DBRS Confirms Spectra Energy Capital at BBB (high) and R-2 (high)

DBRS has today confirmed the Unsecured Debentures and Commercial Paper ratings of Spectra Energy Capital, LLC (Spectra Capital or the Company) at BBB (high) and R-2 (high), respectively, both with Stable trends. The current ratings incorporate DBRS’s expectation that Spectra Capital’s significant capex program (projected to be $1.6 billion in 2010, including $500 million spent through June 30, 2010, and at least $1 billion of growth capex annually through 2014) and its acquisition of the Bobcat Gas Storage assets and development project for $540 million in late August 2010 will result in negative free cash flows and pressure its credit ratios as much of the financing will come from increased long-term debt. The Company expects $900 million of expansion projects to be placed in service, resulting in incremental EBIT of $80 million during 2010. The Company projects a debt-to-total capital ratio of 58% at year-end 2010 and a cash flow-to-total debt ratio of 16% in 2010, with the expectation that these credit metrics will improve through 2012 as the benefits of the expansion capex are derived. Based on current expectations, DBRS believes that the Company’s forecast 2010 credit metrics may be achieved, although subject to certain key risks as noted below.

While Spectra Capital’s capex program is substantial, the spending is allocated to low-risk, mostly regulated gas transmission, distribution and storage projects, which will continue to support its business risk profile.

However, after growing between 2006 and 2008, the Company’s earnings and cash flow declined significantly, beginning in Q4 2008, due to much lower contributions from its DCP Midstream, LLC (DCP, 50%-owned) and Empress NGL Marketing (Empress) operations, both of which own natural gas gathering and processing operations and provide a more volatile source of earnings as a result of commodity price and fractionation spread risk. Despite lower capex, the Company had deteriorating credit metrics and a very high dividend payout ratio (84%) in 2009 compared with 2008, although the trend reversed in the six months ending June 30, 2010 (6M 2010), compared with 6M 2009. Its credit metrics have been relatively volatile, a trend that is likely to continue over the medium term.

In the absence of significant dividend income from its equity affiliates, especially DCP, Spectra Capital’s credit metrics are relatively weak for the current ratings. Based on current expectations, DBRS believes that, in the absence of a substantial recovery in cash flow from DCP and Empress, the Company would require an equity issuance to maintain its debt-to-capital ratio below the 60% level and its other credit metrics within acceptable levels for the current ratings. However, the potential for a weakened financial profile is partly mitigated by the improved business risk profile expected over time.

In addition, Spectra Capital’s Distribution segment earnings are exposed to volume risk, which is sensitive to changes in weather, economic conditions and gas prices. The Company’s Western Canada Transmission & Processing (WCT&P) segment also faces some volume risk at B.C. Field Services and Spectra Energy Facilities L.P. (Midstream) and commodity price and/or fractionation spread risk at Empress. EBIT from both segments benefits from a lower CAD/USD exchange rate.

The above-noted challenges are partly mitigated by the following factors:

(1) Spectra Capital has a good business risk profile, generating about 80% of its segment EBIT from low-risk, mostly regulated operations over the past 18 months, compared with approximately two-thirds of segment EBIT in 2005 to 2008. This factor partly offsets relatively high balance sheet leverage (debt-to-total capital of 55% at June 30, 2010), partly due to the 35% and 40% weighting of the Canadian regulated natural gas transmission and distribution operations with respect to EBIT and long-term debt, respectively (which have higher debt components than U.S. regulated operations). The balance of Spectra Capital’s EBIT generation (approximately 20% for the 12 months ending June 30, 2010) comes from its interests in DCP and Empress.

(2) The Company’s direct debt ($3.8 billion as at June 30, 2010) accounted for 39% of its consolidated total debt, compared with $3.5 billion of direct debt (36% of consolidated total debt) as at June 30, 2009. Virtually all of the Company’s remaining $6.0 billion of consolidated total debt is held at subsidiaries that are engaged in self-supporting and stable natural gas transmission and distribution operations. Spectra Capital’s non-consolidated credit metrics benefited from strong equity earnings from DCP until Q4 2008. Reversal of this trend resulted in a substantial drop in equity earnings and deterioration of credit metrics during 2009 compared with 2008, although the trend reversed in 6M 2010 compared with 6M 2009. Consequently, non-consolidated credit metrics have also been relatively volatile, a trend that is likely to continue over the medium term. In the absence of significant equity earnings from DCP, Spectra Capital’s non-consolidated credit metrics are relatively weak for the current ratings.

Notes:
All figures are in U.S. 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.