on Employee Future Benefits the expected average remaining service period. Employee future benefits provided by Hydro One include pension, post- retirement and post-employment benefits. The costs of the Company’s For post-retirement benefits, all actuarial gains or losses are deferred using pension, post-retirement and post-employment benefit plans are recorded the “corridor” approach. The amount calculated above the “corridor” is over the periods during which employees render service. amortized to results of operations on a straight-line basis over the expected average remaining service life of active employees in the plan and over The Company recognizes the funded status of its defined benefit pension, the remaining life expectancy of inactive employees in the plan. The post- post-retirement and post-employment plans on its consolidated balance retirement benefit obligation is remeasured to its fair value at each year sheets and subsequently recognizes the changes in funded status at the end end based on an annual actuarial report, with an offset to the associated of each reporting year. Defined benefit pension, post-retirement and post- regulatory asset, to the extent of the remeasurement adjustment. employment plans are considered to be underfunded when the projected benefit obligation (PBO) exceeds the fair value of the plan assets. Liabilities For post-employment obligations, the associated regulatory liabilities are recognized on the consolidated balance sheets for any net underfunded representing actuarial gains on transition to US GAAP are amortized to PBO. The net underfunded PBO may be disclosed as a current liability, results of operations based on the “corridor” approach. The actuarial gains long-term liability, or both. The current portion is the amount by which the and losses on post-employment obligations that are incurred during the year actuarial present value of benefits included in the benefit obligation payable are recognized immediately to results of operations. The post-employment in the next 12 months exceeds the fair value of plan assets. If the fair value of benefit obligation is remeasured to its fair value at each year end based on plan assets exceeds the PBO of the plan, an asset is recognized equal to the an annual actuarial report, with an offset to the associated regulatory asset, net overfunded PBO. The post-retirement and post-employment benefit plans to the extent of the remeasurement adjustment. are unfunded because there are no related plan assets. All post-retirement and post-employment benefit costs are attributed to Hydro One recognizes its contributions to the defined contribution pension labour costs and are either charged to results of operations (OM&A costs) plan (DC Plan) as pension expense, with a portion being capitalized as part or capitalized as part of the cost of property, plant and equipment and of labour costs included in capital expenditures. The expensed amount is intangible assets for service cost component and to regulatory assets for all included in operation, maintenance and administration (OM&A) costs in other components of the benefit costs, consistent with their inclusion in OEB- the consolidated statements of operations and comprehensive income. approved rates. Defined Benefit Pension Stock-Based Compensation Defined benefit pension costs are recorded on an accrual basis for Share Grant Plans financial reporting purposes. Pension costs are actuarially determined Hydro One measures share grant plans based on fair value of share grants using the projected benefit method prorated on service and are based on as estimated based on the grant date common share price. The costs are assumptions that reflect management’s best estimate of the effect of future recognized in the financial statements using the graded-vesting attribution events, including future compensation increases. Past service costs from plan method for share grant plans that have both a performance condition and amendments and all actuarial gains and losses are amortized on a straight- a service condition. The Company records a regulatory asset equal to the line basis over the expected average remaining service period of active accrued costs of share grant plans recognized in each period. Costs are employees in the plan, and over the estimated remaining life expectancy of transferred from the regulatory asset to labour costs at the time the share inactive employees in the plan. Pension plan assets, consisting primarily of grants vest and are issued, and are recovered in rates. Forfeitures are listed equity securities, corporate and government debt securities as well as recognized as they occur. private real estate and private infrastructure investments, are recorded at fair value at the end of each year. Hydro One records a regulatory asset equal Deferred Share Unit (DSU) Plans to the net underfunded PBO for its pension plan. Defined benefit pension The Company records the liabilities associated with its Directors’ and costs are attributed to labour costs on a cash basis and a portion directly Management DSU Plans at fair value at each reporting date until settlement, related to acquisition and development of capital assets is capitalized as recognizing compensation expense over the vesting period on a straight-line part of the cost of property, plant and equipment and intangible assets. basis. The fair value of the DSU liability is based on the Company’s common The remaining defined benefit pension costs are charged to results of share closing price at the end of each reporting period. operations (OM&A costs). Hydro One Limited | Annual Report 2019 77
Notes to Consolidated Financial Statements Long-term Incentive Plan (LTIP) rate that produces an amount at which the environmental liabilities could The Company measures the awards issued under its LTIP, at fair value based be settled in an arm’s length transaction with a third party. As the Company on the grant date common share price. The related compensation expense anticipates that the future expenditures will continue to be recoverable in is recognized over the vesting period on a straight-line basis. Forfeitures are future rates, an offsetting regulatory asset has been recorded to reflect the recognized as they occur. future recovery of these environmental expenditures from customers. Hydro One reviews its estimates of future environmental expenditures annually, or Loss Contingencies more frequently if there are indications that circumstances have changed. Hydro One is involved in certain legal and environmental matters that arise in the normal course of business. In the preparation of its Consolidated Asset Retirement Obligations Financial Statements, management makes judgments regarding the future Asset retirement obligations are recorded for legal obligations associated outcome of contingent events and records a loss for a contingency based with the future removal and disposal of long-lived assets. Such obligations on its best estimate when it is determined that such loss is probable and the may result from the acquisition, construction, development and/or normal amount of the loss can be reasonably estimated. Where the loss amount use of the asset. Conditional asset retirement obligations are recorded when is recoverable in future rates, a regulatory asset is also recorded. When a there is a legal obligation to perform a future asset retirement activity but range estimate for the probable loss exists and no amount within the range where the timing and/or method of settlement are conditional on a future is a better estimate than any other amount, the Company records a loss at event that may or may not be within the control of the Company. In such a the minimum amount within the range. case, the obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Management regularly reviews current information available to determine This uncertainty is incorporated in the fair value measurement of the obligation. whether recorded provisions should be adjusted and whether new provisions are required. Estimating probable losses may require analysis of multiple When recording an asset retirement obligation, the present value of the forecasts and scenarios that often depend on judgments about potential estimated future expenditures required to complete the asset retirement actions by third parties, such as federal, provincial and local courts or activity is recorded in the period in which the obligation is incurred, if a regulators. Contingent liabilities are often resolved over long periods of time. reasonable estimate can be made. In general, the present value of the Amounts recorded in the Consolidated Financial Statements may differ from estimated future expenditures is added to the carrying amount of the the actual outcome once the contingency is resolved. Such differences could associated asset and the resulting asset retirement cost is depreciated over have a material impact on future results of operations, financial position and the estimated useful life of the asset. The present value is determined with a cash flows of the Company. discount rate that equates to the Company’s credit-adjusted risk-free rate. Where an asset is no longer in service when an asset retirement obligation Provisions are based upon current estimates and are subject to greater is recorded, the asset retirement cost is recorded in results of operations. uncertainty where the projection period is lengthy. A significant upward or downward trend in the number of claims filed, the nature of the alleged Some of the Company’s transmission and distribution assets, particularly injuries, and the average cost of resolving each claim could change the those located on unowned easements and rights-of-way, may have estimated provision, as could any substantial adverse or favourable verdict asset retirement obligations, conditional or otherwise. The majority of the at trial. A federal or provincial legislative outcome or structured settlement Company’s easements and rights-of-way are either of perpetual duration could also change the estimated liability. Legal fees are expensed as incurred. or are automatically renewed annually. Land rights with finite terms are generally subject to extension or renewal. As the Company expects to use Environmental Liabilities the majority of its facilities in perpetuity, no asset retirement obligations Environmental liabilities are recorded in respect of past contamination when have been recorded for these assets. If, at some future date, a particular it is determined that future environmental remediation expenditures are facility is shown not to meet the perpetuity assumption, it will be reviewed probable under existing statute or regulation and the amount of the future to determine whether an estimable asset retirement obligation exists. In expenditures can be reasonably estimated. Hydro One records a liability such a case, an asset retirement obligation would be recorded at that time. for the estimated future expenditures associated with contaminated land assessment and remediation (LAR) and for the phase-out and destruction The Company’s asset retirement obligations recorded to date relate to of polychlorinated biphenyl (PCB)-contaminated mineral oil removed from estimated future expenditures associated with the removal and disposal electrical equipment, based on the present value of these estimated future of asbestos-containing materials installed in some of its facilities. expenditures. The Company determines the present value with a discount 78 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements Leases certain they will be exercised. The Company does not recognize leases Effective January 1, 2019, the Company adopted Accounting Standards with a term of less than 12 months. A corresponding ROU asset is Codification (ASC) 842 – Leases using the modified retrospective transition recognized at the commencement date of a lease. The ROU asset is approach using the effective date of January 1, 2019, as its date of initial measured as the lease obligation adjusted for any lease payments made application. In the Company’s transition to ASC 842, the Company elected and/or any lease incentives and initial direct costs incurred. ROU assets the package of practical expedients and the land easement practical are included in other long-term assets, and corresponding lease obligations expedient. As a result, a Right-of-Use (ROU) asset and a corresponding are included in other current liabilities and other long-term liabilities on the lease obligation of approximately $27 million was recognized on the Consolidated Balance Sheets. Consolidated Balance Sheet at January 1, 2019, and no adjustments were made to prior period financial statement amounts. There was no material Subsequent to the commencement date, the lease expense recognized impact to the Consolidated Statement of Operations and Comprehensive at each reporting period is the total remaining lease payments over the Income. On adoption, the Company did not identify any finance leases. remaining lease term. Lease obligations are measured as the present value of the remaining unpaid lease payments using the discount rate established At the commencement date of a lease, the minimum lease payments are at commencement date. The amortization of the ROU assets are calculated discounted and recognized as a lease obligation. Discount rates used as the difference between the lease expense and the accretion of interest, correspond to the Company’s incremental borrowing rates. Renewal which is calculated on the effective interest method. Lease modifications and options are assessed for their likelihood of being exercised and are impairments are assessed at each reporting period to assess the need for a included in the measurement of the lease obligation when it is reasonably re-measurement of the lease obligations or ROU assets. 3. NEW ACCOUNTING PRONOUNCEMENTS The following tables present ASCs and ASUs issued by the Financial Accounting Standards Board that are applicable to Hydro One: Recently Adopted Accounting Guidance Guidance Date issued Description Effective date Impact on Hydro One ASC 842 February 2016 Lessees are required to recognize the rights and January 1, 2019 Hydro One adopted ASC 842 on – January 2019 obligations resulting from operating leases as assets January 1, 2019 using the modified (right to use the underlying asset for the term of the retrospective transition approach using lease) and liabilities (obligation to make future lease the effective date of January 1, 2019 payments) on the balance sheet. as its date of initial application. See Note 2 to the Consolidated Financial Statements for impact of adoption. The Company has included the disclosure requirements of ASC 842 in Note 23 to the Consolidated Financial Statements. ASU August 2017 Amendments will better align an entity’s risk January 1, 2019 No impact upon adoption 2017-12 management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and presentation of hedge results. ASU June 2018 Expansion in the scope of ASC 718 to include share- January 1, 2019 No impact upon adoption 2018-07 based payment transactions for acquiring goods and services from non-employees. Previously, ASC 718 was only applicable to share-based payment transactions for acquiring goods and services from employees. Hydro One Limited | Annual Report 2019 79
Notes to Consolidated Financial Statements Guidance Date issued Description Effective date Impact on Hydro One ASU August 2018 The amendment aligns the requirements for capitalizing January 1, 2019 Hydro One early-adopted this ASU 2018-15 implementation costs incurred in a hosting arrangement with a transition date of January 1, that is a service contract with the requirements for 2019. The ASU was applied capitalizing implementation costs incurred to develop prospectively and there was no or obtain internal-use software. The accounting for the material impact upon adoption. service element of a hosting arrangement is not affected by the amendment. ASU June 2016 – The amendments provide users with more decision- January 1, 2019 Hydro One early-adopted these ASUs 2016-13 November 2019 useful information about the expected credit losses on with a transition date of January 1, 2018-19 financial instruments and other commitments to extend 2019 using the modified retrospective 2019-04 credit held by a reporting entity at each reporting date. transition approach. See Note 2 to the 2019-05 Consolidated Financial Statements for 2019-11 impact of adoption. Recently Issued Accounting Guidance Not Yet Adopted Guidance Date issued Description Effective date Anticipated impact on Hydro One ASU 2017-04 January 2017 The amendment removes the second step of the current January 1, 2020 No impact upon adoption two-step goodwill impairment test to simplify the process of testing goodwill. ASU 2018-13 August 2018 Disclosure requirements on fair value measurements in January 1, 2020 No impact upon adoption ASC 820 are modified to improve the effectiveness of disclosures in financial statement notes. ASU 2018-14 August 2018 Disclosure requirements related to single-employer January 1, 2021 Under assessment defined benefit pension or other post-retirement benefit plans are added, removed or clarified to improve the effectiveness of disclosures in financial statement notes. ASU 2019-01 March 2019 This amendment carries forward the exemption January 1, 2020 No impact upon adoption previously provided under ASC 840 relating to the determination of the fair value of underlying assets by lessors that are not manufacturers or dealers. It also provides for clarification on cash-flow presentation of sales-type and financing leases and clarifies that transition disclosures under Topic 250 are not applicable in the adoption of ASC 842. ASU 2019-12 December 2019 The amendments simplify the accounting for income January 1, 2021 Under assessment taxes by removing certain exceptions to the general principles and improving consistent application of Topic 740 by clarifying and amending existing guidance. ASU 2020-01 January 2020 The amendments clarify the interaction of the accounting January 1, 2021 Under assessment for equity securities under Topic 321, investments under the equity method of accounting in Topic 323 and the accounting for certain forward contracts and purchased options accounted for under Topic 815. 80 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements 4. BUSINESS COMBINATIONS $170 million unsecured demand operating credit facility (Demand Facility) which was used to fund the payment of the Merger termination fee and NRLP other Merger-related costs. On June 6, 2019, the $170 million drawn on the In 2018, Hydro One entered into an agreement with the First Nations Demand Facility was repaid, and the Demand Facility is no longer available. Partners, wherein a noncontrolling equity interest in Hydro One’s limited On February 8, 2019, Hydro One redeemed the convertible debentures partnership, NRLP, would be made available for purchase at fair value by and paid the holders of the Instalment Receipts $513 million ($333 per the First Nations Partners. On September 19, 2018, NRLP was formed to $1,000 principal amount) plus accrued and unpaid interest of $7 million. own a new 230 kV transmission line (Niagara Line) in the Niagara region. The redemption of the convertible debentures was paid with cash on hand. The Niagara Line enables generators in the Niagara area to connect to As a result of the termination of the Merger agreement, the deal-contingent the load centres of the Greater Toronto and Hamilton areas. Hydro One foreign-exchange forward contract (Foreign-Exchange Contract) terminated, Networks maintains and operates the Niagara Line in accordance with an with no amounts paid or received by Hydro One. operation and management services agreement. On September 12, 2019, the OEB granted NRLP a transmission licence and granted Hydro One The following amounts related to the termination of the Merger agreement Networks leave to sell the applicable Niagara Line assets to NRLP. were recorded by the Company during the year ended December 31, 2019. All amounts were recognized in the first quarter. On September 18, 2019, the applicable Niagara Line assets were transferred from Hydro One Networks to NRLP for $119 million and $138 million for payment of the US$103 million Merger termination fee operation of the line was contracted to Hydro One Networks. This transfer recorded in operation, maintenance and administration costs; was financed with 60% debt ($71 million) and 40% equity ($48 million). $22 million financing charges, due to reversal of previously recorded The cash payment of $71 million was financed by debt sourced by NRLP unrealized gains upon termination of the Foreign-Exchange Contract; from a Hydro One subsidiary, and the $48 million equity comprised redemption of $513 million convertible debentures and payment of partnership units issued by NRLP to Hydro One Networks. Subsequently, on related interest of $7 million; and the same date, Hydro One Networks sold to the Six Nations of the Grand River Development Corporation and to the Mississaugas of the Credit First $24 million financing charges, due to derecognition of the deferred Nation, through a trust, a 25.0% and 0.1%, respectively, equity interest in financing costs elatedr to convertible debentures. NRLP for total consideration of $12 million, representing the fair value of the equity interest acquired. See Note 17 – Convertible Debentures and Note 18 – Fair Value of Financial Instruments and Risk Management for details of the convertible NRLP is fully consolidated in these Consolidated Financial Statements debentures and the Foreign-Exchange Contract, respectively. as it is controlled by Hydro One. The First Nations Partners’ 25.1% noncontrolling interest in NRLP is classified within equity. Net income Orillia Power Purchase Agreement attributable to the First Nations Partners’ noncontrolling interest for the In August 2016, the Company reached an agreement to acquire Orillia period from September 18, 2019 to December 31, 2019 was not significant. Power Distribution Corporation (Orillia Power), an electricity distribution See Note 28 – Noncontrolling Interest for additional information. company located in Simcoe County, Ontario, from the City of Orillia for approximately $41 million, including the assumption of approximately In addition, the Mississaugas of the Credit First Nation had an option to $15 million in outstanding indebtedness and regulatory liabilities, subject purchase an additional 19.9% equity interest in NRLP from Hydro One to closing adjustments and regulatory approval by the OEB. In 2016, Networks at a price based on the value of the Niagara Line assets on the Hydro One filed an application with the OEB to acquire Orillia Power, date of closing, subject to certain conditions. On December 31, 2019, the which was denied by the OEB in April 2018. In September 2018, Hydro Mississaugas of the Credit First Nation exercised the option. The transaction One filed a new application with the OEB for approval to acquire Orillia closed on January 31, 2020. See Note 34 – Subsequent Events for Power. An OEB oral hearing was held on December 2-3, 2019. A decision additional information. by the OEB is pending. Avista Corporation Purchase Agreement Peterborough Distribution Purchase Agreement In July 2017, Hydro One reached an agreement to acquire Avista In July 2018, Hydro One reached an agreement to acquire the business and Corporation (Merger). On January 23, 2019, Hydro One and Avista distribution assets of Peterborough Distribution Inc., an electricity distribution Corporation announced that the companies have mutually agreed to company located in east central Ontario, from the City of Peterborough terminate the Merger agreement. As a result of the termination of the Merger for approximately $105 million. The acquisition is conditional upon the agreement, on January 24, 2019, Hydro One paid a US$103 million satisfaction of customary closing conditions and approval by the OEB and termination fee to Avista Corporation as required by the Merger agreement. the Competition Bureau. In October 2018, the Company filed an application In January 2019, the Company cancelled the $1.0 billion non-revolving with the OEB for approval of the acquisition. In November 2018, the equity bridge credit facility and the US$2.6 billion non-revolving debt Competition Bureau issued no action letter, meaning that transaction can bridge credit facility (Acquisition Credit Facilities), with no amounts drawn. proceed from the Competition Bureau’s position. An OEB oral hearing was On February 1, 2019, Hydro One entered into a credit agreement for a held on December 2–3, 2019. A decision by the OEB is pending. Hydro One Limited | Annual Report 2019 81
Notes to Consolidated Financial Statements 5. DEPRECIATION, AMORTIZATION AND ASSET REMOVAL COSTS Year ended December 31 (millions of dollars) 2019 2018 Depreciation of property, plant and equipment 671 654 Amortization of intangible assets 81 71 Amortization of regulatory assets 25 22 Depreciation and amortization 777 747 Asset removal costs 101 90 878 837 6. FINANCING CHARGES Year ended December 31 (millions of dollars) 2019 2018 Interest on long-term debt 479 447 Derecognition of deferred financing costs(Notes 4, 17) 24 — Unrealized loss (gain) on Foreign-Exchange Contract (Notes 4, 18) 22 (25) Interest on short-term notes 19 14 Interest on convertible debentures (Notes 4, 17) 7 62 Other 18 21 Less: Interest capitalized on construction and development in progress (48) (53) Interest earned on cash and cash equivalents (7) (7) 514 459 7. INCOME TAXES As a rate regulated utility company, the Company’s effective tax rate excludes temporary differences that are recoverable in future rates charged to customers. Income tax expense differs from the amount that would have been recorded using the combined Canadian federal and Ontario statutory income tax rate. The reconciliation between the statutory and the effective tax rates is provided as follows: Year ended December 31 (millions of dollars) 2019 2018 Income before income tax expense 796 850 Income tax expense at statutory rate of 26.5% (2018 – 26.5%) 211 225 Increase (decrease) resulting from: Net temporary differences recoverable in future rates charged to customers: Capital cost allowance in excess of depreciation and amortization1 (105) (68) Impact of tax deductions from deferred tax asset sharing2 (60) (68) Overheads capitalized for accounting but deducted for tax purposes (21) (20) Interest capitalized for accounting but deducted for tax purposes (13) (14) Pension and post-retirement benefit contributions in excess of pension expense (11) (11) Environmental expenditures (7) (6) Other (3) (9) Net temporary differences (220) (196) Net permanent differences 3 1 Write-off of unregulated deferred income tax asset (Note 12) — 885 Total income tax expense (recovery) (6) 915 Effective income tax rate (0.8)% 107.6% 1 Included in current period’s amount is the accelerated tax depreciation of up to three times the first-year rate for certain eligible capital investments acquired after November 20, 2018 and placed in-service before January 1, 2028, as introduced in the 2019 federal and Ontario budgets and enacted in the second quarter of 2019. 2 Impact of tax deductions from deferred tax sharing represents the OEB’s prescribed allocation to ratepayers of the net deferred tax asset that originated from the transition from the payments in lieu of tax regime under the Electricity Act, 1998 (Ontario) to tax payments under the federal and provincial tax regime. 82 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements The major components of income tax expense are as follows: Year ended December 31 (millions of dollars) 2019 2018 Current income tax expense 24 25 Deferred income tax expense (recovery) (30) 890 Total income tax expense (recovery) (6) 915 Deferred Income Tax Assets and Liabilities Deferred income tax assets and liabilities that are expected to be included in the rate-setting process are offset by regulatory assets and liabilities to reflect the anticipated recovery or disposition of these balances within future electricity rates. Deferred income tax assets and liabilities arise from differences between the tax basis and the carrying amounts of the assets and liabilities. At December 31, 2019 and 2018, deferred income tax assets and liabilities consisted of the following: December 31 (millions of dollars) 2019 2018 Deferred income tax assets Post-retirement and post-employment benefits expense in excess of cash payments 638 526 Non-capital losses 331 302 Non-depreciable capital property 271 271 Pension obligations 405 197 Investment in subsidiaries 95 86 Tax credit carryforwards 92 71 Depreciation and amortization in excess of capital cost allowance 59 20 Environmental expenditures 51 59 Other 20 24 1,962 1,556 Less: valuation allowance (375) (366) Total deferred income tax assets 1,587 1,190 Deferred income tax liabilities Capital cost allowance in excess of depreciation and amortization 377 9 Regulatory amounts that are not recognized for tax purposes 495 188 Goodwill 10 10 Other 18 23 Total deferred income tax liabilities 900 230 Net deferred income tax assets 687 960 The net deferred income tax assets are presented on the Consolidated Balance Sheets as follows: December 31 (millions of dollars) 2019 2018 Long-term: Deferred income tax assets 748 1,018 Deferred income tax liabilities (61) (58) Net deferred income tax assets 687 960 Hydro One Limited | Annual Report 2019 83
Notes to Consolidated Financial Statements The valuation allowance for deferred tax assets as at December 31, 2019 was $375 million (2018 – $366 million). The valuation allowance primarily relates to temporary differences for non-depreciable assets and investments in subsidiaries. As of December 31, 2019 and 2018, the Company had non-capital losses carried forward available to reduce future years’ taxable income, which expire as follows: Year of expiry (millions of dollars) 2019 2018 2034 2 2 2035 221 221 2036 551 551 2037 172 172 2038 95 192 2039 202 — Total losses 1,243 1,138 8. ACCOUNTS RECEIVABLE December 31 (millions of dollars) 2019 2018 Accounts receivable – billed 330 292 Accounts receivable – unbilled 393 357 Accounts receivable, gross 723 649 Allowance for doubtful accounts (22) (21) Accounts receivable, net 701 628 The following table shows the movements in the allowance for doubtful accounts for the years ended December 31, 2019 and 2018: Year ended December 31 (millions of dollars) 2019 2018 Allowance for doubtful accounts – beginning (21) (29) Write-offs 18 25 Additions to allowance for doubtful accounts (19) (17) Allowance for doubtful accounts – ending (22) (21) 9. OTHER CURRENT ASSETS December 31 (millions of dollars) 2019 2018 Regulatory assets (Note 12) 52 42 Prepaid expenses and other assets 49 41 Materials and supplies 21 20 Derivative instrument – Foreign-Exchange Contract (Notes 4, 18) — 22 122 125 84 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements 10. PROPERTY, PLANT AND EQUIPMENT Property, Plant Accumulated Construction December 31, 2019 (millions of dollars) and Equipment Depreciation in Progress Total Transmission 17,454 5,714 711 12,451 Distribution 10,991 3,747 85 7,329 Communication 1,355 1,002 43 396 Administration and service 1,617 931 53 739 Easements 663 77 — 586 32,080 11,471 892 21,501 Property, Plant Accumulated Construction December 31, 2018 (millions of dollars) and Equipment Depreciation in Progress Total Transmission 16,559 5,449 766 11,876 Distribution 10,580 3,561 75 7,094 Communication 1,306 922 48 432 Administration and service 1,548 893 58 713 Easements 647 75 — 572 30,640 10,900 947 20,687 Financing charges capitalized on property, plant and equipment under construction were $45 million in 2019 (2018 – $51 million). 11. INTANGIBLE ASSETS Intangible Accumulated Development December 31, 2019 (millions of dollars) Assets Amortization in Progress Total Computer applications software 912 512 56 456 Other 5 5 — — 917 517 56 456 Intangible Accumulated Development December 31, 2018 (millions of dollars) Assets Amortization in Progress Total Computer applications software 790 440 60 410 Other 5 5 — — 795 445 60 410 Financing charges capitalized to intangible assets under development were $3 million in 2019 (2018 – $2 million). The estimated annual amortization expense for intangible assets is as follows: 2020 – $63 million; 2021 – $61 million; 2022 – $58 million; 2023 – $48 million; and 2024 – $37 million. Hydro One Limited | Annual Report 2019 85
Notes to Consolidated Financial Statements 12. REGULATORY ASSETS AND LIABILITIES Regulatory assets and liabilities arise as a result of the rate-setting process. Hydro One has recorded the following regulatory assets and liabilities: December 31 (millions of dollars) 2019 2018 Regulatory assets: Deferred income tax regulatory asset 1,128 908 Pension benefit regulatory asset 1,125 547 Environmental 141 165 Post-retirement and post-employment benefits 105 — Post-retirement and post-employment benefits – non-service cost 77 39 Foregone revenue deferral 67 — Stock-based compensation 42 43 Debt premium 17 22 Distribution system code exemption — 10 Other 26 29 Total regulatory assets 2,728 1,763 Less: current portion (52) (42) 2,676 1,721 Regulatory liabilities: Tax rule changes variance 44 5 Distribution rate riders 42 6 Pension cost differential 31 55 Green energy expenditure variance 31 52 Retail settlement variance account 23 39 Earnings sharing mechanism deferral 21 — External revenue variance 6 26 Deferred income tax regulatory liability 5 86 Post-retirement and post-employment benefits — 130 Other 9 18 Total regulatory liabilities 212 417 Less: current portion (45) (91) 167 326 Deferred Income Tax Regulatory Asset and Liability calculation would result in an impairment of a portion of both Hydro One Deferred income taxes are recognized on temporary differences between Networks’ transmission and distribution deferred income tax regulatory the carrying amount of assets and liabilities in the financial statements and asset. In October 2017, the Company filed a Motion to Review and Vary the corresponding tax bases used in the computation of taxable income. The (Motion) the Original Decision and filed an appeal with the Ontario Company has recognized regulatory assets and liabilities that correspond Divisional Court (Appeal). In both cases, the Company’s position was that to deferred income taxes that flow through the rate-setting process. In the the OEB made errors of fact and law in its determination of allocation of the absence of rate-regulated accounting, the Company’s income tax expense tax savings between the shareholders and ratepayers. On December 19, would have been recognized using the liability method and there would be 2017, the OEB granted a hearing of the merits of the Motion which was held no regulatory accounts established for taxes to be recovered through future on February 12, 2018. On August 31, 2018, the OEB granted the Motion rates. As a result, the 2019 income tax expense would have been higher by and returned the portion of the Original Decision relating to the deferred tax approximately $221 million (2018 – lower by $686 million). asset to an OEB panel for reconsideration. On September 28, 2017, the OEB issued its decision and order on Hydro On March 7, 2019, the OEB issued its reconsideration decision and One Networks’ 2017 and 2018 transmission rates revenue requirements concluded that their Original Decision was reasonable and should be (Original Decision). In its Original Decision, the OEB concluded that the upheld. Also, on March 7, 2019 the OEB issued its decision for Hydro One net deferred tax asset resulting from transition from the payments in lieu of Networks’ 2018–2022 distribution rates, in which it directed the Company tax regime under the Electricity Act, 1998 (Ontario) to tax payments under to apply the Original Decision to Hydro One Networks’ distribution rates. As the federal and provincial tax regime should not accrue entirely to Hydro a result, as at December 31, 2018, the Company recognized an impairment One shareholders and that a portion should be shared with ratepayers. On charge of Hydro One Networks’ distribution deferred income tax regulatory November 9, 2017, the OEB issued a decision and order that calculated the asset of $474 million and Hydro One Networks’ transmission deferred portion of the tax savings that should be shared with ratepayers. The OEB’s income tax regulatory asset of $558 million, an increase in deferred income 86 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements tax regulatory liability of $81 million, and a decrease in the foregone the extent of the remeasurement adjustment. In the absence of rate-regulated revenue deferral regulatory asset of $68 million. The regulatory balances accounting, 2019 OCI would have been lower by $235 million (2018 – relating to deferred tax asset sharing will continue to decrease as the tax higher by $166 million). savings are shared with ratepayers. Notwithstanding the recognition of the effects of the decision in the financial statements, on April 5, 2019, the Post-Retirement and Post-Employment Company filed an appeal with the Ontario Divisional Court with respect Benefits – Non-Service Cost to the OEB’s deferred tax benefit decision. The appeal was heard on Hydro One applied to the OEB for a regulatory asset account to record November 21, 2019 and a decision is pending. the components other than service costs relating to its post- retirement and post-employment benefits that would have previously been capitalized Pension Benefit Regulatory Asset to property, plant and equipment and intangible assets prior to adoption In accordance with OEB rate orders, pension costs are recovered on a cash of ASU 2017-07. In May 2018 and March 2019, the OEB approved the basis as employer contributions are paid to the pension fund in accordance regulatory asset account for Hydro One Networks’ transmission business with the Pension Benefits Act (Ontario). The Company recognizes the net and distribution business, respectively. Hydro One has recorded the unfunded status of pension obligations on the Consolidated Balance Sheets components other than service costs relating to its post-retirement and with an offset to the associated regulatory asset. A regulatory asset is post-employment benefits that would have been capitalized to property, recognized because management considers it to be probable that pension plant and equipment and intangible assets, in the Post-Retirement and benefit costs will be recovered in the future through the rate-setting process. Post-Employment Benefits – Non-Service Cost regulatory asset. Hydro One The pension benefit obligation is remeasured to the present value of the proposed disposition methodologies for the accumulated balance in the actuarially determined benefit obligation at each year end based on an 2020–2022 transmission rate application which is pending an OEB decision. annual actuarial report, with an offset to the associated regulatory asset, to the extent of the remeasurement adjustment. In the absence of rate-regulated Foregone Revenue Deferral accounting, OCI would have been lower by $597 million (2018 – higher by The foregone revenue deferral account is primarily made up of the difference $435 million) and OM&A expenses would have been lower by $20 million between revenue earned based on distribution rates approved by the OEB (2018 – higher by $1 million). in Hydro One Networks’ 2018–2022 distribution rates application, effective May 1, 2018, and revenue earned under the interim rates until the approved Environmental 2018 and 2019 rates were implemented on July 1, 2019. The balance of Hydro One records a liability for the estimated future expenditures this account is being recovered from ratepayers over an 18-month period required to remediate environmental contamination. A regulatory asset is ending December 31, 2020. The foregone revenue deferral account also recognized because management considers it to be probable environmental records the difference between revenue earned based on transmission expenditures will be recovered in the future through the rate-setting process. rates approved by the OEB in Hydro One Networks’ 2019 transmission The Company has recorded an equivalent amount as a regulatory asset. In rate application, effective May 1, 2019, and the revenue earned under the 2019, the environmental regulatory asset decreased by $3 million (2018 interim rates until the approved 2019 rates were implemented on July 1, – $15 million) to reflect related changes in the Company’s PCB and LAR 2019. The balance of this account was being recovered from ratepayers environmental liabilities. The environmental regulatory asset is amortized to over a 6-month period ended December 31, 2019. The 2019 revenue results of operations based on the pattern of actual expenditures incurred requirement related to NRLP (see Note 1 – Description of the Business and charged to environmental liabilities. The OEB has the discretion to and Note 4 – Business Combinations) is also recorded in this account. examine and assess the prudency and the timing of recovery of all of Hydro One’s actual environmental expenditures. In the absence of rate-regulated Stock-based Compensation accounting, 2019 OM&A expenses would have been lower by $3 million The Company recognizes costs associated with share grant plans in a (2018 – $15 million). In addition, 2019 amortization expense would have regulatory asset as management considers it probable that share grant been lower by $25 million (2018 – $22 million), and 2019 financing plans’ costs will be recovered in the future through the rate-setting process. charges would have been higher by $4 million (2018 – $6 million). In the absence of rate-regulated accounting, there would be no material impact to OM&A expenses (2018 – OM&A expenses would be higher by Post-Retirement and Post-Employment Benefits $1 million). Share grant costs are transferred to labour costs at the time the In accordance with OEB rate orders, post-retirement and post-employment share grants vest and are issued, and are recovered in rates in accordance benefits costs are recovered on an accrual basis. The Company recognizes with recovery of said labour costs. the net unfunded status of post-retirement and post-employment obligations on the Consolidated Balance Sheets with an incremental offset to the Debt Premium associated regulatory assets. A regulatory asset is recognized because The value of debt assumed in the acquisition of HOSSM has been recorded management considers it to be probable that post-retirement and post- at fair value in accordance with US GAAP – Business Combinations. The employment benefit costs will be recovered in the future through the rate- OEB allows for recovery of interest at the coupon rate of the Senior Secured setting process. The post-retirement and post-employment benefit obligation Bonds and a regulatory asset has been recorded for the difference between is remeasured to the present value of the actuarially determined benefit the fair value and face value of this debt. The debt premium is recovered obligation at each year end based on an annual actuarial report, with an over the remaining term of the debt. offset to the associated regulatory asset or liability as the case may be, to Hydro One Limited | Annual Report 2019 87
Notes to Consolidated Financial Statements Distribution System Code (DSC) Exemption Court. The appeal was held in abeyance pending the outcome of the motion In June 2010, Hydro One Networks filed an application with the OEB made before the OEB. During the year, the Company reflected a portion of regarding the OEB’s new cost responsibility rules contained in the OEB’s pension costs incurred in the Hydro One Networks’ distribution Pension Cost October 2009 Notice of Amendment to the DSC, with respect to the Differential regulatory account, pending the outcome of the motion before connection of certain renewable generators that were already connected the OEB. On December 19, 2019, the OEB affirmed its earlier decision with or that had received a connection impact assessment prior to October 21, respect to recovery of the revenue requirement associated with pension 2009. The application sought approval to record and defer the costs. As a result, Hydro One derecognized the portion relating to pension unanticipated costs incurred by Hydro One Networks that resulted from costs charged to operations as a reversal of revenues of $13 million as this the connection of certain renewable generation facilities. The OEB ruled amount is no longer probable for recovery. Hydro One also transferred to that identified specific expenditures can be recorded in a deferral account property, plant and equipment and intangible assets the portion attributable subject to the OEB’s review in subsequent Hydro One Networks distribution to capital expenditures in the amount of $37 million. Hydro One has applications. In 2015, the OEB also approved Hydro One’s request to decided to discontinue its appeal of the OEB decision with the Ontario discontinue this deferral account. The remaining balance in this account Divisional Court. In the absence of rate-regulated accounting, 2019 at December 31, 2016, including accrued interest, was approved for revenue would have been higher by $5 million (2018 – $29 million). disposition by the OEB in March 2019, and was transferred to the 2019–2020 Rate Rider. Green Energy Expenditure Variance In April 2010, the OEB requested the establishment of deferral accounts Tax Rule Changes Variance which capture the difference between the revenue recorded on the basis The 2019 federal and Ontario budgets (Budgets) provided certain time- of Green Energy Plan expenditures incurred and the actual recoveries limited investment incentives permitting Hydro One to deduct accelerated received. The smart grid variance account balance as at December 31, capital cost allowance of up to three times the first-year rate for capital 2016, including accrued interest, was approved for disposition by the investments acquired after November 20, 2018 and placed in-service OEB in March 2019, and was transferred to the 2019–2020 Rate Rider. before January 1, 2028. The Budgets measures enacted in the second quarter of 2019 required Hydro One to refund the tax benefits related to Retail Settlement Variance Account (RSVA) the accelerated depreciation rules to ratepayers. The tax benefit to be returned Hydro One has deferred certain retail settlement variance amounts to ratepayers in the future gave rise to a regulatory liability and resulted in under the provisions of Article 490 of the OEB’s Accounting Procedures a decrease in revenues as current rates do not include the benefit of the Handbook. The RSVA account tracks the difference between the cost accelerated tax; therefore, the revenue subject to refund cannot be recognized. of power purchased from the Independent Electricity System Operator (IESO) and the cost of power recovered from ratepayers. The balance Distribution Rate Riders as at December 31, 2014, including accrued interest, was approved for In March 2019, as part of its decision on Hydro One Networks’ distribution disposition by the OEB in March 2019, and was transferred to the 2019– rates application for 2018–2022, the OEB approved the disposition of 2020 Rate Rider. certain deferral and variance accounts which were accumulated in a 2019–2020 Rate Rider. The Distribution Rate Riders balance includes the Earnings Sharing Mechanism Deferral 2019–2020 Rate Rider, where amounts are currently being disposed of In March 2019, the OEB approved the establishment of an earnings sharing over an 18-month period ending December 31, 2020, and the 2015–2017 mechanism deferral account for Hydro One Networks distribution to record Rate Rider balance, representing over-collected amounts to be returned to over-earnings, if any, realized for any year from 2018 to 2022. Under this ratepayers in a future rate application. mechanism, Hydro One shares 50% of regulated earnings that exceed the OEB-approved regulatory return-on-equity by more than 100 basis points Pension Cost Differential with distribution ratepayers. This account is asymmetrical to the benefit Variances between the pension cost recognized and the cost embedded of ratepayers. in rates as part of the rate-setting process for Hydro One Networks’ transmission business are recognized as a regulatory asset or regulatory External Revenue Variance liability, as the case may be. Similar variances were recognized for the The external revenue variance account balance reflects the difference distribution business prior to January 1, 2018, but are no longer recognized between actual export service revenue and external revenues from based on the March 7, 2019 decision. In March 2019, the OEB approved secondary land use, and the OEB-approved amounts. The account also the disposition of the distribution business portion of the balance as at records the difference between actual net external station maintenance, December 31, 2016, including accrued interest, and the balance was engineering and construction services revenue, and other external revenue, transferred to the 2019–2020 Rate Rider. The transmission portion of the and the OEB-approved amounts. In September 2017, the OEB approved balance as at December 31, 2018, including accrued interest, was requested the disposition of the external revenue variance account as at December 31, for disposition in the 2020–2022 transmission rate application. On March 26, 2015, including accrued interest, which was returned to customers over a 2019, the Company filed a motion to review and vary the OEB’s decision as two-year period ended December 31, 2018. The balance as at December 31, it relates to rates revenue requirement recovery of employer pension costs. 2018, including accrued interest, was requested for disposition in the Concurrently, the Company filed an appeal with the Ontario Divisional 2020–2022 transmission rate application. 88 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements 13. OTHER LONG-TERM ASSETS December 31 (millions of dollars) 2019 2018 Right-of-Use assets (Notes 3, 23) 75 — Other 12 5 87 5 14. ACCOUNTS PAYABLE AND OTHER CURRENT LIABILITIES December 31 (millions of dollars) 2019 2018 Accounts payable 189 179 Accrued liabilities 642 590 Accrued interest 104 96 Regulatory liabilities (Note 12) 45 91 Lease obligations (Note 23) 9 — 989 956 15. OTHER LONG-TERM LIABILITIES December 31 (millions of dollars) 2019 2018 Post-retirement and post-employment benefit liability(Note 20) 1,723 1,417 Pension benefit liability (Note 20) 1,125 547 Environmental liabilities (Note 21) 111 139 Lease obligations (Note 23) 69 — Long-term accounts payable 6 12 Asset retirement obligations (Note 22) 10 10 Other liabilities 11 10 3,055 2,135 16. DEBT AND CREDIT AGREEMENTS Short-Term Notes and Credit Facilities Hydro One meets its short-term liquidity requirements in part through the issuance of commercial paper under Hydro One Inc.’s Commercial Paper Program which has a maximum authorized amount of $2,300 million. These short-term notes are denominated in Canadian dollars with varying maturities up to 365 days. The Commercial Paper Program is supported by Hydro One Inc.’s revolving standby credit facilities totalling $2,300 million. At December 31, 2019, Hydro One’s consolidated committed and unsecured credit facilities (Operating Credit Facilities) consisted of the following: (millions of dollars) Maturity Total Amount Amount Drawn Hydro One Inc. Revolving standby credit facilities June 20241 2,300 — Hydro One Five-year senior, revolving term credit facility June 20241 250 — Total 2,550 — 1 On June 3, 2019, the maturity dates for the Operating Credit Facilities were extended from November 2021 and June 2022 to June 2024. On February 1, 2019, Hydro One entered into a credit agreement for a any credit extension under its credit facility is subject to various conditions $170 million unsecured Demand Facility which was used to fund the payment including that no event of default has occurred or would result from such of the Merger termination fee and other Merger-related costs (See Note 4 credit extension. – Business Combinations). On June 6, 2019, the $170 million drawn on the Demand Facility was repaid, and the Demand Facility is no longer available. Subsidiary Debt Guarantee Hydro One Holdings Limited (HOHL) is an indirect wholly-owned subsidiary The Company may use the credit facilities for working capital and general of Hydro One that may offer and sell debt securities. Any debt securities issued corporate purposes. If used, interest on the credit facilities would apply by HOHL are fully and unconditionally guaranteed by the Company. At based on Canadian benchmark rates. The obligation of each lender to make December 31, 2019 or 2018, no debt securities have been issued by HOHL. Hydro One Limited | Annual Report 2019 89
Notes to Consolidated Financial Statements Long-Term Debt The following table presents long-term debt outstanding at December 31, 2019 and 2018: December 31 (millions of dollars) 2019 2018 Floating-rate Series 31 notes due 20191 — 228 1.48% Series 37 notes due 20192 — 500 4.40% Series 20 notes due 2020 300 300 1.62% Series 33 notes due 20202 350 350 1.84% Series 34 notes due 2021 500 500 2.57% Series 39 notes due 20212 300 300 3.20% Series 25 notes due 2022 600 600 2.54% Series 42 notes due 2024 700 — 2.97% Series 40 notes due 2025 350 350 2.77% Series 35 notes due 2026 500 500 3.02% Series 43 notes due 2029 550 — 7.35% Debentures due 2030 400 400 6.93% Series 2 notes due 2032 500 500 6.35% Series 4 notes due 2034 385 385 5.36% Series 9 notes due 2036 600 600 4.89% Series 12 notes due 2037 400 400 6.03% Series 17 notes due 2039 300 300 5.49% Series 18 notes due 2040 500 500 4.39% Series 23 notes due 2041 300 300 6.59% Series 5 notes due 2043 315 315 4.59% Series 29 notes due 2043 435 435 4.17% Series 32 notes due 2044 350 350 5.00% Series 11 notes due 2046 325 325 3.91% Series 36 notes due 2046 350 350 3.72% Series 38 notes due 2047 450 450 3.63% Series 41 notes due 2049 750 750 3.64% Series 44 notes due 2050 250 — 4.00% Series 24 notes due 2051 225 225 3.79% Series 26 notes due 2062 310 310 4.29% Series 30 notes due 2064 50 50 Hydro One Inc. long-term debt (a) 11,345 10,573 6.6% Senior Secured Bonds due 2023 (Principal amount – $105 million) 121 129 4.6% Note Payable due 2023 (Principal amount – $36 million) 39 39 HOSSM long-term debt (b) 160 168 11,505 10,741 Add: Net unamortized debt premiums 12 13 Add: Unrealized mark-to-market loss (gain)2 1 (5) Less: Unamortized deferred debt issuance costs (43) (40) Total long-term debt 11,475 10,709 1 The interest rates of the floating-rate notes are referenced to the three-month Canadian dollar bankers’ acceptance rate, plus a margin. 2 The unrealized mark-to-market net loss of $1 million relates to $50 million of the Series 33 notes due 2020 and $300 million Series 39 notes due 2021 (2018 – unrealized mark-to- market net gain also related to $500 million Series 37 notes due 2019). The unrealized mark-to-market net loss is offset by a $1 million unrealized mark-to-market net gain (2018 – $5 million net loss) on the related fixed-to-floating interest-rate swap agreements, which are accounted for as fair value hedges. 90 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements (a) Hydro One Inc. long-term debt In 2019, Hydro One Inc. issued long-term debt totalling $1,500 million At December 31, 2019, long-term debt of $11,345 million (2018 – (2018 – $1,400 million) and repaid long-term debt of $728 million (2018 – $10,573 million) was outstanding, the majority of which was issued under $750 million) under its MTN Program. Hydro One Inc.’s Medium Term Note (MTN) Program. The maximum authorized principal amount of notes issuable under the current MTN (b) HOSSM long-term debt Program prospectus filed in March 2018 is $4,000 million. At December 31, At December 31, 2019, HOSSM long-term debt of $160 million (2018 – 2019, $1,100 million remained available for issuance until April 2020. $168 million), with a principal amount of $141 million (2018 – $143 million) was outstanding. In 2019, no long-term debt was issued (2018 – $nil), and $2 million (2018 – $3 million) of long-term debt was repaid. The total long-term debt is presented on the consolidated balance sheets as follows: December 31 (millions of dollars) 2019 2018 Current liabilities: Long-term debt payable within one year 653 731 Long-term liabilities: Long-term debt 10,822 9,978 Total long-term debt 11,475 10,709 Principal and Interest Payments At December 31, 2019, principal repayments, interest payments, and related weighted-average interest rates were as follows: Long-Term Weighted Debt Principal Interest Average Repayments Payments Interest Rate (millions of dollars) (millions of dollars) (%) Year 1 653 473 2.9 Year 2 803 455 2.1 Year 3 604 436 3.2 Year 4 131 423 6.1 Year 5 700 410 2.5 2,891 2,197 2.8 Years 6–10 1,400 1,901 2.9 Thereafter 7,195 4,151 5.0 11,486 8,249 4.2 17. CONVERTIBLE DEBENTURES The following table presents the change in convertible debentures during the years ended December 31, 2019 and 2018: Year ended December 31 (millions of dollars) 2019 2018 Carrying value – beginning 489 487 Amortization of deferred financing costs — 2 Derecognition of deferred financing costs (Notes 4, 6) 24 — Redemption (Note 4) (513) — Carrying value – ending — 489 Face value – ending — 513 Hydro One Limited | Annual Report 2019 91
Notes to Consolidated Financial Statements In August 2017, in connection with the proposed Merger (see Note 4 – Hydro One classifies its fair value measurements based on the following Business Combinations), the Company completed the sale (Debenture hierarchy, as prescribed by the accounting guidance for fair value, which Offering) of $1,540 million aggregate principal amount of 4.00% prioritizes the inputs to valuation techniques used to measure fair value convertible unsecured subordinated debentures (Convertible Debentures). into three levels: The Convertible Debentures were sold on an instalment basis at a price of $1,000 per Convertible Debenture, of which $333 (Initial Instalment) was Level 1 inputs are unadjusted quoted prices in active markets for identical paid on closing of the Debenture Offering and the remaining $667 (Final assets or liabilities that Hydro One has the ability to access. An active Instalment) would have been payable following the satisfaction of certain market for the asset or liability is one in which transactions for the asset conditions precedent to the closing of the Merger. The gross proceeds or liability occur with sufficient frequency and volume to provide ongoing received from the Initial Instalment were $513 million. The Company incurred pricing information. financing costs of $27 million, which had been initially deferred and were Level 2 inputs are those other than quoted market prices that are observable, being amortized to financing charges. either directly or indirectly, for an asset or liability. Level 2 inputs include, but As a result of the termination of the Merger agreement (see Note 4 – are not limited to, quoted prices for similar assets or liabilities in an active Business Combinations), on February 8, 2019, Hydro One redeemed the market, quoted prices for identical or similar assets or liabilities in markets Convertible Debentures and paid the holders of the instalment receipts that are not active and inputs other than quoted market prices that are $513 million ($333 per $1,000 principal amount) plus accrued and unpaid observable for the asset or liability, such as interest-rate curves and yield interest of $7 million. In addition, unamortized deferred financing costs of curves observable at commonly quoted intervals, volatilities, credit risk and $24 million were derecognized and expensed in financing charges. The default rates. A Level 2 measurement cannot have more than an insignificant interest expense recorded in 2019 was $7 million (2018 – $62 million). portion of the valuation based on unobservable inputs. Level 3 inputs are any fair value measurements that include unobservable 18. FAIR VALUE OF FINANCIAL INSTRUMENTS inputs for the asset or liability for more than an insignificant portion of the AND RISK MANAGEMENT valuation. A Level 3 measurement may be based primarily on Level 2 inputs. Fair value is considered to be the exchange price in an orderly transaction between market participants to sell an asset or transfer a liability at the Non-Derivative Financial Assets and Liabilities measurement date. The fair value definition focuses on an exit price, which At December 31, 2019 and 2018, the Company’s carrying amounts of is the price that would be received in the sale of an asset or the amount that cash and cash equivalents, accounts receivable, due from related parties, would be paid to transfer a liability. short-term notes payable, accounts payable, and due to related parties are representative of fair value due to the short-term nature of these instruments. Fair Value Measurements of Long-Term Debt The fair values and carrying values of the Company’s long-term debt at December 31, 2019 and 2018 are as follows: 2019 2019 2018 2018 December 31 (millions of dollars) Carrying Value Fair Value Carrying Value Fair Value Long-term debt measured at fair value: $50 million of MTN Series 33 notes 50 50 49 49 $500 million MTN Series 37 notes — — 495 495 $300 million MTN Series 39 notes 301 301 301 301 Other notes and debentures 11,124 13,121 9,864 10,820 Long-term debt, including current portion 11,475 13,472 10,709 11,665 a $50 million fixed-to-floating interest-rate swap agreement to convert Fair Value Measurements of Derivative Instruments $50 million of the $350 million MTN Series 33 notes maturing April 30, Fair Value Hedges 2020 into three-month variable rate debt; and At December 31, 2019, Hydro One Inc. had interest-rate swaps with a total notional amount of $350 million (2018 – $850 million) that were used to a $300 million fixed-to-floating interest-rate swap agreement to convert convert fixed-rate debt to floating-rate debt. These swaps are classified the $300 million MTN Series 39 notes maturing June 25, 2021 into three- as fair value hedges. Hydro One Inc.’s fair value hedge exposure was month variable rate debt. approximately 3% (2018 – 8%) of its total long-term debt. At December 31, 2019, Hydro One Inc. had the following interest-rate swaps designated as fair value hedges: 92 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements Cash Flow Hedges Canadian per 1.00 US dollars based on the settlement date. The Foreign- At December 31, 2019, Hydro One Inc. had a total of $800 million Exchange Contract was contingent on the Company closing the proposed in 3-year pay-fixed, receive-floating interest-rate swap agreements Merger (see Note 4 – Business Combinations) and was intended to mitigate designated as cash flow hedges. These cash flow hedges are intended the foreign currency risk related to the portion of the Merger purchase price to offset the variability of interest rates on the issuances of short-term financed with the issuance of Convertible Debentures. This contract was commercial paper between January 9, 2020 and March 9, 2023. an economic hedge and did not qualify for hedge accounting. It has been accounted for as an undesignated contract with changes in fair value being At December 31, 2019 and 2018, the Company had no interest-rate swaps recorded in earnings as they occurred. As a result of the termination of the classified as undesignated contracts. Merger agreement (see Note 4 – Business Combinations) in January 2019, the Foreign-Exchange Contract was terminated and previously recorded In October 2017, the Company entered into a Foreign-Exchange Contract unrealized gains of $22 million were reversed in financing charges. No to convert $1,400 million Canadian to US dollars at an initial forward rate payment was due or payable by Hydro One related to the Foreign- of 1.27486 Canadian per 1.00 US dollars, and a range up to 1.28735 Exchange Contract. Fair Value Hierarchy The fair value hierarchy of financial assets and liabilities at December 31, 2019 and 2018 is as follows: Carrying Fair December 31, 2019 (millions of dollars) Value Value Level 1 Level 2 Level 3 Assets: Derivative instruments1 Fair value hedges (interest-rate swaps) 1 1 — 1 — Cash flow hedges (interest-rate swaps) 2 2 — 2 — 3 3 — 3 — Liabilities: Long-term debt, including current portion 11,475 13,472 — 13,472 — 11,475 13,472 — 13,472 — 1 Derivative assets are included in other long-term assets on the consolidated balance sheets. Carrying Fair December 31, 2018 (millions of dollars) Value Value Level 1 Level 2 Level 3 Assets: Derivative instrument – Foreign-Exchange Contract1 22 22 — — 22 22 22 — — 22 Liabilities: Long-term debt, including current portion 10,709 11,665 — 11,665 — Convertible debentures 489 491 491 — — Derivative instruments – fair value hedges (interest-rate swaps)2 5 5 — 5 — 11,203 12,161 491 11,670 — 1 Derivative assets are included in other current assets on the consolidated balance sheets. 2 Derivative liabilities are included in other long-term liabilities on the consolidated balance sheets. The fair value of the hedged portion of the long-term debt is primarily There were no transfers between any of the fair value levels during the years based on the present value of future cash flows using a swap yield curve to ended December 31, 2019 or 2018. determine the assumption for interest rates. The fair value of the unhedged portion of the long-term debt is based on unadjusted period-end market prices for the same or similar debt of the same remaining maturities. Hydro One Limited | Annual Report 2019 93
Notes to Consolidated Financial Statements Changes in the Fair Value of Financial Instruments Classified in Level 3 The following table summarizes the changes in fair value of financial instruments classified in Level 3 for the years ended December 31, 2019 and 2018. Year ended December 31 (millions of dollars) 2019 2018 Fair value of asset (liability) – beginning 22 (3) Unrealized gain (loss) on Foreign-Exchange Contract included in financing charges (22) 25 Fair value of asset – ending — 22 Risk Management the amount of AOCI, net of tax, related to cash flow hedges to be Exposure to market risk, credit risk and liquidity risk arises in the normal reclassified to results of operations in the next 12 months is not significant. course of the Company’s business. Actual amounts reclassified to results of operations depend on the market risk in effect until the derivative contracts mature. For all forecasted Market Risk transactions, the maximum term over which the Company is hedging Market risk refers primarily to the risk of loss which results from changes in exposures to the variability of cash flows is approximately three years. costs, foreign exchange rates and interest rates. The Company is exposed to fluctuations in interest rates, as its regulated return on equity is derived Credit Risk using a formulaic approach that takes anticipated interest rates into account. Financial assets create a risk that a counterparty will fail to discharge an The Company is not currently exposed to material commodity price risk or obligation, causing a financial loss. At December 31, 2019 and 2018, there material foreign exchange risk. were no significant concentrations of credit risk with respect to any class of financial assets. The Company’s revenue is earned from a broad base The Company uses a combination of fixed and variable-rate debt to of customers. As a result, Hydro One did not earn a material amount of manage the mix of its debt portfolio. The Company also uses derivative revenue from any single customer. At December 31, 2019 and 2018, there financial instruments to manage interest-rate risk. The Company may utilize was no material accounts receivable balance due from any single customer. interest-rate swaps designated as fair value hedges as a means to manage its interest rate exposure to achieve a lower cost of debt. The Company may At December 31, 2019, the Company’s allowance for doubtful accounts also utilize interest-rate derivative instruments, such as cash flow hedges, was $22 million (2018 – $21 million). The allowance for doubtful accounts to manage its exposure to short-term interest rates or to lock in interest-rate reflects the Company’s current lifetime expected credit losses for all accounts levels in anticipation of future financing. receivable balances, which are based on historical overdue balances, customer payments and write-offs. At December 31, 2019, approximately A hypothetical 100 basis points increase in interest rates associated with 5% (2018 – 5%) of the Company’s net accounts receivable were variable-rate debt would not have resulted in a significant decrease in outstanding for more than 60 days. Hydro One’s net income for the years ended December 31, 2019 and 2018. Hydro One manages its counterparty credit risk through various techniques For derivative instruments that are designated and qualify as fair value including: entering into transactions with highly rated counterparties; limiting hedges, the gain or loss on the derivative instrument as well as the total exposure levels with individual counterparties; entering into master offsetting loss or gain on the hedged item attributable to the hedged agreements which enable net settlement and the contractual right of offset; risk are recognized in the Consolidated Statements of Operations and and monitoring the financial condition of counterparties. The Company Comprehensive Income. The net unrealized loss (gain) on the hedged debt monitors current credit exposure to counterparties on both an individual and and the related interest-rate swaps for the years ended December 31, 2019 an aggregate basis. The Company’s credit risk for accounts receivable is and 2018 were not material. limited to the carrying amounts on the Consolidated Balance Sheets. For derivative instruments that are designated and qualify as cash flow Derivative financial instruments result in exposure to credit risk since there hedges, the unrealized gain or loss, net of tax, on the derivative instrument is a risk of counterparty default. The credit exposure of derivative contracts, is recorded as OCI and is reclassified to results of operations in the same before collateral, is represented by the fair value of contracts at the reporting period during which the hedged transaction affects results of operations. date. At December 31, 2019 and 2018, the counterparty credit risk exposure The unrealized gain, net of tax, on the cash flow hedges for the year on the fair value of these interest-rate swap contracts was not material. ended December 31, 2019 recorded in OCI was $2 million (2018 – $nil), At December 31, 2019, Hydro One’s credit exposure for all derivative resulting in an AOCI balance of $2 million related to cash flow hedges instruments, and applicable payables and receivables, had a credit rating at December 31, 2019 (2018 – $nil). No amounts were reclassified to of investment grade, with three financial institutions as the counterparties. results of operations during 2019 or 2018. The Company estimates that 94 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements Liquidity Risk Canada. The Universal Base Shelf Prospectus allows Hydro One to offer, Liquidity risk refers to the Company’s ability to meet its financial obligations from time to time in one or more public offerings, up to $4.0 billion of debt, as they come due. Hydro One meets its short-term operating liquidity equity or other securities, or any combination thereof, during the 25-month requirements using cash and cash equivalents on hand, funds from period ending on July 18, 2020. On November 23, 2018, HOHL filed a operations, the issuance of commercial paper, and the Operating Credit short form base shelf prospectus (US Debt Shelf Prospectus) with securities Facilities. The short-term liquidity under the Commercial Paper Program, regulatory authorities in Canada and the US. The US Debt Shelf Prospectus Operating Credit Facilities, and anticipated levels of funds from operations allows HOHL to offer, from time to time in one or more public offerings, are expected to be sufficient to fund normal operating requirements. up to US$3.0 billion of debt securities, unconditionally guaranteed by Hydro One, during the 25-month period ending on December 23, 2020. On June 18, 2018, Hydro One filed a short form base shelf prospectus At December 31, 2019, no securities have been issued under the Universal (Universal Base Shelf Prospectus) with securities regulatory authorities in Base Shelf Prospectus or the US Debt Shelf Prospectus. 19. CAPITAL MANAGEMENT The Company’s objectives with respect to its capital structure are to maintain effective access to capital on a long-term basis at reasonable rates, and to deliver appropriate financial returns. In order to ensure ongoing access to capital, the Company targets to maintain strong credit quality. At December 31, 2019 and 2018, the Company’s capital structure was as follows: December 31 (millions of dollars) 2019 2018 Long-term debt payable within one year 653 731 Short-term notes payable 1,143 1,252 Less: cash and cash equivalents (30) (483) 1,766 1,500 Long-term debt 10,822 9,978 Convertible debentures — 489 Preferred shares 418 418 Common shares 5,661 5,643 Retained earnings 3,667 3,459 Total capital 22,324 21,487 Hydro One Inc. and HOSSM have customary covenants typically beyond the limitations imposed by the Income Tax Act (Canada) in the form associated with long-term debt. Long-term debt and credit facility covenants of credits to a notional account. Hydro One contributions to the DC Plan for limit permissible debt to 75% of its total capitalization, limit the ability to the year ended December 31, 2019 were $1 million (2018 – $1 million). sell assets and impose a negative pledge provision, subject to customary exceptions. At December 31, 2019, the Company was in compliance with Pension Plan, Supplemental Plan, and Post-Retirement and all financial covenants and limitations associated with the outstanding Post-Employment Plans borrowings and credit facilities. The Pension Plan is a defined benefit contributory plan which covers eligible regular employees of Hydro One and its subsidiaries. The Pension 20. PENSION AND POST-RETIREMENT AND Plan provides benefits based on highest three-year average pensionable POST-EMPLOYMENT BENEFITS earnings. For management employees who commenced employment on or after January 1, 2004, and for the Society of United Professionals (Society)- Hydro One has a defined benefit pension plan (Pension Plan), a DC Plan, represented staff hired after November 17, 2005, benefits are based on a supplemental pension plan (Supplemental Plan), and post-retirement highest five-year average pensionable earnings. After retirement, pensions and post-employment benefit plans. are indexed to inflation. Membership in the Pension Plan was closed to management employees who were not eligible or had not irrevocably DC Plan elected to join the Pension Plan as of September 30, 2015. These employees Hydro One established a DC Plan effective January 1, 2016. The DC Plan are eligible to join the DC Plan. covers eligible management employees hired on or after January 1, 2016, as well as management employees hired before January 1, 2016 who were Company and employee contributions to the Pension Plan are based on not eligible or had not irrevocably elected to join the Pension Plan as of actuarial reports, including valuations performed at least every three years, September 30, 2015. Members of the DC Plan have an option to contribute and actual or projected levels of pensionable earnings, as applicable. 4%, 5% or 6% of their pensionable earnings, with matching contributions by The most recent actuarial valuation was performed effective December 31, Hydro One up to an annual contribution limit. There is also a Supplemental 2018 and filed on September 30, 2019. The next actuarial valuation will DC Plan that provides members of the DC Plan with employer contributions Hydro One Limited | Annual Report 2019 95
Notes to Consolidated Financial Statements be performed no later than effective December 31, 2021. Total annual cash Hydro One recognizes the overfunded or underfunded status of the Pension Pension Plan employer contributions for 2019 were $61 million (2018 – Plan, and post-retirement and post-employment benefit plans (Plans) as $75 million). Estimated annual Pension Plan employer contributions for the an asset or liability on its Consolidated Balance Sheets, with offsetting years 2020, 2021, 2022, 2023 and 2024 are approximately $66 million, regulatory assets and liabilities as appropriate. The underfunded benefit $65 million, $64 million, $64 million, and $64 million, respectively. obligations for the Plans, in the absence of regulatory accounting, would be recognized in AOCI. The impact of changes in assumptions used to measure The Supplemental Plan provides members of the Pension Plan with benefits pension and post-retirement benefit obligations is generally recognized that would have been earned and payable under the Pension Plan beyond over the expected average remaining service period of the employees the limitations imposed by the Income Tax Act (Canada). The Supplemental and using the corridor approach for the post-retirement benefit plan. For Plan obligation is included with other post-retirement and post-employment post-employment benefit plan, the impact of changes in assumptions are benefit obligations on the Consolidated Balance Sheets. recognized immediately in the net periodic benefit cost. The measurement date for the Plans is December 31. The following tables provide the components of the unfunded status of the Company’s Plans at December 31, 2019 and 2018: Post-Retirement and Pension Benefits Post-Employment Benefits Year ended December 31 (millions of dollars) 2019 2018 2019 2018 Change in projected benefit obligation Projected benefit obligation, beginning of year 7,752 8,258 1,465 1,565 Current service cost 145 176 56 50 Employee contributions 55 52 — — Interest cost 303 282 60 54 Benefits paid (371) (362) (47) (49) Net actuarial loss (gain) 1,089 (654) 243 (158) Recognition of prior service — — — 3 Net transfers1 — — 6 — Projected benefit obligation, end of year 8,973 7,752 1,783 1,465 Change in plan assets Fair value of plan assets, beginning of year 7,205 7,277 — — Actual return on plan assets 922 190 — — Benefits paid (371) (362) (47) (49) Employer contributions 61 75 47 49 Employee contributions 55 52 — — Administrative expenses (24) (27) — — Fair value of plan assets, end of year 7,848 7,205 — — Unfunded status 1,125 547 1,783 1,465 1 Effective January 1, 2019, liabilities associated with the HOSSM post-employment benefit plans were transferred to the Hydro One post-employment benefit plans. Hydro One presents its benefit obligations and plan assets net on its Consolidated Balance Sheets as follows: Post-Retirement and Pension Benefits Post-Employment Benefits December 31 (millions of dollars) 2019 2018 2019 2018 Other assets1 3 3 — — Accrued liabilities — — 60 55 Pension benefitliability 1,125 547 — — Post-retirement and post-employment benefit liability2 — — 1,723 1,417 Net unfunded status 1,122 544 1,783 1,472 1 Represents the funded status of HOSSM defined benefit pension plan. 2 Includes $nil (2018 – $7 million) relating to HOSSM post-employment benefit plans. Effective January 1, 2019, liabilities associated with the HOSSM post-employment benefit plans were transferred to the Hydro One post-employment benefit plans. 96 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements The funded or unfunded status of the Plans refers to the difference between the fair value of plan assets and the PBO for the Plans. The funded/unfunded status changes over time due to several factors, including contribution levels, assumed discount rates and actual returns on plan assets. The following table provides the PBO, accumulated benefit obligation (ABO) and fair value of plan assets for the Pension Plan: December 31 (millions of dollars) 2019 2018 PBO 8,973 7,752 ABO 8,183 7,144 Fair value of plan assets 7,848 7,205 On an ABO basis, the Pension Plan was funded at 96% at December 31, 2019 (2018 – 101%). On a PBO basis, the Pension Plan was funded at 87% at December 31, 2019 (2018 – 93%). The ABO differs from the PBO in that the ABO includes no assumption about future compensation levels. Components of Net Periodic Benefit Costs The following table provides the components of the net periodic benefit costs for the years ended December 31, 2019 and 2018 for the Pension Plan: Year ended December 31 (millions of dollars) 2019 2018 Current service cost 145 176 Interest cost 303 282 Expected return on plan assets, net of expenses (462) (467) Amortization of actuarial losses 55 84 Net periodic benefit costs 41 75 Charged to results of operations1 30 32 1 The Company accounts for pension costs consistent with their inclusion in OEB-approved rates. During the year ended December 31, 2019, pension costs of $73 million (2018 – $75 million) were attributed to labour, of which $30 million (2018 – $32 million) was charged to operations, and $43 million (2018 – $43 million) was capitalized as part of the cost of property, plant and equipment and intangible assets. The following table provides the components of the net periodic benefit costs for the years ended December 31, 2019 and 2018 for the post-retirement and post-employment benefit plans: Year ended December 31 (millions of dollars) 2019 2018 Current service cost 56 50 Interest cost 60 53 Amortization of actuarial losses 7 15 Recognition of prior service — 3 Net periodic benefit costs 123 121 Charged to results of operations1 50 52 1 The Company accounts for post-retirement and post-employment costs consistent with their inclusion in OEB-approved rates. During the year ended December 31, 2019, post-retirement and post-employment costs of $123 million (2018 – $121 million) were attributed to labour, of which $50 million (2018 – $52 million) was charged to operations, $39 million (2018 – $41 million) was recorded as regulatory assets, and $34 million (2018 – $28 million) was capitalized as part of the cost of property, plant and equipment and intangible assets. Assumptions level of compensation and rate of compensation increases, employee age, The measurement of the obligations of the Plans and the costs of providing length of service, and the anticipated rate of increase of health care costs, benefits under the Plans involves various factors, including the development among other factors. The impact of changes in assumptions used to measure of valuation assumptions and accounting policy elections. When developing the obligations of the Plans is generally recognized over the expected average the required assumptions, the Company considers historical information as remaining service period of the plan participants. In selecting the expected well as future expectations. The measurement of benefit obligations and rate of return on plan assets, Hydro One considers historical economic costs is impacted by several assumptions including the discount rate applied indicators that impact asset returns, as well as expectations regarding future to benefit obligations, the long-term expected rate of return on plan assets, long-term capital market performance, weighted by target asset class Hydro One’s expected level of contributions to the Plans, the incidence of allocations. In general, equity securities, real estate and private equity mortality, the expected remaining service period of plan participants, the investments are forecasted to have higher returns than fixed-income securities. Hydro One Limited | Annual Report 2019 97
Notes to Consolidated Financial Statements The following weighted average assumptions were used to determine the benefit obligations at December 31, 2019 and 2018: Post-Retirement and Pension Benefits Post-Employment Benefits Year ended December 31 2019 2018 2019 2018 Significant assumptions: Weighted average discount rate 3.10% 3.90% 3.10% 4.00% Rate of compensation scale escalation (long-term) 2.50% 2.50% 2.50% 2.50% Rate of cost of living increase 2.00% 2.00% 2.00% 2.00% Rate of increase in health care cost trends1 — — 4.04% 4.04% 1 5.09% per annum in 2020, grading down to 4.04% per annum in and after 2031 (2018 – 5.19% per annum in 2019, grading down to 4.04% per annum in and after 2031). The following weighted average assumptions were used to determine the net periodic benefit costs for the years ended December 31, 2019 and 2018. Assumptions used to determine current year-end benefit obligations are the assumptions used to estimate the subsequent year’s net periodic benefit costs. Year ended December 31 2019 2018 Pension Benefits: Weighted average expected rate of return on plan assets 6.50% 6.50% Weighted average discount rate 3.90% 3.40% Rate of compensation scale escalation (long-term) 2.50% 2.50% Rate of cost of living increase 2.00% 2.00% Average remaining service life of employees (years) 15 15 Post-Retirement and Post-Employment Benefits: Weighted average discount rate 4.00% 3.40% Rate of compensation scale escalation (long-term) 2.50% 2.50% Rate of cost of living increase 2.00% 2.00% Average remaining service life of employees (years) 15.5 15.5 Rate of increase in health care cost trends1 4.04% 4.04% 1 5.19% per annum in 2019, grading down to 4.04% per annum in and after 2031 (2018 – 5.26% per annum in 2018, grading down to 4.04% per annum in and after 2031). The discount rate used to determine the current year pension obligation and the subsequent year’s net periodic benefit costs is based on a yield curve approach. Under the yield curve approach, expected future benefit payments for each plan are discounted by a rate on a third-party bond yield curve corresponding to each duration. The yield curve is based on “AA” long-term corporate bonds. A single discount rate is calculated that would yield the same present value as the sum of the discounted cash flows. The effect of a 1% change in health care cost trends on the PBO for the post-retirement and post-employment benefits at December 31, 2019 and 2018 is as follows: December 31 (millions of dollars) 2019 2018 Projected benefit obligation: Effect of a 1% increase in health care cost trends 281 230 Effect of a 1% decrease in health care cost trends (213) (175) The effect of a 1% change in health care cost trends on the service cost and interest cost for the post-retirement and post-employment benefits for the years ended December 31, 2019 and 2018 is as follows: Year ended December 31 (millions of dollars) 2019 2018 Service cost and interest cost: Effect of a 1% increase in health care cost trends 21 23 Effect of a 1% decrease in health care cost trends (16) (16) 98 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements The following approximate life expectancies were used in the mortality assumptions to determine the PBO for the pension and post-retirement and post- employment plans at December 31, 2019 and 2018: December 31 2019 2018 Life expectancy at age 65 for a member currently at: (years) (years) Age 65 – male 22 22 Age 65 – female 25 25 Age 45 – male 23 23 Age 45 – female 26 25 Estimated Future Benefit Payments At December 31, 2019, estimated future benefit payments to the participants of the Plans were: Post-Retirement and Post-Employment (millions of dollars) Pension Benefits Benefits 2020 345 61 2021 354 61 2022 362 62 2023 369 64 2024 375 64 2025 through to 2029 1,945 342 Total estimated future benefit payments through to 2029 3,750 654 Components of Regulatory Assets A portion of actuarial gains and losses and prior service costs is recorded within regulatory assets on Hydro One’s Consolidated Balance Sheets to reflect the expected regulatory inclusion of these amounts in future rates, which would otherwise be recorded in OCI. These amounts are reflected in the following table: Year ended December 31 (millions of dollars) 2019 2018 Pension Benefits: Actuarial loss (gain) for the year 652 (350) Amortization of actuarial losses (55) (84) 597 (434) Post-Retirement and Post-Employment Benefits: Actuarial loss (gain) for the year 242 (158) Amortization of actuarial losses (7) (15) Amortization of prior service cost — (3) Amounts not subject to regulatory treatment — 10 235 (166) The following table provides the components of regulatory assets that have not been recognized as components of net periodic benefit costs for the years ended December 31, 2019 and 2018: Year ended December 31 (millions of dollars) 2019 2018 Pension Benefits: Actuarial loss 1,125 547 Post-Retirement and Post-Employment Benefits: Actuarial loss (gain) 105 (130) Hydro One Limited | Annual Report 2019 99
Notes to Consolidated Financial Statements The following table provides the components of regulatory assets at December 31 that are expected to be amortized as components of net periodic benefit costs in the following year: Post-Retirement and Pension Benefits Post-Employment Benefits December 31 (millions of dollars) 2019 2018 2019 2018 Actuarial loss (gain) 95 55 2 (1) Pension Plan Assets and Procedures (SIPP), which is reviewed and approved by the Human Investment Strategy Resource Committee of Hydro One’s Board of Directors. The Company On a regular basis, Hydro One evaluates its investment strategy to ensure manages net assets by engaging knowledgeable external investment that Pension Plan assets will be sufficient to pay Pension Plan benefits when managers who are charged with the responsibility of investing existing due. As part of this ongoing evaluation, Hydro One may make changes funds and new funds (current year’s employee and employer contributions) to its targeted asset allocation and investment strategy. The Pension Plan is in accordance with the approved SIPP. The performance of the managers managed at a net asset level. The main objective of the Pension Plan is to is monitored through a governance structure. Increases in net assets are sustain a certain level of net assets in order to meet the pension obligations a direct result of investment income generated by investments held by the of the Company. The Pension Plan fulfils its primary objective by adhering Pension Plan and contributions to the Pension Plan by eligible employees to specific investment policies outlined in its Statement of Investment Policies and by the Company. The main use of net assets is for benefit payments to eligible Pension Plan members. Pension Plan Asset Mix At December 31, 2019, the Pension Plan target asset allocations and weighted average asset allocations were as follows: Target Pension Plan Allocation (%) Assets (%) Equity securities 45 52 Debt securities 35 35 Real Estate and Infrastructure 20 13 100 100 At December 31, 2019, the Pension Plan held $21 million (2018 – $18 million) Hydro One corporate bonds and $504 million (2018 – $546 million) of debt securities of the Province. Concentrations of Credit Risk The Pension Plan’s Statement of Investment Beliefs and Guidelines provides Hydro One evaluated its Pension Plan’s asset portfolio for the existence guidelines and restrictions for eligible investments taking into account credit of significant concentrations of credit risk as at December 31, 2019 and ratings, maximum investment exposure and other controls in order to limit the 2018. Concentrations that were evaluated include, but are not limited to, impact of this risk. The Pension Plan manages its counterparty credit risk with investment concentrations in a single entity, concentrations in a type of respect to bonds by investing in investment-grade and government bonds industry, and concentrations in individual funds. At December 31, 2019 and with respect to derivative instruments by transacting only with highly and 2018, there were no significant concentrations (defined as greater rated financial institutions, and also by ensuring that exposure is diversified than 10% of plan assets) of risk in the Pension Plan’s assets. across counterparties. The risk of default on transactions in listed securities is considered minimal, as the trade will fail if either party to the transaction does not meet its obligation. 100 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements Fair Value Measurements The following tables present the Pension Plan assets and liabilities measured and recorded at fair value on a recurring basis and their level within the fair value hierarchy at December 31, 2019 and 2018: December 31, 2019 (millions of dollars) Level 1 Level 2 Level 3 Total Pooled funds — 22 1,079 1,101 Cash and cash equivalents 159 — — 159 Short-term securities — 98 — 98 Derivative instruments — 5 — 5 Corporate shares – Canadian 107 — — 107 Corporate shares – Foreign 3,545 219 — 3,764 Bonds and debentures – Canadian — 2,427 — 2,427 Bonds and debentures – Foreign — 165 — 165 Total fair value of plan assets1 3,811 2,936 1,079 7,826 December 31, 2019 (millions of dollars) Level 1 Level 2 Level 3 Total Derivative instruments — 2 — 2 Total fair value of plan liabilities1 — 2 — 2 1 At December 31, 2019, the total fair value of Pension Plan assets and liabilities excludes $36 million of interest and dividends receivable, $10 million of pension administration expenses payable, $3 million of sold investments receivable, and $5 million of purchased investments payable. December 31, 2018 (millions of dollars) Level 1 Level 2 Level 3 Total Pooled funds — 21 651 672 Cash and cash equivalents 210 — — 210 Short-term securities — 78 — 78 Derivative instruments — (7) — (7) Corporate shares – Canadian 115 — — 115 Corporate shares – Foreign 3,222 183 — 3,405 Bonds and debentures – Canadian — 2,506 — 2,506 Bonds and debentures – Foreign — 197 — 197 Total fair value of plan assets1 3,547 2,978 651 7,176 1 At December 31, 2018, the total fair value of Pension Plan assets and liabilities excludes $35 million of interest and dividends receivable, $10 million of pension administration expenses payable, $6 million of sold investments receivable, and $2 million of purchased investments payable. See Note 18 – Fair Value of Financial Instruments and Risk Management for a description of levels within the fair value hierarchy. Changes in the Fair Value of Financial Instruments Classified in Level 3 gains and losses presented in the table below could, therefore, include The following table summarizes the changes in fair value of financial changes in fair value based on both observable and unobservable inputs. instruments classified in Level 3 for the years ended December 31, 2019 The Level 3 financial instruments are comprised of pooled funds whose and 2018. The Pension Plan classifies financial instruments as Level 3 when valuations are provided by the investment managers. Sensitivity analysis the fair value is measured based on at least one significant input that is not is not provided as the underlying assumptions used by the investment observable in the markets or due to lack of liquidity in certain markets. The managers are not available. Year ended December 31 (millions of dollars) 2019 2018 Fair value, beginning of year 651 549 Realized and unrealized gains (losses) (4) 59 Purchases 463 90 Sales and disbursements (31) (47) Fair value, end of year 1,079 651 There were no significant transfers between any of the fair value levels during the years ended December 31, 2019 and 2018. Hydro One Limited | Annual Report 2019 101
Notes to Consolidated Financial Statements Valuation Techniques Used to Determine Fair Value Short-term securities are valued at cost plus accrued interest, which Pooled funds mainly consist of private equity, real estate and infrastructure approximates fair value due to their short-term nature. Short-term securities investments. Private equity investments represent private equity funds that are categorized as Level 2. invest in operating companies that are not publicly traded on a stock exchange. Investment strategies in private equity include limited partnerships Derivative instruments are used to hedge the Pension Plan’s foreign currency in businesses that are characterized by high internal growth and operational exposure back to Canadian dollars. The notional principal amount of efficiencies, venture capital, leveraged buyouts and special situations such contracts outstanding as at December 31, 2019 was $742 million (2018 as distressed investments. Real estate and infrastructure investments represent – $299 million), the most significant currencies being hedged against the funds that invest in real assets which are not publicly traded on a stock Canadian dollar are the United States dollar, euro, British pound sterling, exchange. Investment strategies in real estate include limited partnerships and Japanese yen. The net realized gain on contracts for the year ended that seek to generate a total return through income and capital growth by December 31, 2019 was $1 million (2018 – $7 million net realized loss). investing primarily in global and Canadian limited partnerships. Investment The terms to maturity of the forward exchange contracts at December 31, strategies in infrastructure include limited partnerships in core infrastructure 2019 are within three months. The fair value is determined using standard assets focusing on assets that generate stable, long-term cash flows and interpolation methodology primarily based on the World Markets exchange deliver incremental returns relative to conventional fixed-income investments. rates. Derivative instruments are categorized as Level 2. Private equity, real estate and infrastructure valuations are reported by the Corporate shares are valued based on quoted prices in active markets fund manager and are based on the valuation of the underlying investments and are categorized as Level 1. Corporate shares which are valued based which includes inputs such as cost, operating results, discounted future cash on quoted prices in active markets, but held within a pension investment flows and market-based comparable data. Since these valuation inputs are holding company, are categorized as Level 2. Investments denominated in not highly observable, private equity and infrastructure investments have foreign currencies are translated into Canadian currency at year-end rates been categorized as Level 3 within pooled funds. of exchange. Cash equivalents consist of demand cash deposits held with banks and cash Bonds and debentures are presented at published closing trade quotations, held by the investment managers. Cash equivalents are categorized as Level 1. and are categorized as Level 2. 21. ENVIRONMENTAL LIABILITIES The following tables show the movements in environmental liabilities for the years ended December 31, 2019 and 2018: Year ended December 31, 2019 (millions of dollars) PCB LAR Total Environmental liabilities – beginning 108 57 165 Interest accretion 4 — 4 Expenditures (17) (8) (25) Revaluation adjustment (5) 2 (3) Environmental liabilities – ending 90 51 141 Less: current portion (19) (11) (30) 71 40 111 Year ended December 31, 2018 (millions of dollars) PCB LAR Total Environmental liabilities – beginning 134 62 196 Interest accretion 5 1 6 Expenditures (16) (6) (22) Revaluation adjustment (15) — (15) Environmental liabilities – ending 108 57 165 Less: current portion (15) (11) (26) 93 46 139 102 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements The following tables show the reconciliation between the undiscounted basis of the environmental liabilities and the amount recognized on the Consolidated Balance Sheets after factoring in the discount rate: December 31, 2019 (millions of dollars) PCB LAR Total Undiscounted environmental liabilities 97 51 148 Less: discounting environmental liabilities to present value (7) — (7) Discounted environmental liabilities 90 51 141 December 31, 2018 (millions of dollars) PCB LAR Total Undiscounted environmental liabilities 118 58 176 Less: discounting environmental liabilities to present value (10) (1) (11) Discounted environmental liabilities 108 57 165 At December 31, 2019, the estimated future environmental expenditures were as follows: December 31 (millions of dollars) 2019 2020 30 2021 31 2022 29 2023 25 2024 8 Thereafter 25 148 Hydro One records a liability for the estimated future expenditures for PCBs LAR and for the phase-out and destruction of PCB-contaminated mineral The Environment Canada regulations, enacted under the Canadian oil removed from electrical equipment when it is determined that future Environmental Protection Act, 1999, govern the management, storage and environmental remediation expenditures are probable under existing disposal of PCBs based on certain criteria, including type of equipment, statute or regulation and the amount of the future expenditures can be in-use status, and PCB-contamination thresholds. Under current regulations, reasonably estimated. Hydro One’s PCBs have to be disposed of by the end of 2025, with the exception of specifically exempted equipment. Contaminated equipment There are uncertainties in estimating future environmental costs due to will generally be replaced, or will be decontaminated by removing PCB- potential external events such as changes in legislation or regulations, and contaminated insulating oil and retro filling with replacement oil that contains advances in remediation technologies. In determining the amounts to be PCBs in concentrations of less than 2 ppm. recorded as environmental liabilities, the Company estimates the current cost of completing required work and makes assumptions as to when the At December 31, 2019, the Company’s best estimate of the total estimated future expenditures will actually be incurred, in order to generate future cash future expenditures to comply with current PCB regulations was $97 million flow information. A long-term inflation rate assumption of approximately (2018 – $118 million). These expenditures are expected to be incurred 2% has been used to express these current cost estimates as estimated over the period from 2020 to 2024. As a result of its annual review of future expenditures. Future expenditures have been discounted using factors environmental liabilities, the Company recorded a revaluation adjustment ranging from approximately 2.0% to 6.3%, depending on the appropriate in 2019 to decrease the PCB environmental liability by $5 million (2018 – rate for the period when expenditures are expected to be incurred. All $15 million). factors used in estimating the Company’s environmental liabilities represent management’s best estimates of the present value of costs required to meet LAR existing legislation or regulations. However, it is reasonably possible that At December 31, 2019, the Company’s best estimate of the total estimated numbers or volumes of contaminated assets, cost estimates to perform work, future expenditures to complete its LAR program was $51 million (2018 inflation assumptions and the assumed pattern of annual cash flows may – $58 million). These expenditures are expected to be incurred over the differ significantly from the Company’s current assumptions. In addition, period from 2020 to 2044. As a result of its annual review of environmental with respect to the PCB environmental liability, the availability of critical liabilities, the Company recorded a revaluation adjustment in 2019 to resources such as skilled labour and replacement assets and the ability increase the LAR environmental liability by $2 million (2018 – $nil). to take maintenance outages in critical facilities may influence the timing of expenditures. Hydro One Limited | Annual Report 2019 103
Notes to Consolidated Financial Statements 22. ASSET RETIREMENT OBLIGATIONS are expected to be incurred. All factors used in estimating the Company’s asset retirement obligations represent management’s best estimates of Hydro One records a liability for the estimated future expenditures for the the cost required to meet existing legislation or regulations. However, it is removal and disposal of asbestos-containing materials installed in some of reasonably possible that numbers or volumes of contaminated assets, cost its facilities. Asset retirement obligations, which represent legal obligations estimates to perform work, inflation assumptions and the assumed pattern associated with the retirement of certain tangible long-lived assets, are of annual cash flows may differ significantly from the Company’s current computed as the present value of the projected expenditures for the future assumptions. Asset retirement obligations are reviewed annually or more retirement of specific assets and are recognized in the period in which frequently if significant changes in regulations or other relevant factors occur. the liability is incurred, if a reasonable estimate can be made. If the asset Estimate changes are accounted for prospectively. As a result of its annual remains in service at the recognition date, the present value of the liability review of asset retirement obligations, no revaluation adjustment to the asset is added to the carrying amount of the associated asset in the period the retirement obligations was recorded in 2019 (2018 – revaluation adjustment liability is incurred and this additional carrying amount is depreciated over was recorded to increase the asset retirement obligations by $1 million). the remaining life of the asset. If an asset retirement obligation is recorded in respect of an out-of-service asset, the asset retirement cost is charged At December 31, 2019, Hydro One had recorded asset retirement to results of operations. Subsequent to the initial recognition, the liability obligations of $10 million (2018 – $10 million), primarily consisting of the is adjusted for any revisions to the estimated future cash flows associated estimated future expenditures associated with the removal and disposal of with the asset retirement obligation, which can occur due to a number of asbestos-containing materials installed in some of its facilities. The amount factors including, but not limited to, cost escalation, changes in technology of interest recorded is nominal. applicable to the assets to be retired, changes in legislation or regulations, as well as for accretion of the liability due to the passage of time until the obligation is settled. Depreciation expense is adjusted prospectively for 23. LEASES any increases or decreases to the carrying amount of the associated asset. Hydro One has operating lease contracts for buildings used in administrative and service-related functions and storing telecommunications equipment. In determining the amounts to be recorded as asset retirement obligations, These leases have typical terms of between three and five years with the Company estimates the current fair value for completing required work renewal options of additional three- to five-year terms at prevailing market and makes assumptions as to when the future expenditures will actually rates at the time of extension. All leases include a clause to enable upward be incurred, in order to generate future cash flow information. A long-term revision of the rental charge on an annual basis or on renewal according inflation assumption of approximately 2% has been used to express these to prevailing market conditions or pre-established rents. There are no current cost estimates as estimated future expenditures. Future expenditures restrictions placed upon Hydro One by entering into these leases. Renewal have been discounted using factors ranging from approximately 2.0% to options are included in the lease term when their exercise is reasonably 4.0%, depending on the appropriate rate for the period when expenditures certain. Other information related to the Company’s operating leases was as follows: Year ended December 31 (millions of dollars) 2019 Lease expense 10 Lease payments made 8 December 31 2019 Weighted-average remaining lease term1 (years) 8 Weighted-average discount rate 2.7% 1 Includes renewal options that are reasonably certain to be exercised. At December 31, 2019, future minimum operating lease payments were as follows: December 31 (millions of dollars) 2019 2020 12 2021 12 2022 11 2023 10 2024 9 Thereafter 33 Total undiscounted minimum lease payments1 87 Less: discounting minimum lease payments to present value (9) Total discounted minimum lease payments 78 1 Excludes committed amounts of $6 million for leases that have not yet commenced. 104 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements At December 31, 2018, future minimum operating lease payments were as follows: December 31 (millions of dollars) 2018 2019 7 2020 11 2021 4 2022 1 2023 1 Thereafter 4 Total undiscounted minimum lease payments 28 Hydro One presents its ROU assets and lease obligations on the Consolidated Balance Sheet as follows: December 31 (millions of dollars) 2019 Other long-term assets (Note 13) 75 Accounts payable and other current liabilities (Note 14) 9 Other long-term liabilities (Note 15) 69 24. SHARE CAPITAL The amount and timing of any dividends payable by Hydro One is at the discretion of the Hydro One Board of Directors and is established on the Common Shares basis of Hydro One’s results of operations, maintenance of its deemed The Company is authorized to issue an unlimited number of common regulatory capital structure, financial condition, cash requirements, the shares. At December 31, 2019, the Company had 596,818,436 (2018 – satisfaction of solvency tests imposed by corporate laws for the declaration 595,938,975) common shares issued and outstanding. and payment of dividends and other factors that the Board of Directors may consider relevant. The following tables present the changes to common shares during the years ended December 31, 2019 and 2018: Ownership by Year ended December 31, 2019 (number of shares) Public Province Total Common shares – beginning 313,526,327 282,412,648 595,938,975 Common shares issued – LTIP1 416,519 — 416,519 Common shares issued – share grants2 462,942 — 462,942 Common shares – ending3 314,405,788 282,412,648 596,818,436 52.7% 47.3% 100% 1 In 2019, Hydro One issued from treasury 416,519 common shares in accordance with provisions of the LTIP. This included the exercise of 302,520 stock options for cash proceeds of $6 million. 2 In 2019, Hydro One issued from treasury 462,942 common shares in accordance with provisions of the Power Workers’ Union (PWU) and the Society Share Grant Plans. 3 On January 16, 2020, Hydro One issued from treasury 117,980 common shares in accordance with provisions of the LTIP. See Note 34 – Subsequent Events. Ownership by Year ended December 31, 2018 (number of shares) Public Province Total Common shares – beginning 312,974,063 282,412,648 595,386,711 Common shares issued – share grants1 481,460 — 481,460 Common shares issued – LTIP2 70,804 — 70,804 Common shares – ending 313,526,327 282,412,648 595,938,975 52.6% 47.4% 100% 1 In 2018, Hydro One issued from treasury 481,460 common shares in accordance with provisions of the PWU and the Society Share Grant Plans. 2 In 2018, Hydro One issued from treasury 70,804 common shares in accordance with provisions of the LTIP. Hydro One Limited | Annual Report 2019 105
Notes to Consolidated Financial Statements Preferred Shares The holders of Series 2 preferred shares will be entitled to receive quarterly The Company is authorized to issue an unlimited number of preferred shares, floating rate cumulative dividends, if and when declared by the Board of issuable in series. At December 31, 2019 and 2018, two series of preferred Directors, at a rate equal to the sum of the then three-month Government of shares were authorized for issuance: the Series 1 preferred shares and the Canada treasury bill rate and 3.53% as reset quarterly. The Series 2 preferred Series 2 preferred shares. At December 31, 2019 and 2018, the Company shares will not be redeemable by Hydro One prior to November 20, 2020, had 16,720,000 Series 1 preferred shares and no Series 2 preferred shares but will be redeemable by Hydro One at a redemption price equal to $25.00 issued and outstanding. for each Series 2 preferred share redeemed, if redeemed on November 20, 2025 or on November 20 of every fifth year thereafter, or $25.50 for each Hydro One may from time to time issue preferred shares in one or more Series 2 preferred share redeemed, if redeemed on any other date after series. Prior to issuing shares in a series, the Hydro One Board of Directors November 20, 2020, in each case plus any accrued or unpaid dividends. is required to fix the number of shares in the series and determine the The holders of Series 2 preferred shares will have the right, at their option, on designation, rights, privileges, restrictions and conditions attaching to that November 20, 2025 and on November 20 of every fifth year thereafter, to series of preferred shares. Holders of Hydro One’s preferred shares are convert all or any of their Series 2 preferred shares into Series 1 preferred not entitled to receive notice of, to attend or to vote at any meeting of the shares on a one-for-one basis, subject to certain restrictions on conversion. shareholders of Hydro One except that votes may be granted to a series of preferred shares when dividends have not been paid on any one or more Share Ownership Restrictions series as determined by the applicable series provisions. Each series of The Electricity Act imposes share ownership restrictions on securities of Hydro preferred shares ranks on parity with every other series of preferred shares, One carrying a voting right (Voting Securities). These restrictions provide and are entitled to a preference over the common shares and any other that no person or company (or combination of persons or companies acting shares ranking junior to the preferred shares, with respect to dividends and jointly or in concert) may beneficially own or exercise control or direction the distribution of assets and return of capital in the event of the liquidation, over more than 10% of any class or series of Voting Securities, including dissolution or winding up of Hydro One. common shares of the Company (Share Ownership Restrictions). The Share Ownership Restrictions do not apply to Voting Securities held by the For the period commencing from the date of issue of the Series 1 preferred Province, nor to an underwriter who holds Voting Securities solely for the shares and ending on and including November 19, 2020, the holders of purpose of distributing those securities to purchasers who comply with the Series 1 preferred shares are entitled to receive fixed cumulative preferential Share Ownership Restrictions. dividends of $1.0625 per share per year, if and when declared by the Board of Directors, payable quarterly. The dividend rate will reset on November 20, 2020 and every five years thereafter at a rate equal to the 25. DIVIDENDS sum of the then five-year Government of Canada bond yield and 3.53%. In 2019, preferred share dividends in the amount of $18 million (2018 – The Series 1 preferred shares will not be redeemable by Hydro One $18 million) and common share dividends in the amount of $570 million prior to November 20, 2020, but will be redeemable by Hydro One on (2018 – $542 million) were declared and paid. November 20, 2020 and on November 20 of every fifth year thereafter at a redemption price equal to $25.00 for each Series 1 preferred share 26. EARNINGS PER COMMON SHARE redeemed, plus any accrued or unpaid dividends. The holders of Series 1 Basic earnings per common share (EPS) is calculated by dividing net income preferred shares will have the right, at their option, on November 20, 2020 (loss) attributable to common shareholders of Hydro One by the weighted- and on November 20 of every fifth year thereafter, to convert all or any of average number of common shares outstanding. their Series 1 preferred shares into Series 2 preferred shares on a one-for- one basis, subject to certain restrictions on conversion. At December 31, Diluted EPS is calculated by dividing net income (loss) attributable to 2019, no preferred share dividends were in arrears. common shareholders of Hydro One by the weighted-average number of common shares outstanding adjusted for the effects of potentially dilutive stock-based compensation plans, including the share grant plans and the LTIP, which are calculated using the treasury stock method. Year ended December 31 2019 2018 Net income (loss) attributable to common shareholders (millions of dollars) 778 (89) Weighted average number of shares Basic 596,437,577 595,756,470 Effect of dilutive stock-based compensation plans 2,410,860 2,147,473 Diluted 598,848,437 597,903,943 EPS Basic $ 1.30 $ (0.15) Diluted $ 1.30 $ (0.15) 106 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements The common shares contingently issuable as a result of the Convertible issuable under the PWU Share Grant Plan shall not exceed 3,981,763 Debentures are not included in diluted EPS for the year ended December 31, common shares. In 2015, 3,979,062 common shares were granted under 2019 and 2018, as conditions for closing the Merger were not met. As a result of the PWU Share Grant Plan. the termination of the Merger agreement (see Note 4 – Business Combinations), the Convertible Debentures were redeemed on February 8, 2019. The Society Share Grant Plan provides for the issuance of common shares of Hydro One from treasury to certain eligible members of The Society 27. STOCK-BASED COMPENSATION annually, commencing on April 1, 2018 and continuing until the earlier of April 1, 2029 or the date an eligible employee no longer meets the eligibility Share Grant Plans criteria of the Society Share Grant Plan. To be eligible, an employee must be Hydro One has two share grant plans (Share Grant Plans), one for the a member of the Pension Plan on September 1, 2015, be employed on the benefit of certain members of the PWU (PWU Share Grant Plan) and one for date annual share issuance occurs and continue to have under 35 years of the benefit of certain members of the Society (Society Share Grant Plan). service. Therefore, the requisite service period for the Society Share Grant Plan began on September 1, 2015. The number of common shares issued The PWU Share Grant Plan provides for the issuance of common shares of annually to each eligible employee will be equal to 2.0% of such eligible Hydro One from treasury to certain eligible members of the PWU annually, employee’s salary as at September 1, 2015, divided by $20.50, being the commencing on April 1, 2017 and continuing until the earlier of April 1, price of the common shares of Hydro One in its IPO. The aggregate number 2028 or the date an eligible employee no longer meets the eligibility of common shares issuable under the Society Share Grant Plan shall not criteria of the PWU Share Grant Plan. To be eligible, an employee must exceed 1,434,686 common shares. In 2015, 1,433,292 common shares be a member of the Pension Plan on April 1, 2015, be employed on the were granted under the Society Share Grant Plan. date annual share issuance occurs and continue to have under 35 years of service. The requisite service period for the PWU Share Grant Plan began on The fair value of the Hydro One 2015 share grants of $111 million was July 3, 2015, which is the date the share grant plan was ratified by the PWU. estimated based on the grant date share price of $20.50 and is recognized The number of common shares issued annually to each eligible employee using the graded-vesting attribution method as the share grant plans have will be equal to 2.7% of such eligible employee’s salary as at April 1, 2015, both a performance condition and a service condition. In 2019, 462,942 divided by $20.50, being the price of the common shares of Hydro One in common shares (2018 – 481,460) were issued under the Share Grant Plans. its Initial Public Offering (IPO). The aggregate number of common shares Total share-based compensation recognized during 2019 was $9 million (2018 – $12 million) and was recorded as a regulatory asset. A summary of share grant activity under the Share Grant Plans during the years ended December 31, 2019 and 2018 is presented below: Share Grants Weighted- Year ended December 31, 2019 (number of common shares) Average Price Share grants outstanding – beginning 4,234,155 $ 20.50 Vested and issued1 (462,942) — Forfeited (96,836) $ 20.50 Share grants outstanding – ending 3,674,377 $ 20.50 1 In 2019, Hydro One issued from treasury 462,942 common shares to eligible employees in accordance with provisions of the Share Grant Plans. Share Grants Weighted- Year ended December 31, 2018 (number of common shares) Average Price Share grants outstanding – beginning 4,825,732 $ 20.50 Vested and issued1 (481,460) — Forfeited (110,117) $ 20.50 Share grants outstanding – ending 4,234,155 $ 20.50 1 In 2018, Hydro One issued from treasury 481,460 common shares to eligible employees in accordance with provisions of the Share Grant Plans. Directors’ DSU Plan director as compensation in addition to any regular retainer or fee to which Under the Directors’ DSU Plan, directors can elect to receive credit for their the director is entitled. Each DSU represents a unit with an underlying value annual cash retainer in a notional account of DSUs in lieu of cash. Hydro equivalent to the value of one common share of the Company and is entitled One’s Board of Directors may also determine from time to time that special to accrue common share dividend equivalents in the form of additional DSUs circumstances exist that would reasonably justify the grant of DSUs to a at the time dividends are paid, subsequent to declaration by Hydro One’s Board of Directors. Hydro One Limited | Annual Report 2019 107
Notes to Consolidated Financial Statements A summary of DSU awards activity under the Directors’ DSU Plan during the years ended December 31, 2019 and 2018 is presented below: Year ended December 31 (number of DSUs) 2019 2018 DSUs outstanding – beginning 46,697 187,090 Granted 29,938 82,375 Settled1 (24,015) (222,768) DSUs outstanding – ending 52,620 46,697 1 In 2018, DSUs related to the Company’s former Board of Directors were settled at the June 29, 2018 closing price of the Company’s common shares of $20.04, with an amount of approximately $5 million paid during the fourth quarter of 2018. For the year ended December 31, 2019, an expense of $1 million (2018 – Management DSU Plan $1 million) was recognized in earnings with respect to the Directors’ DSU Under the Management DSU Plan, eligible executive employees can elect Plan. At December 31, 2019, a liability of $1 million (2018 – $1 million) to receive a specified proportion of their annual short-term incentive in a related to Directors’ DSUs has been recorded at the December 31, 2019 notional account of DSUs in lieu of cash. Each DSU represents a unit with closing price of the Company’s common shares of $25.08. This liability an underlying value equivalent to the value of one common share of the is included in long-term accounts payable and other liabilities on the Company and is entitled to accrue common share dividend equivalents in Consolidated Balance Sheets. the form of additional DSUs at the time dividends are paid, subsequent to declaration by Hydro One’s Board of Directors. A summary of DSU awards activity under the Management DSU Plan during the years ended December 31, 2019 and 2018 is presented below: Year ended December 31 (number of DSUs) 2019 2018 DSUs outstanding – beginning 108,296 67,829 Granted 24,996 40,467 Paid (81,106) — DSUs outstanding – ending 52,186 108,296 For the year ended December 31, 2019, an expense of $1 million (2018 Company matches 25% of their contributions, with no maximum Company – $1 million) was recognized in earnings with respect to the Management contribution per calendar year. In 2019, Company contributions made under DSU Plan. At December 31, 2019, a liability of $1 million (2018 – $2 million) the ESOP were $2 million (2018 – $2 million). related to Management DSUs has been recorded at the December 31, 2019 closing price of the Company’s common shares of $25.08. This liability LTIP is included in long-term accounts payable and other liabilities on the Effective August 31, 2015, the Board of Directors of Hydro One adopted an Consolidated Balance Sheets. LTIP. Under the LTIP, long-term incentives are granted to certain executive and management employees of Hydro One and its subsidiaries, and all Employee Share Ownership Plan equity-based awards will be settled in newly issued shares of Hydro One In 2015, Hydro One established Employee Share Ownership Plans from treasury, consistent with the provisions of the plan which also permit (ESOP) for certain eligible management and non-represented employees the participants to surrender a portion of their awards to satisfy related (Management ESOP) and for certain eligible Society-represented staff withholding taxes requirements. The aggregate number of shares issuable (Society ESOP). Under the Management ESOP, the eligible management under the LTIP shall not exceed 11,900,000 shares of Hydro One. and non-represented employees may contribute between 1% and 6% of their base salary towards purchasing common shares of Hydro One. The The LTIP provides flexibility to award a range of vehicles, including Company matches 50% of their contributions, up to a maximum Company Performance Share Units (PSUs), Restricted Share Units (RSUs), stock contribution of $25,000 per calendar year. Under the Society ESOP, the options, share appreciation rights, restricted shares, DSUs, and other share- eligible Society-represented staff may contribute between 1% and 4% of based awards. The mix of vehicles is intended to vary by role to recognize their base salary towards purchasing common shares of Hydro One. The the level of executive accountability for overall business performance. 108 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements PSUs and RSUs A summary of PSU and RSU awards activity under the LTIP during the years ended December 31, 2019 and 2018 is presented below: PSUs RSUs Year ended December 31 (number of units) 2019 2018 2019 2018 Units outstanding – beginning 605,180 429,980 442,470 393,430 Granted — 445,120 — 345,790 Vested and issued (78,121) (123) (92,112) (106,591) Forfeited (153,805) (31,767) (84,745) (31,849) Settled (201,910) (238,030) (58,620) (158,310) Units outstanding – ending1 171,344 605,180 206,993 442,470 1 Units outstanding at December 31, 2019 include 7,740 PSUs and 96,330 RSUs that may be settled in cash if certain conditions are met. At December 31, 2019, a liability of $3 million has been recorded with respect to these awards and is included in accrued liabilities on the Consolidated Balance Sheet. No awards were granted in 2019. The grant date total fair value of the Stock Options awards granted in 2018 was $16 million. The compensation expense related The Company is authorized to grant stock options under its LTIP to certain to the PSU and RSU awards recognized by the Company during 2019 was eligible employees. No stock options were granted in 2019 (2018–1,450,880 $9 million (2018 – $15 million). stock options were granted). The stock options granted are exercisable for a period not to exceed seven years from the date of grant. The original Amounts recognized in 2019 were affected by the reversal in the third three-year vesting period for 706,070 stock options was modified in 2019 quarter of 2019 of approximately $3 million of previously recognized due to agreements reached with five option-holders, resulting in applicable compensation expense to reflect forfeitures of PSUs and RSUs in the third stock options being fully vested in 2019. The incremental compensation cost quarter of 2019. The expense recognized in 2018 included $5 million resulting from the modification was not significant. related to previously awarded PSUs and RSUs to the Company’s former President and Chief Executive Officer for which costs had not previously The fair value-based method is used to measure compensation expense been recognized. These awards, consisting of 238,030 PSUs and 158,310 related to stock options and the expense is recognized over the vesting period RSUs, were settled in 2018 through a one-time cash settlement arrangement. on a straight-line basis. The fair value of the stock option awards granted was estimated on the date of grant using a Black-Scholes valuation model. Updates related to stock options subject to modification were not significant. Stock options granted and the weighted-average assumptions used in the valuation model for options granted during 2018 are as follows: Exercise price1 $ 20.70 Grant date fair value per option $ 1.66 Valuation assumptions: Expected dividend yield2 3.78% Expected volatility3 15.01% Risk-free interest rate4 2.00% Expected option term5 4.5 years 1 Hydro One common share price on the date of the grant. 2 Based on dividend and Hydro One common share price on the date of the grant. 3 Based on average daily volatility of Hydro One’s peer entities for a 4.5-year term. 4 Based on bond yield for an equivalent Canadian government bond. 5 Determined using the option term and the vesting period. Hydro One Limited | Annual Report 2019 109
Notes to Consolidated Financial Statements A summary of stock options activity during the years ended December 31, 2019 and 2018 is presented below: Weighted- Number of average Stock Options exercise price Stock options outstanding – January 1, 2018 — Granted 1,450,880 $ 20.70 Forfeited1 (500,970) $ 20.66 Stock options outstanding – December 31, 20182,3 949,910 $ 20.72 Exercised4 (302,520) $ 20.76 Forfeited1 (243,840) $ 20.75 Stock options outstanding – December 31, 20192 403,550 $ 20.66 1 Stock options forfeited in 2019 had a fair value of $1.65 per option (2018 – $1.67). 2 During 2019, 706,070 stock options vested with a modified fair value of $1.04 per option (2018 – no stock options vested), of which 302,520 stock options were exercised. At December 31, 2019, all stock options outstanding were vested and exercisable (2018 – all stock options were non-vested). 3 Stock options outstanding at December 31, 2019 have an aggregate intrinsic value of $2 million (2018 – $nil) and weighted-average remaining contractual term of 5.2 years (2018 – 6.2 years). 4 Stock options exercised in 2019 had an aggregate intrinsic value of $1 million. The compensation expense related to stock options recognized by the Company during 2019 was $1 million (2018 – $1 million). At December 31, 2019, the unrecognized compensation expense related to stock options not yet vested was $nil (2018 – $1 million). On January 16, 2020, 117,980 stock options were exercised. See Note 34 – Subsequent Events. 28. NONCONTROLLING INTEREST Total noncontrolling interest consists of noncontrolling interest attributable to B2M LP and noncontrolling interest attributable to NRLP. The following tables show the movements in total noncontrolling interest during the years ended December 31, 2019 and 2018: Year ended December 31, 2019 (millions of dollars) Temporary Equity Equity Total Noncontrolling interest – beginning 21 49 70 Contributions from sale of noncontrolling interest (Note 4) — 12 12 Distributions to noncontrolling interest (3) (6) (9) Net income attributable to noncontrolling interest 2 4 6 Noncontrolling interest – ending 20 59 79 Year ended December 31, 2018 (millions of dollars) Temporary Equity Equity Total Noncontrolling interest – beginning 22 50 72 Distributions to noncontrolling interest (3) (5) (8) Net income attributable to noncontrolling interest 2 4 6 Noncontrolling interest – ending 21 49 70 110 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements B2M LP The Class B units have a mandatory put option which requires that upon On December 16, 2014, transmission assets totalling $526 million were the occurrence of an enforcement event (i.e., an event of default such as transferred from Hydro One Networks to B2M LP. This was financed by 60% a debt default by the SON or insolvency event), Hydro One purchase debt ($316 million) and 40% equity ($210 million). On December 17, 2014, the Class B units of B2M LP for net book value on the redemption date. the SON acquired a 34.2% equity interest in B2M LP for consideration of The noncontrolling interest relating to the Class B units is classified on the $72 million, representing the fair value of the equity interest acquired. The Consolidated Balance Sheet as temporary equity because the redemption SON’s initial investment in B2M LP consists of $50 million of Class A units feature is outside the control of the Company. The balance of the and $22 million of Class B units. noncontrolling interest is classified within equity. The following tables show the movements in B2M LP noncontrolling interest during the years ended December 31, 2019 and 2018: Year ended December 31, 2019 (millions of dollars) Temporary Equity Equity Total Noncontrolling interest – beginning 21 49 70 Distributions to noncontrolling interest (3) (6) (9) Net income attributable to noncontrolling interest 2 4 6 Noncontrolling interest – ending 20 47 67 Year ended December 31, 2018 (millions of dollars) Temporary Equity Equity Total Noncontrolling interest – beginning 22 50 72 Distributions to noncontrolling interest (3) (5) (8) Net income attributable to noncontrolling interest 2 4 6 Noncontrolling interest – ending 21 49 70 NRLP representing the fair value of the equity interest acquired. NRLP is fully On September 18, 2019, Hydro One Networks sold to the Six Nations consolidated in these Consolidated Financial Statements as it is controlled of the Grand River Development Corporation and, through a trust, to the by Hydro One. The First Nations Partners’ 25.1% noncontrolling interest in Mississaugas of the Credit First Nation a 25.0% and 0.1% equity interest in NRLP is classified within equity. NRLP partnership units, respectively, for total consideration of $12 million, The following table shows the movements in NRLP noncontrolling interest during the year ended December 31, 2019: Year ended December 31, 2019 (millions of dollars) Equity Noncontrolling interest – beginning — Contributions from sale of noncontrolling interest (Note 4) 12 Distributions to noncontrolling interest — Net income attributable to noncontrolling interest — Noncontrolling interest – ending 12 On January 31, 2020, the Mississaugas of the Credit First Nation purchased an additional 19.9% equity interest in NRLP. See Note 4 – Business Combinations and Note 34 – Subsequent Events for additional information. Hydro One Limited | Annual Report 2019 111
Notes to Consolidated Financial Statements 29. RELATED PARTY TRANSACTIONS The Province is a shareholder of Hydro One with approximately 47.3% ownership at December 31, 2019. The IESO, Ontario Power Generation Inc. (OPG), Ontario Electricity Financial Corporation (OEFC), and the OEB are related parties to Hydro One because they are controlled or significantly influenced by the Ministry of Energy. Ontario Charging Network LP (OCN LP) is a joint-venture limited partnership between a subsidiary of Hydro One and OPG. The following is a summary of the Company’s related party transactions during the years ended December 31, 2019 and 2018: Year ended December 31 (millions of dollars) Related Party Transaction 2019 2018 Province Dividends paid 288 275 IESO Power purchased 1,808 1,636 Revenues for transmission services 1,636 1,672 Amounts related to electricity rebates 692 477 Distribution revenues related to rural rate protection 240 239 Distribution revenues related to the supply of electricity to remote northern communities 35 35 Funding received related to Conservation and Demand Management programs 42 62 OPG1 Power purchased 8 10 Revenues related to provision of services and supply of electricity 9 9 Costs related to the purchase of services 1 — OEFC Power purchased from power contracts administered by the OEFC 2 2 OEB OEB fees 9 8 OCN LP2 Investment in OCN LP 2 — 1 The OPG has provided a $2.5 million guarantee to Hydro One related to the OCN Guarantee. See Note 32 – Commitments for details related to the OCN Guarantee. 2 OCN LP owns and operates electric vehicle fast charging stations across Ontario, under the Ivy Charging Network brand. Sales to and purchases from related parties are based on the requirements of the OEB’s Affiliate Relationships Code. Outstanding balances at period end are interest-free and settled in cash. Invoices are issued monthly, and amounts are due and paid on a monthly basis. 30. CONSOLIDATED STATEMENTS OF CASH FLOWS The changes in non-cash balances related to operations consist of the following: Year ended December 31 (millions of dollars) 2019 2018 Accounts receivable (73) 11 Due from related parties (160) (2) Other assets (11) 2 Accounts payable 7 2 Accrued liabilities 38 17 Due to related parties 213 (68) Accrued interest 8 (3) Long-term accounts payable and other liabilities — (7) Post-retirement and post-employment benefit liability 33 25 55 (23) 112 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements Capital Expenditures The following tables reconcile investments in property, plant and equipment and intangible assets and the amounts presented in the Consolidated Statements of Cash Flows for the years ended December 31, 2019 and 2018. The reconciling items include net change in accruals and capitalized depreciation. Property, Plant Intangible Year ended December 31, 2019 (millions of dollars) and Equipment Assets Total Capital investments (1,551) (116) (1,667) Reconciling items 38 1 39 Cash outflow for capital expenditures (1,513) (115) (1,628) Property, Plant Intangible Year ended December 31, 2018 (millions of dollars) and Equipment Assets Total Capital investments (1,454) (121) (1,575) Reconciling items 36 1 37 Cash outflow for capital expenditures (1,418) (120) (1,538) Capital Contributions Hydro One will periodically reassess the estimated load forecast which Hydro One enters into contracts governed by the OEB Transmission will lead to a decrease, or an increase in the capital contributions from System Code when a transmission customer requests a new or upgraded the customer. The increase or decrease in capital contributions is recorded transmission connection. The customer is required to make a capital directly to property, plant and equipment in service. In 2019, capital contribution to Hydro One based on the shortfall between the present value contributions from these reassessments totalled $3 million (2018 – $7 million), of the costs of the connection facility and the present value of revenues. which represents the difference between the revised load forecast of The present value of revenues is based on an estimate of load forecast for electricity transmitted compared to the load forecast in the original contract, the period of the contract with Hydro One. Once the connection facility subject to certain adjustments. is commissioned, in accordance with the OEB Transmission System Code, Supplementary Information Year ended December 31 (millions of dollars) 2019 2018 Net interest paid 494 519 Income taxes paid 21 17 31. CONTINGENCIES Transfer of Assets The transfer orders by which the Company acquired certain of Ontario Legal Proceedings Hydro’s businesses as of April 1, 1999 did not transfer title to some assets Hydro One is involved in various lawsuits and claims in the normal course located on Reserves (as defined in the Indian Act (Canada)). Currently, of business. In the opinion of management, the outcome of such matters will the OEFC holds these assets. Under the terms of the transfer orders, the not have a material adverse effect on the Company’s consolidated financial Company is required to manage these assets until it has obtained all position, results of operations or cash flows. consents necessary to complete the transfer of title of these assets to itself. The Company cannot predict the aggregate amount that it may have to pay, Hydro One Inc., Hydro One Networks, Hydro One Remote Communities, either on an annual or one-time basis, to obtain the required consents. In and Norfolk Power Distribution Inc. were defendants in a class action suit 2019, the Company paid approximately $2 million (2018 – $2 million) in commenced in 2015 in which the representative plaintiff was seeking up to respect of consents obtained. If the Company cannot obtain the required $125 million in damages related to allegations of improper billing practices. consents, the OEFC will continue to hold these assets for an indefinite The plaintiff’s application for leave to appeal the lower court’s refusal to certify period of time. If the Company cannot reach a satisfactory settlement, it the lawsuit as a class action was denied by the Ontario Court of Appeal on may have to relocate these assets to other locations at a cost that could be March 26, 2019, which means that the lawsuit has effectively ended. substantial or, in a limited number of cases, to abandon a line and replace There were four putative class action lawsuits filed by Avista Corporation it with diesel-generation facilities. The costs relating to these assets could shareholders in relation to the Merger. The plaintiffs in the four lawsuits were, have a material adverse effect on the Company’s results of operations if respectively, Fink, Jenß, Samuel and Sharpenter. All of these class action the Company is not able to recover them in future rate orders. lawsuits have now been dismissed. Hydro One Limited | Annual Report 2019 113
Notes to Consolidated Financial Statements 32. COMMITMENTS The following table presents a summary of Hydro One’s commitments under outsourcing and other agreements due in the next five years and thereafter: December 31, 2019 (millions of dollars) Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter Outsourcing and other agreements 162 34 10 8 11 13 Long-term software/meter agreement 22 1 2 1 2 — Outsourcing Agreements capital projects as deemed required by the Company. The agreement with Hydro One has an agreement with Inergi LP for the provision of back-office Brookfield for these services expires in December 2024, with an option for and IT outsourcing services, including supply chain, pay operations, IT, and the Company to renew the agreement for an additional term of three years. finance and accounting services. The agreement expires on February 28, 2021 for IT services and on October 31, 2021 for supply chain services. Long-term Software/Meter Agreement The agreement for pay operations, and for finance and accounting services Trilliant Holdings Inc. and Trilliant Networks (Canada) Inc. (collectively was extended in September 2019 and now expires on December 31, 2020. Trilliant) provide services to Hydro One for the supply, maintenance and In addition, the agreement for settlement services expired on December 31, support services for smart meters and related hardware and software, 2019, and these services are now insourced. including additional software licences, as well as certain professional services. The agreement with Trilliant for these services expires in December Brookfield Global Integrated Solutions (Brookfield) provides services to 2025, with an option for the Company to renew the agreement for an Hydro One, including facilities management and execution of certain additional term of five years. Other Commitments The following table presents a summary of Hydro One’s other commercial commitments by year of expiry in the next five years and thereafter: December 31, 2019 (millions of dollars) Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter Operating Credit Facilities1 — — — — 2,550 — Letters of credit2 193 2 — — — — Guarantees3 332 — — — — — 1 On June 3, 2019, the maturity dates for the Operating Credit Facilities were extended from November 2021 and June 2022 to June 2024. 2 Letters of credit consist of $179 million letters of credit related to retirement compensation arrangements, a $4 million in letters of credit to satisfy debt service reserve requirements, a $9 million letter of credit provided to the IESO for prudential support and $3 million in letters of credit for various operating purposes. 3 Guarantees consist of $325 million prudential support provided to the IESO by Hydro One Inc. on behalf of its subsidiaries, and guarantees totalling $7 million provided by Hydro One to the Minister of Natural Resources relating to OCN LP (OCN Guarantee). The OPG has provided a $2.5 million guarantee to Hydro One related to the OCN Guarantee. Prudential Support 33. SEGMENTED REPORTING Purchasers of electricity in Ontario, through the IESO, are required to Hydro One has three reportable segments: provide security to mitigate the risk of their default based on their expected activity in the market. The IESO could draw on these guarantees and/or The Transmission Segment, which comprises the transmission of high letters of credit if these purchasers fail to make a payment required by a voltage electricity across the province, interconnecting more than 70 local default notice issued by the IESO. The maximum potential payment is the distribution companies and certain large directly connected industrial face value of any letters of credit plus the amount of the parental guarantees. customers throughout the Ontario electricity grid; The Distribution Segment, which comprises the delivery of electricity to end Retirement Compensation Arrangements customers and certain other municipal electricity distributors; and Bank letters of credit have been issued to provide security for Hydro One Other Segment, which includes certain corporate activities and the Inc.’s liability under the terms of a trust fund established pursuant to the operations of the Company’s telecommunications business. supplementary pension plan for eligible employees of Hydro One Inc. The supplementary pension plan trustee is required to draw upon these letters of The designation of segments has been based on a combination of regulatory credit if Hydro One Inc. is in default of its obligations under the terms of this status and the nature of the services provided. Operating segments of the plan. Such obligations include the requirement to provide the trustee with an Company are determined based on information used by the chief operating annual actuarial report as well as letters of credit sufficient to secure Hydro decision-maker in deciding how to allocate resources and evaluate the One Inc.’s liability under the plan, to pay benefits payable under the plan performance of each of the segments. The Company evaluates segment and to pay the letter of credit fee. The maximum potential payment is the performance based on income before financing charges and income face value of the letters of credit. A bank letter of credit has also been issued taxes from continuing operations (excluding certain allocated corporate to provide security for Hydro One’s retirement compensation arrangement governance costs). trust agreement. 114 Hydro One Limited | Annual Report 2019
Notes to Consolidated Financial Statements Year ended December 31, 2019 (millions of dollars) Transmission Distribution Other Consolidated Revenues 1,652 4,788 40 6,480 Purchased power — 3,111 — 3,111 Operation, maintenance and administration 355 610 216 1,181 Depreciation and amortization 462 409 7 878 Income (loss) before financing charges and income tax expense 835 658 (183) 1,310 Capital investments 1,035 624 8 1,667 Year ended December 31, 2018 (millions of dollars) Transmission Distribution Other Consolidated Revenues 1,686 4,422 42 6,150 Purchased power — 2,899 — 2,899 Operation, maintenance and administration 409 602 94 1,105 Depreciation and amortization 435 395 7 837 Income (loss) before financing charges and income tax expense 842 526 (59) 1,309 Capital investments 985 577 13 1,575 Total Assets by Segment: December 31 (millions of dollars) 2019 2018 Transmission 15,029 13,973 Distribution 10,017 9,325 Other 2,015 2,359 Total assets 27,061 25,657 Total Goodwill by Segment: December 31 (millions of dollars) 2019 2018 Transmission 157 157 Distribution 168 168 Total goodwill 325 325 All revenues, assets and substantially all costs, as the case may be, are earned, held or incurred in Canada. 34. SUBSEQUENT EVENTS trust, a 19.9% equity interest in NRLP for total consideration of $9 million. Following this transaction, Hydro One’s interest in the equity portion of NRLP Dividends was reduced to 55%, with the Six Nations of the Grand River Development On February 11, 2020, preferred share dividends of $5 million and common Corporation and the Mississaugas of the Credit First Nation owning 25% share dividends of $144 million ($0.2415 per common share) were declared. and 20%, respectively, of equity interest in NRLP. NRLP Stock Options On January 31, 2020, the Mississaugas of the Credit First Nation purchased On January 16, 2020, Hydro One issued from treasury 117,980 common an additional 19.9% equity interest in NRLP. On this date, Hydro One shares in accordance with provisions of the LTIP. This issuance resulted from Networks sold to the Mississaugas of the Credit First Nation, through a the exercise of 117,980 stock options for cash proceeds of $2 million. Hydro One Limited | Annual Report 2019 115
Corporate and Shareholder Information Regulatory Stakeholders Hydro One is committed to understanding the interests of Corporate Offices Equity Index Inclusions maintaining and enhancing 483 Bay Street, South Tower Dow Jones Select Utilities (Canada) Index long-term relationships with Toronto, ON FTSE All-World Index Series its regulatory stakeholders. M5G 2P5 MSCI World (Canada) Index 1.416.345.5000 S&P/TSX Composite Index www.HydroOne.com S&P/TSX Utilities Index S&P/TSX Composite Dividend Index S&P/TSX Composite Low Volatility Index Customer Inquiries Provincial Government, Customer Service: S&P/TSX Composite High Dividend Index Ministry of Energy 1.888.664.9376 or Policy, legislation, regulations Debt Securities CustomerCommunications@HydroOne.com For details of the public debt securities of Report an Emergency (24 hours): Hydro One and its subsidiaries, please 1.800.434.1235 refer to the “Debt Information” section under www.HydroOne.com/Investors. Shareholder Services Ontario If you are a registered shareholder and have Online Information inquiries regarding your account, wish to change Hydro One is committed to open and full financial Ontario Energy Board (OEB) your name or address, or have questions about Independent electric utility price disclosure and best practices in corporate and service quality regulation dividends, duplicate mailings, lost stock certificates, governance. We invite you to visit the Investor share transfers or estate settlements, contact our Relations section of www.HydroOne.com/Investors transfer agent and registrar: where you will find additional information about our Computershare Trust Company of Canada business, including events and presentations, news 100 University Avenue, 8th Floor releases, regulatory filings, governance practices, Toronto, ON corporate social responsibility and our continuous disclosure materials, including quarterly financial M5J 2Y1 Independent Electricity System Operator 1.514.982.7555 or 1.800.564.6253 releases, annual information forms and management Wholesale power market rules, service@computershare.com information circulars. You may also subscribe to intermediary, North American our news by email to automatically receive Hydro reliability standards Institutional Investors and Analysts One news releases electronically. Institutional investors, securities analysts and others requiring additional financial information can visit Common Share Dividend Information www.HydroOne.com/Investors or contact us at: 2020 Expected Dividend Dates National Energy Office national 1.416.345.6867 Declaration Date Record Date Payment Date Board de l’énergie Investor.Relations@HydroOne.com or February 11, 2020 March 11, 2020 March 31, 2020 May 7, 2020 June 10, 2020 June 30, 2020 Omar.Javed@HydroOne.com August 10, 2020 September 9, 2020 September 30, 2020 November 5, 2020 December 9, 2020 December 31, 2020 National Energy Board Media Inquiries Federal regulator, international 1.416.345.6868 or 1.877.506.7584 power lines and substations Media.Relations@HydroOne.com Unless indicated otherwise, all common share dividends paid by Hydro One are designated Sustainability as “eligible” dividends for the purposes of the Hydro One is committed to continuing to Income Tax Act (Canada) and any similar grow responsibly and we focus our social and provincial legislation. environmental sustainability efforts where we can make the most meaningful impacts on both. To learn Dividend Reinvestment Plan (DRIP) North American Electric more, visit www.HydroOne.com/OurCommitment Hydro One offers a convenient dividend reinvestment Reliability Corporation or email CSR@HydroOne.com. program for eligible shareholders to purchase Continent-wide bulk power reliability standards, certification, monitoring additional Hydro One shares by reinvesting their Stock Exchange Listing cash dividends without incurring brokerage or Toronto Stock Exchange (TSX): H administration fees. For plan information and (CUSIP #448811208) enrolment materials or to learn more about the For more information, visit: Hydro One DRIP, visit www.HydroOne.com/DRIP www.HydroOne.com/Regulatory or Computershare Trust Company of Canada at www.InvestorCentre.com/HydroOne. Independent Auditors KPMG LLP Cert no. XXX-XXX-000 116 Hydro One Limited | Annual Report 2019