DBRS Confirms Trans Quebec & Maritimes Pipeline at A (low)

DBRS has today confirmed the Senior Unsecured Bonds rating of Trans Québec & Maritimes Pipeline Inc. (TQM or the Company) at A (low) with a Stable trend, based on the following factors:

(1) TQM continues to benefit from its stable, regulated operation on a cost-of-service basis with no throughput risk. Continued stability is expected with most of its revenues derived from a long-term commitment until 2018 from TransCanada PipeLines Limited (TCPL), one of its two 50% partners. The other 50% owner, Gaz Métro Limited Partnership (Gaz Métro), is the sole distributor of natural gas shipped within most of Québec. TCPL and Gaz Métro inc. (Gaz Métro’s general partner) are rated “A” by DBRS. TQM is part of the integrated TCPL Canadian Mainline pipeline system and, as such, acts as TCPL’s extension to reach both the Québec market and certain New England markets.

(2) The Company has an improved financial profile as a result of changes made to its tolling methodology. Under the previous methodology that had been in place since 1995, TQM’s cost-of-service tolling methodology was based on a deemed equity component of 30% and allowed returns on equity (ROE) (8.46% in 2007 and 8.71% in 2008) that were based on forecasted long-term Government of Canada bond yields. In March 2009, the National Energy Board (NEB) deviated from its previous methodology by setting a 6.4% after-tax weighted-average cost of capital (ATWACC) return (with no explicit deemed capital structure) for each of 2007 and 2008 under TQM’s cost of capital application (the Decision). This compared to the 11% allowed ROE on 40% equity (equivalent to a 6.9% ATWACC return) requested by TQM and the 5.5% ATWACC return that would have resulted if the NEB had retained its previous methodology.

TQM agreed to assume the risk that the imbedded cost of debt could exceed the market-based cost of debt as the difference was relatively small at that time. The ATWACC returns for 2007 and 2008 reflected the market cost of debt in those years.

While the Decision applied only to TQM’s 2007 and 2008 tolls, the precedent set by the results formed the basis for determination of TQM’s final 2009 and interim 2010 tolls. The Company is currently negotiating with its shippers with respect to final tolls for 2010 and beyond. DBRS believes that the Decision strengthened TQM’s financial profile and its position within its current rating category and recognized the potential for the Company’s business risk to rise over time (see below). The 6.4% ATWACC return approved by the NEB is comparable to allowed ROEs of 9.85% in 2007 and 9.75% in 2008 on a 40% deemed equity component, which represents significant improvement from the previous parameters. DBRS notes that TQM has moved its capital structure toward the 60% debt/40% equity ratio (38.5% equity at March 31, 2010) since the Decision was published, largely through net debt reduction and temporary suspension of dividends to partners. As expected, the impact on TQM’s key credit metrics has been positive relative to the results under the previous methodology (e.g., cash flow-to-debt and EBIT interest coverage improved to 16.2% and 3.11 times, respectively, in Q1 2010 compared with 12.5% and 2.37 times, respectively, in 2008).

(3) While the Company has no direct competition within Québec, TQM, as part of the integrated TCPL Canadian Mainline, faces competition from two major pipeline systems: (a) The Alliance and Vector pipelines for supply of western Canadian gas going into the U.S. Midwest and eastern Canada. Significant declines in natural gas production volumes in western Canada have driven up per unit tolls in 2010, raising tolls to the markets served along the TQM pipeline as well; (b) Higher volumes on Maritimes & Northeast Pipeline (M&NP), which extends from the east coast offshore Canada to Atlantic Canada and the U.S. Northeast, has resulted in significantly lower volumes from TQM into Portland Natural Gas Transmission System (PNGTS), since completion of M&NP’s Phase IV expansion in January 2009.

Another issue for TQM is the fact that natural gas is a secondary fuel source in its primary market compared with alternative fuels, particularly lower-cost residential hydro-electricity in Québec. Fuel oil is also extensively used in the province by industrial customers with fuel-switching capabilities. As a result of weak natural gas demand in Québec due to a decline in economic activity and the lower volumes from TQM into PNGTS noted above, TQM is forecasting a significant decline in throughput in 2010 compared to 2009 levels, although this is expected to stabilize going forward. Finally, TQM faces long-term by-pass risk if significant shale gas development in Québec allows producers to flow natural gas directly into Gaz Métro’s distribution network. While the impact of these factors on TQM’s credit profile is somewhat mitigated by the regulated cost-of-service methodology and its long-term commitment from TCPL until 2018, the Company’s business risk profile could rise over time if the declining throughput trend were to continue over the medium to long term.

(4) Bond maturities in September 2010 (Series I – $100 million and J – $75 million) are to be refinanced with the issuance of $100 million of Series L Bonds and up to $75 million expected to be drawn under the revolving term loan agreement. Following this refinancing, TQM’s next maturity will be with respect to the amounts drawn under the revolving term loan agreement maturing in September 2011. When viewed together with the cost-of-service regulatory framework and the aforementioned long-term contract with TCPL, DBRS views the resulting refinancing risk in 2011 as modest.

Finally, DBRS notes that all of TQM’s outstanding long-term debt is scheduled to mature prior to expiry of the long-term commitment from TCPL in 2018. However, as that date approaches, market conditions could challenge the current tolling method if TQM volumes decline substantially in the interim period.

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

The applicable methodology is Rating North American Energy Utilities (Electric, Natural Gas, and Pipelines), which can be found on our website under Methodologies.

This is a Corporate rating.