DBRS Upgrades Issuer Rating of Inter Pipeline Fund to BBB (high), Trend Changed to Stable

DBRS has today upgraded the Issuer Rating of Inter Pipeline Fund (IPF) to BBB (high) from BBB and changed the trend to Stable from Positive. The upgrade reflects DBRS’s expectation that the $1.8 billion expansion project at its subsidiary, Inter Pipeline (Corridor) Inc. (Corridor, rated “A”, concurrent upgrade and trend change from Positive to Stable, see separate press release) will be completed on schedule and on budget in late 2010 and that certain refinancing risks (detailed below) will be addressed in a satisfactory and timely manner.

Upon expansion completion, but in any event no later than January 1, 2011, construction costs will be added to the rate base and Corridor will begin to receive incremental revenue. Corridor’s rate base is expected to more than triple relative to the existing level, resulting in a similar increase in earnings in the first full year following expansion completion, adjusted for the impact of changes in allowed return on equity (ROE). IPF has estimated that it expects incremental EBITDA of $145 million per year from Corridor upon expansion commencement (equivalent to 44% of IPF’s 2009 consolidated EBITDA). Consequently, IPF’s business risk profile will improve as low-risk Corridor earnings become a larger part of IPF’s operations, offsetting the negative impact of the Corridor expansion on IPF’s credit metrics. Corridor is supported by a long-term cost-of-service firm service agreement with quality shippers. Also underpinning the upgrade are the following factors:

(1) IPF has positioned its balance sheet and liquidity position to accommodate the required $450 million equity injection into Corridor, expected in late 2010. Upon expansion completion, IPF will be required to make the equity contribution in order to repay advances under the two “recourse to IPF” tranches of Corridor’s revolving credit facility.

While IPF’s consolidated credit ratios have been weakened by the ongoing Corridor expansion, the Corridor debt (other than the equity contribution portion) is non-recourse to IPF, mitigating the impact on IPF’s financial profile. Consequently, DBRS’s focus is on IPF’s non-consolidated credit ratios. IPF has issued equity over time (including net issuance of $144 million in December 2007 and $166 million in June 2009, and a regular and a premium dividend reinvestment plan (DRIP) that raised an additional net $100 million through March 31, 2010) in order to partly offset the negative impact of the Corridor expansion on IPF’s credit metrics. Additionally, IPF has maintained a conservative payout ratio (72% for the last 12 months (LTM) ending March 31, 2010, based on cash available for distribution (DBRS defined), although its target is 90%). These factors have allowed IPF to maintain sufficient availability under its credit facility to fund the equity injection upon expansion commencement.

(2) While IPF and Corridor face material refinancing risk over the near to medium term, DBRS considers it to be manageable and expects it to be addressed well in advance of the maturity dates.

(a) IPF faces refinancing risk following completion of the Corridor expansion in late 2010 and on its own credit facility maturity in September 2012. IPF had $578 million of availability on its credit facility as at March 31, 2010. However, on a pro forma basis, IPF’s obligation to contribute $450 million of equity into Corridor upon expansion commissioning would reduce IPF’s effective availability to $128 million, a relatively low level. DBRS expects IPF to access the capital markets within a reasonable time frame following the equity injection in order to refinance some of its bank debt, thereby restoring its liquidity position to a more favourable level.

(b) In August 2012, the two “non-recourse to IPF” tranches of Corridor’s revolving credit facility (combined total availability of $1.654 billion) come due. DBRS expects that Corridor will re-finance a majority portion of these amounts with long-term debt well in advance of the maturity date, with the balance to be funded on an ongoing basis by a scaled-back commercial paper (CP) program that is 100% backstopped by committed credit facilities.

(c) Successful completion of the Corridor expansion would largely alleviate the risk with respect to IPF’s credit facility maturity in September 2012 as the latter will benefit from increased earnings from Corridor, as well as from other recently announced growth projects (including the Polaris Pipeline project related to Imperial Oil Limited’s Kearl oil sands project Phase 1, expected to be completed in late 2012).

(3) On a non-consolidated basis, following the Corridor expansion and the $450 million equity injection (funded with bank debt) in late 2010, DBRS expects a debt-to-capital ratio in the mid- to high 40% range, cash flow-to-debt in the mid-20% range and EBITDA interest coverage in the mid-4.0 to mid-5.0 times range (34.3%, 41.2% and 10.22 times at March 31, 2010) over the medium term, which would be consistent with the upgraded rating based on the improved business risk profile. While IPF has indicated that it could increase its non-consolidated balance sheet leverage to the 50% level with one or more acquisitions in the future, DBRS would evaluate the potential rating impact of any such transaction at that time.

IPF faces other challenges, which are considered manageable:

(1) The NGL Extraction segment faces competition from upstream field services and is exposed to commodity price/fractionation spread risk (commodity-based contracts accounted for approximately 28% of total 2009 EBITDA). IPF has the ability to reduce its exposure to the fractionation spread risk through hedging activity and re-injection of propane-plus barrels back into the natural gas stream when extraction is uneconomic. IPF’s medium-term earnings outlook remains strong, subject to volatility at the Cochrane plant within the NGL Extraction segment, which should become a less material factor following Corridor expansion commissioning. As of March 31, 2010, approximately 51% of forecast propane-plus volumes at the Cochrane NGL extraction plant had been hedged for Q2 2010 to Q4 2010 at a price of $0.74 per U.S. gallon and 31% for 2011 at $0.75 per U.S. gallon. Given stagnant natural gas production in Alberta, throughput risk under the fee-based contracts is an issue. This could be partially mitigated by the advent of shale gas in the medium term and northern gas in the long term.

(2) IPF’s conventional oil pipelines service mature crude oil fields with reserves that are in long-term production decline. IPF has the ability to continually raise tolls to maintain revenue due to the lack of meaningful competition. Furthermore, the Bow River expansion project (completed in January 2010), which allows customers to ship segregated crude oil streams south from Hardisty to refining customers in Montana, should help to stem the declining volume trend.

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 the DBRS website under Methodologies.

This is a Corporate (Energy) rating.