DBRS Confirms DCP Midstream, LLC at BBB and R-2 (middle), Stable Trends

DBRS has today confirmed the Unsecured Notes and Commercial Paper ratings of DCP Midstream, LLC (DCP or the Company) at BBB and R-2 (middle), respectively, both with Stable trends. The confirmations reflect the stand-alone nature and credit quality of DCP, which is owned 50% each by Spectra Energy Corp (Spectra, owner of Spectra Energy Capital, LLC, which is rated BBB (high) by DBRS) and ConocoPhillips (COP, rated “A” by DBRS).

Despite considerable improvement in DCP’s cash flow-to-debt and interest coverage ratios in recent years, the Company’s ratings are constrained by the significant volatility of its earnings and cash flow (largely due to energy price exposure), as well as DBRS’s expectation that the Company may manage its consolidated balance sheet leverage to higher levels than previously expected. DCP has forecast a consolidated total debt-to-capital ratio of 55% at year-end 2008, up from the low- to mid-40% range of previous years. Despite the higher balance sheet leverage beginning in Q3 2007, DCP’s other credit metrics remain strong and are reasonable for the current ratings as the Company continues to benefit from the strong crude oil and natural gas liquids (NGL) pricing environment. However, DCP remains subject to volatility given its significant exposure to energy prices. A $1 per barrel and $0.10 per million British thermal unit (MMBtu) rise (fall) in crude oil and natural gas prices results in a $24 million and $4 million rise (fall) in EBIT, respectively.

On August 29, 2007, DCP acquired Momentum Energy Group, Inc. (MEG) for $635 million, thereby expanding the Company’s operations into the Fort Worth, Piceance and Powder River producing basins. Concurrently, DCP sold certain MEG subsidiaries to its minority-owned affiliate, DCP Midstream Partners, LP (DCP MLP, a master limited partnership formed by DCP in December 2005) for $165 million (financed by DCP MLP with $65 million of cash and debt, and $100 million of equity). Consequently, DCP’s balance sheet leverage rose significantly.

At year-end 2007, DCP held a 35.4% interest in DCP MLP through 1.5% general partner (GP) and 33.9% limited partner (LP) interests. (DCP’s interest in DCP MLP was subsequently reduced to 30.1% as a result of a common unit offering completed by the latter during March 2008.) Despite its minority ownership position, DCP is required to consolidate its interest in DCP MLP due to its GP interest, although the impact on consolidated EBIT and cash flow are relatively small (7% and 6%, respectively, in 2007). DCP receives ongoing cash distributions from DCP MLP; however, these amounts are not currently material to the Company. DBRS estimates that the total cash distribution to DCP was approximately $22 million during 2007, equivalent to only 1% of non-consolidated cash flow. Despite the foregoing, DCP MLP’s $630 million of debt, although non-recourse to DCP, represented 21.5% of the latter’s $2.93 billion of consolidated total debt at year-end 2007. Consequently, DCP’s consolidated credit metrics are distorted by the accounting methodology, and DBRS believes that non-consolidated credit metrics (i.e., treating DCP MLP on an equity accounting basis) are a more meaningful basis upon which to evaluate the Company’s financial profile.

On a non-consolidated basis, DBRS estimates that DCP’s net debt-to-capital ratio rose to 53% in 2007 from 38% in 2006 (to 57% from 41% on a consolidated basis). Despite the higher balance sheet leverage, the Company’s cash flow-to-debt and EBIT interest coverage ratios (60.5% and 8.4 times, respectively, on a non-consolidated basis in 2007) remain strong and are reasonable for the current credit ratings, although subject to significant commodity price exposure.

For 2008 (on a consolidated basis), DCP is projecting net income of $1.3 billion ($1.1 billion in 2007) and cash flow of $1.7 billion ($1.5 billion in 2007), based mainly on (a) continued strong energy pricing, with crude oil and natural gas prices forecast to average $83 per barrel and $8 per MMBtu, respectively, and a 60% NGL-to-crude oil price relationship, (b) a full year of earnings from the assets acquired in the MEG transaction and (c) additional acquisitions expected during 2008.

DCP has forecast $1.2 billion of distributions to partners and $460 million of capex (excluding DCP MLP), which would consume cash flow before acquisitions and working capital needs and before DCP MLP capex. DCP has also forecast a total debt-to-capital ratio of 55% at year-end 2008 and an EBITDA interest coverage ratio of 10.4 times in 2008, which would compare favourably with 2007 levels (58% and 9.5 times, respectively, based on DBRS calculations).

Based on these assumptions, the Company would have limited scope to add significant debt to its balance sheet during 2008. Continued volatility in cash flow-to-debt and interest coverage ratios is expected in the absence of a shift to more fee-based contracts (which account for only 8% of forecast gross margin in 2008, similar to 2007 levels) or implementation of a significant hedging program, which are not expected to occur.

However, DCP’s other credit metrics are expected to remain within the parameters of the current ratings over the medium term in the absence of substantial debt-financed acquisition activity. DBRS believes that the level of distributions to the partners would be adjusted over time to reflect the level of free cash flow generated by the business. DBRS notes that Spectra’s $0.6 billion share of DCP’s forecast distributions to partners is an important component to support the former’s consolidated $2.4 billion capital and investment program in 2008.

Note:
All figures are in U.S. dollars unless otherwise noted.