DBRS Confirms TransCanada Keystone Pipeline at R-1 (low)

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, as well as the positive attributes of the pipeline, primarily the long-term contractual arrangements outlined below. 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’s capital structure, with an estimated 50% to 60% of debt component, is in line with TCPL’s financial profile (debt-to-capital of 56% at September 30, 2010) and within the parameters of the current rating. Keystone USA has become a wholly-owned subsidiary of TCPL since August 2009.

In addition to the guarantee of TCPL, which is also the operator and among the largest owners and operators of pipelines, the rating also reflects the following strengths of Keystone USA:

(1) Base Keystone is 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 cover about 90% (or 530,000 barrels per day (b/d)) of the pipeline’s design capacity of 590,000 b/d. Phase 1 of the project commenced on June 30, 2010, and Phase 2 was in commercial service on February 1, 2011. The project, incorporating converted portions of TCPL’s existing gas pipelines, is largely on schedule, with a small (estimated 7%) cost overrun. A capital cost sharing mechanism on a 50/50 basis with shippers has also mitigated in part any cost overruns on the project.

(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, as 90% of the pipeline capacity is 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 as mentioned above.

(3) Competitive tolling arrangements 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) Bitumen reserves are abundant in the oil sands sector. New projects came on stream during 2008 to 2010 and some other projects are expected to achieve first oil (including Suncor Energy Inc.’s Firebag 3 and 4 and Imperial Oil Limited’s Kearl oil sands project) over the next few years, driven in part by rising crude oil prices (WTI is currently in the $85/b to $90/b range).

The Partnership faces several challenges, which are considered manageable. (1) 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. (2) 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. (3) Refinancing risk exists, 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 and the substantial equity component 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-inch and 36-inch pipeline) extends from Hardisty, Alberta, to U.S. Midwest markets at Wood River and Patoka, Illinois, and Cushing, Oklahoma. Phase I in service on June 30, 2010 has an initial nominal capacity of 435,000 b/d, which was expanded to 590,000 b/d, when Phase II became operational recently. The construction of the pipeline began in May 2008. Despite the current regulatory delays due to environmental concerns, 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 mid to late 2013. The pipeline system is further expandable to 1.5 million b/d at a relatively low cost, enhancing future growth opportunities. TCPL’s recently proposed Bakken and Marketlink projects could potentially ship 250,000 b/d of crude oil through interconnect with Keystone from Montana, North Dakota and the U.S. mid-continent to refineries in Oklahoma and the U.S. Gulf Coast, enhancing Keystone’s competitive position.

The capital cost for Base Keystone is estimated at approximately $6.3 billion (equivalent) compared with US$5.4 billion ($5.9 billion equivalent) projected in 2008, or a 7% cost overrun, with Keystone XL (collectively, Keystone) estimated at approximately $6.7 billion. These cost estimates reflect the current projected cost of approximately $13 billion for both projects versus the original estimate of approximately US$12 billion. The key contributors include foreign exchange variances, weather-related cost increases at Base Keystone, as well as environmental issues and regulatory delays associated with Keystone XL. 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:
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.