DBRS Confirms TransCanada PipeLines at “A” and R-1 (low)

DBRS has today confirmed the ratings of TransCanada PipeLines Limited (TCPL or the Company) as indicated above. The rating for its 100% parent, TransCanada Corporation’s (TCC) recent issue of Preferred Shares – cumulative has also been confirmed based on the strength of TCPL. TCC was established as the parent company of TCPL through a plan of arrangement effective May 2003. Currently, it has no other debt besides the preferreds, and holds no material assets other than the common shares of TCPL and receivables from certain of its subsidiaries. The rating confirmations reflect the Company’s continued stable earnings and cash flow from its regulated pipelines mostly on a cost-of-service basis and contracted power volumes. Furthermore, substantial growth prospects exist, underpinned by long-term contracts on project completion. Financing challenges for its mega-projects to 2012 are mitigated in part by the strengthened capital base through issuance of substantial equity and other debt instruments with quasi-equity treatment by DBRS. Completed or phased-in projects also augment incremental cash flow for future developments. However, incremental debt is expected at least for the next two years, pressuring the balance sheet and particularly the interest and cash flow coverage ratios.

Cash flow-to-debt has weakened to 0.14 times for the last 12 months to September 30, 2009 (LTM) and will likely not improve until 2011 as substantial capex spent on the three largest projects, base Keystone crude oil pipeline (Base Keystone), the restart of Units 1 & 2 of Bruce Power A (Bruce Restart) and Alberta North Corridor, has yet to generate cash flow. Fixed charge coverage also declined to 2.11 times, below the 2004 level. However, debt-to-capital should remain satisfactory and is expected at below the 60% level, going forward. DBRS expects TCPL to manage its credit metrics consistent with the current credit ratings. In addition to cash balances of $2.4 billion at September 30, 2009, the Company maintains adequate liquidity through commercial paper programs of its own and that of TransCanada Keystone Pipeline, LP (Keystone - rated by DBRS at R-1 (low)), totalling $3 billion, fully backed by credit lines to 2012 and 2010, respectively. The U.S. operation also has a US$1.0 billion credit facility to 2013. DBRS expects the Company to arrange permanent financing for Keystone before the base project completion in 2011. Alternative funding sources include issuance of preferreds, convertibles or hybrids, or further asset monetization in an effort to balance its rising debt load as seen in the past. Any material deterioration from current credit metrics, whether from cost overruns, project delays or excessive throughput exposure (although not expected), could have rating implications.

Despite cash flow pressure for the next one to two years as mentioned above, the staged start-up of TCPL’s now 100%-owned Keystone Phase 1 (Base Keystone; over 90% complete) from Q1 2010 should greatly enhance credit metrics, with the full impact felt in 2013 when Keystone XL (extending to the Gulf Coast) comes onstream. Keystone’s expected EBITDA of about $1.2 billion based on the existing contracted volumes approximates 30% of the Company’s 2008 EBITDA, or 60% of the Canadian pipelines’ annualized EBITDA based on 9M 2009 results. The inroad into crude pipelines, such as Keystone, adds diversification to TCPL’s gas focused pipeline operations, alleviating concerns about the Canadian pipelines’ declining rate base and the steadily lower gas supply in western Canada, leading to much higher tolls in the next couple of years. The increased stake in Keystone also affirms TCPL’s continued focus on stable regulated operations, which should enhance its business risk profile, providing more predictable earnings and cash flow. This also diminishes the merchant power component of the operation, brought on by the KeySpan-Ravenswood, LLC (Ravenswood) acquisition (at a cost of approximately $2.9 billion), which bears a higher risk profile, albeit offset in part by rising capacity payments expected over time. Keystone is mostly supported by long-term contracts (covering about 83% of the pipeline’s design capacity on a cost-of-service basis for the variable portion of the tolling arrangements). Capital cost-sharing provisions with shippers should reduce risks associated with cost overruns.

On June 16, 2009, DBRS confirmed TCPL’s ratings, following its concurrent announcements of its underwritten equity issuance and its agreement to acquire from its original 50% joint venture partner and a major shipper, ConocoPhillips (rated “A” with a Stable trend), the remaining 20% equity interest in the Keystone pipeline partnerships it did not already own, for US$750 million upfront (effectively at book value) plus $1.7 billion of capex to 2012. This purchase, together with its move in Q3 2008 to raise its stake in Keystone to 79.9% from 50%, added about $5.3 billion to capital commitments, largely accounting for the escalated capex to $22 billion to 2012/2013 (about $9.5 billion spent to date). Nevertheless, the Company has strengthened its balance sheet, with debt-to-capital having improved to 56% at September 30, 2009 (62% in 2006) through four series of equity issuance, totalling about $6 billion in the past two-and-a-half years. Earlier equity proceeds also helped to fund two major acquisitions, American Natural Resources Company and ANR Storage Company (collectively, ANR) and Great Lakes Gas Transmission Limited Partnership in early 2007, and Ravenswood in August 2008. The enlarged equity base should better position TCPL for continued high capital spending in 2010 and 2011 projected at $6 billion and $5.2 billion, respectively.

DBRS anticipates that TCPL will continue to re-balance its pipelines and energy portfolios while maintaining its conservative credit metrics. Over the longer term, DBRS expects that about two-thirds of EBITDA (about 73% at September 30, 2009, and 76% in 2006) will emanate from the more stable regulated pipelines, with the remaining one-third from energy, principally power and storage. The Company will likely pursue higher-return power developments, which are unregulated, such as, Bruce Restart and various other power projects, principally in the growing Ontario market, all supported by long-term contracts with mostly creditworthy counterparties. Other projects, such as the Coolidge power project in Phoenix, Arizona (Coolidge), will be similarly supported by contractual arrangements. Coolidge is TCPL’s first foray in power outside its western Canada and eastern North America regions. Returns in terms of net earnings (before extraordinary items) to net asset value are estimated at approximately 7% for energy and 4% for pipelines in 2008 (including projects under development).

As a drawback to the Company’s power developments, Bruce Restart (49% interest) is plagued by cost overruns (currently at 24% to $1.7 billion (net to TCPL) over the original estimate in 2005) and potential six- to 12-month project delays to 2011. The current review on cost and progress could result in further cost pressures (a total of 38% to $1.9 billion net), although this is not expected to have a material impact on the Company’s financial metrics. A more favourable floor price contract has recently been re-negotiated for Bruce B, mitigating lower power prices in a recessionary environment, with Bruce A supported by long-term contracts with Ontario Power Authority (rated A (high), Stable trend), including certain capital cost-sharing mechanisms during construction. The project is about 75% complete.

Longer-term prospects include northern gas developments at Mackenzie Delta and Alaska, which are expected by late in the next decade. Both systems will interconnect with the Alberta system, supplying much of the natural gas needed for the growing oil sands production and enhancing the system’s current $2.0 billion expansion program into the Fort McMurray oil sands region. TCPL has recently signed an agreement with Exxon Mobil Corporation to work together to advance the Alaska project. An open season is planned in 2010. International ventures should be supported by long-term contracts, as seen in the Mexican pipeline project commenced in late 2006, so as to minimize the attendant political and other risks.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Utilities (Electric, Pipelines & Gas Distribution), which can be found on the DBRS website under Methodologies.

This is a Corporate (Energy) rating.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

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