DBRS Confirms Fort Chicago Energy’s BBB (high) and STA-2 (low) Ratings

DBRS has today confirmed the Senior Unsecured Notes of Fort Chicago Energy Partners L.P. (Fort Chicago or the Partnership) of BBB (high) with a Stable trend and concurrently confirmed its stability rating at STA-2 (low). The Partnership continues to benefit from relatively stable operations and financial profile, largely underpinned by its 50% ownership in both the U.S. and Canadian portions of the Alliance Pipeline (collectively, Alliance, each rated A (low) by DBRS) supported by take-or-pay contracts to 2015. While uncertainties exist during the contract renewal period scheduled in December 2010, the pipeline’s economic value extends beyond the contract term due to its competitive tolls to ship rich natural gas (gas plus liquids in one pipeline) to Chicago. The Partnership’s Natural Gas Liquids (NGLs) and Power segments also provide diversification. All segments are characterized by long-life assets mostly supported by longer-term contracts.

The Pipelines segment (Pipelines), principally Alliance, remains the predominant business, accounting for the bulk of distributable cash flow (DCF) since 2004 (average 68%). Power (3%) is expected to drive future growth through acquisitions and greenfield projects, such as the assets acquired from Countryside Power Income Fund (Countryside) in 2007 and the recent Glen Park purchase (approximately $80 million cost) together with the East Windsor co-generation project (East Windsor) commenced in November 2009. The NGLs business (29%) at Aux Sable generates earnings and cash flow volatility due to its exposure to commodity prices. However, this is mitigated by its 20-year contract with a subsidiary of BP plc (BP), which ensures a base level of earnings and the flow-through of all associated operating, maintenance and most capital costs. The favourable market conditions with improved fractionation (frac) spreads resulted in stronger operating results in the first half of 2010 (H1 2010), similar to 2007 and 2008.

Despite the Partnership’s holding company status, the structural subordination issue is largely mitigated by the stable base level of cash distributions received, which is more than sufficient to service its unconsolidated debt of about $420 million plus convertible/exchangeable debentures of about $50 million at December 31, 2009. All subsidiary/affiliate debt is non-recourse and mostly amortizing, with each entity considered self-financing. Alliance, the largest cash contributor, has a regulated capital structure, ensuring stable cash distributions to the Partnership, supported by contractual arrangements. The Power segment is mostly supported by medium- to long-term contracts, which provide capacity payments for the California power plants and cost recovery for the Ontario facilities. East Windsor has a 20-year power purchase agreement (PPA) with Ontario Power Authority (rated A (high)), which is capacity-based. Aux Sable provides certain base earnings through the contractual fixed fee payments. It also carries minimal debt.

The Partnership’s non-consolidated financial metrics are a more meaningful measure for its financial performance, given the proportional consolidation of Alliance, Aux Sable and East Windsor, despite the stand-alone nature of these businesses On an unconsolidated basis, debt-to-capital of 42% (37% in 2008), while acceptable, is on the high side, negatively affected by the recent Glen Park acquisition funded by debt and substantial asset impairment charges (non-cash) at Power in 2009. However, cash flow-to-debt at 0.31 times for the last 12 months to June 30, 2010, albeit declined from periods prior to 2009, is still adequate relative to its peers. DBRS expects the Partnership to reduce its balance sheet leverage over time helped by its Dividend Reinvestment Plan Program (DRIP) instituted in 2009 and the potential conversion of the convertible debentures (convertibles). The Partnership’s $300 million credit facilities come due for renewal in 2011 together with $48 million senior notes maturity, which DBRS expects should be extended, or refinanced, given the Partnership’s strong credit profile. It succeeded in issuing $200 million senior unsecured notes in July 2009 to term out its Countryside acquisition loan and refinanced the Glen Park loans with convertibles (treated 100% debt by DBRS) in July 2010.

The Partnership is limited by its significant payout based on cash available for distributions (after capex) in the 78% to 82% range for 2006 to 2009, although this is fairly typical of the pipeline income fund industry, which requires external funding for expansions and acquisitions. The lower ratio (43%, or adjusted 75% including distributions through DRIP) in H1 2010 was driven by the high uptake in DRIP and favourable frac spreads. Should the latter weaken (not expected near term) with contribution at the low end of the Partnership’s guidance range, a potential full payout could occur. The Partnership intends to continue with its $1.00 distribution per unit by way of dividends, post conversion to a corporation anticipated by year-end 2010 in response to the federal government’s substantially enacted legislation to impose taxation on income trusts starting in 2011. DBRS expects to discontinue the Stability Rating at that time. Other limiting factors include forex risks as about half of Fort Chicago’s operations are in the U.S. Aux Sable generally provides a partial hedge against U.S. dollar exposure as a stronger Canadian dollar has historically been correlated with a higher crude oil price, which strongly influences NGL prices and, ultimately, ethane frac margins.

DBRS expects the Partnership to maintain a fairly stable financial profile, given its stable operations and low capex requirements in the next couple of years as most major projects are complete. It will likely further capitalize on the strength of Alliance and Aux Sable to attract new sources of liquids-rich gas as well as to grow its power business. Longer-term growth prospects include potential bolt-on acquisitions and projects under review, including Jordan Cove in Oregon (FERC regulatory approvals received). Post conversion, the Partnership will continue to focus on long-term growth and on returning a significant portion of its income to shareholders.

Notes:
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.