DBRS Confirms TransCanada Keystone at R-1 (low), Stable Trend

DBRS has today confirmed the R-1 (low) rating of the Canadian-based Commercial Paper (CP) of TransCanada Keystone Pipeline, LP (Keystone USA or the Partnership) with a Stable trend based on the strength of the guarantee of TransCanada PipeLines Limited (TCPL rated “A” and R-1 (low) with Stable trends, see separate report), its 100% parent. Furthermore, TCPL’s wholly-owned U.S. subsidiary, TransCanada PipeLine USA Ltd., is also a guarantor. The CP program issues U.S. or Canadian dollar paper up to the equivalent of US$1 billion and is supported by a US$1 billion 364-day credit facility with a one-year term-out option. The proceeds from Canadian CP are swapped into U.S. dollars and a forward foreign currency contract entered into to settle on the maturity date of the CP to minimize foreign exchange risk. Keystone USA was initially financed with a capital structure consisting of approximately 50% to 60% debt (compared with TCPL’s debt-to-capital of 56% as of September 30, 2009) prior to its becoming a wholly-owned subsidiary on August 14, 2009. DBRS expects the final capital structure to be in line with TCPL’s financial profile and within the parameters of the current rating based on long-term contractual arrangements.

The Partnership represents the U.S. portion of the pipeline, which, together with the Canadian portion (Keystone Canada), forms an integral part of the base Keystone Pipeline System (collectively, Base Keystone). 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 (COP - 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) including assumed debt, plus $1.7 billion of capex to 2012. The transaction closed on August 14, 2009. In addition to the TCPL guarantee, the rating also reflects the following Keystone USA strengths:

(1) Upon full completion in late 2010, Base Keystone will be supported by long-term take-or-pay shipper contracts with an average term of 18 years, mostly with strong investment-grade counterparties (about 80% based on DBRS ratings). These commitments will cover about 90% (or 530,000 barrels per day (b/d)) of the pipeline’s design capacity of 590,000 b/d. A capital cost sharing mechanism on a 50/50 basis with shippers should mitigate in part the potential cost overruns often associated with mega-projects. In addition, part of Base Keystone is composed of converted portions of TCPL’s existing gas pipelines, reducing construction risk to some extent. The project is largely on time and on budget to date.

(2) The pipeline’s tolling structure includes: (a) a fixed toll that recovers fixed costs (including fixed financing costs), effectively eliminating almost all of the throughput risk, since 90% of Base Keystone capacity has been committed, and (b) a variable toll that covers operating, maintenance and administration expenses on a cost-of-service basis, effectively eliminating operating cost risk. The capital portion of the project is recovered through pre-established fixed tolls adjusted for capital variances shared on a 50/50 basis with shippers due to cost overruns as mentioned above.

(3) Competitive tolling arrangements as expected on completion should ensure the viability of Keystone USA beyond the contract terms. DBRS estimates that a significant portion of the construction costs would have been recovered through depreciation charges during the average 18-year contract term, increasing the competitiveness of future tolls.

(4) TCPL, the operator of Keystone USA, is among the largest pipeline operators in North America, with extensive experience in building and operating pipelines.

(5) Bitumen reserves are abundant in the oil sands sector, with new projects coming on stream during 2008 and 2009 and a couple of major projects commencing production, after Base Keystone is in full service in 2010.

The Partnership faces several challenges, which are considered manageable. (1) The previous concerns of potential project cost overruns and delays which could affect the economics and competitiveness of Keystone USA are now largely mitigated as the project is over 90% complete with the first phase of Base Keystone being commissioned for in-service expected in Q1 2010 (potentially only a couple of months delay from its original schedule). Any minor cost overruns will likely be covered by contingencies and included in the fixed portion of the tolls. A substantial portion of project costs (approximately 60%) has been committed through materials and construction contracts awarded. (2) Should a shipper default prior to or after pipeline completion, Keystone USA would have to bear its portion of the fixed capital cost until a substitute shipper is found, although Keystone USA retains the right to sue for damages for any shipper defaults. (3) For Base Keystone, approximately 20% of the contracted volumes are with non-investment-grade shippers, which presents an element of uncertainty, although financial assurances in the form of parental guarantees or letters of credit are required and have been obtained for certain shippers. (4) The aftermaths of the global financial crisis, the economic slowdown and environmental concerns could lead to more delays in oil sands developments, limiting the supply source. While some major projects are still being deferred, certain projects of lesser scale are proceeding. The continued postponement of two major upgrader projects could enhance the value of heavy crude pipelines, such as Base Keystone, which ships heavy crude oil to the U.S. Midwest markets and ultimately to the Gulf Coast through expansions and extensions (Keystone XL), where refineries are better equipped to handle heavier crude. The improving crude oil prices from Q2 2009 to the mid-to-high $70s per barrel level should suffice to support most oil sands projects, going forward. (5) Refinancing risk exists, following pipeline completion, although this is partly mitigated by the value of Keystone USA’s pipeline capacity, underpinned by the strong take-or-pay long-term transportation contracts as well as the substantial equity component (currently estimated at more than 40%) in the project. With a 100% ownership interest, TCPL will likely refinance the CP outstandings using its balance sheet capacity.

Base Keystone (a 3,456-kilometre (2,148-mile) 30- and 36-inch pipeline), when completed, will extend from Hardisty, Alberta, to U.S. Midwest markets at Wood River and Patoka, Illinois, and Cushing, Oklahoma. Phased start-up is expected in Q1 2010, with an initial nominal capacity of 435,000 b/d, which will be expanded to 590,000 b/d in Q1 2011. The construction of the pipeline began in May 2008. Keystone XL (3,200-kilometre (1,900-mile) 36-inch pipeline), the proposed extension and expansion project, would increase the capacity to 1.09 million b/d from Hardisty to Port Arthur, Texas, and other U.S. Midwest markets, with in-service expected in Q4 2012 or early 2013. The pipeline system is further expandable to 1.5 million b/d at relatively low cost, enhancing future growth opportunities.

The capital cost for Base Keystone is estimated at approximately $6.1 billion (equivalent) and at approximately $13.4 billion, including Keystone XL (collectively Keystone), which are close to original estimates of approximately US$12 billion. The capital cost sharing mechanism for any project cost overruns between Keystone and the shippers is 50/50 for Base Keystone and 75/25 for Keystone XL.

Note:
The Commercial Paper is guaranteed by TransCanada PipeLines Limited and TransCanada PipeLine USA Ltd.

All figures are in Canadian dollars unless otherwise noted.

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

This is a Corporate (Energy) rating.