DBRS Downgrades Long-Term Debt of Enbridge Inc. to A (low) and Enbridge Pipelines Inc. to “A”; Confirms CP Ratings and Enbridge Inc.’s Preferred Share Rating

DBRS has today downgraded the rating on the Medium-Term Notes & Unsecured Debentures of Enbridge Pipelines Inc. (EPI) to “A” from A (high) and the rating on the Medium-Term Notes & Unsecured Debentures of Enbridge Inc. (ENB) to A (low) from “A.” Both trends are Stable. These rating actions follow the announcement of the new Competitive Tolling Settlement (CTS), which would introduce volume and operational risks to EPI’s Enbridge System (Canadian Mainline), as described below. As a critical component of ENB’s operations (Canadian Mainline accounted for approximately one-third of ENB’s DBRS-adjusted earnings in 2010), the rating action on the long-term debt of EPI (100% owned by ENB) has resulted in a similar rating action on the long-term debt of ENB. The previous ratings did not allow for a fundamental change in volume sensitivity. While the final terms of the CTS must be approved by the National Energy Board (NEB), DBRS does not expect the full throughput protection of the current tolling methodology to be reinstated.

Concurrently, DBRS has confirmed the Commercial Paper (CP) ratings of EPI and ENB at R-1 (low) and ENB’s Cumulative Redeemable Preferred Shares (Preferred Shares) rating at Pfd-2 (low), all with Stable trends. The confirmation of ENB’s Preferred Shares reflects DBRS’s belief that the existing rating is already conservative relative to the long-term debt rating and that DBRS views it as unlikely that intermediate-ranking instruments will be issued in the future.

The downgrades were based on the potentially negative business risk and financial profile implications of the new CTS (to be in effect from July 1, 2011, to June 30, 2021) on EPI and to a lesser extent on ENB, which will apply to (1) the Canadian Mainline and (2) the U.S. Lakehead Pipe Line System (Lakehead System), owned indirectly through EPI’s 25.5% interest in Enbridge Energy Partners, L.P. (EEP).

The CTS will result in a single International Joint Tariff (ITF) that will apply to the combined Canadian Mainline/Lakehead System. Lakehead System tolls would remain unchanged as these would continue to be determined under the existing agreements and U.S. Federal Energy Regulatory Commission (FERC) methodology. Therefore, any shortfall in tolls (e.g., due to lower throughput) under the CTS for the Lakehead System compared with the Lakehead System’s existing agreements would potentially reduce the tolls available to the Canadian Mainline.

DBRS notes that the CTS introduces volume and operational risks to the Canadian Mainline through a fixed-toll methodology (based on tolls of US$3.85 per barrel of heavy crude oil from Hardisty, Alberta, to Chicago, adjusted by 75% of the Canadian Gross Domestic Producer Implicit Price (GDPP) Index for the remaining nine years of the settlement) as opposed to the cost-of-service basis for the current tolling arrangements, outlined in more detail below. Although mitigated by certain minimum-volume thresholds, the CTS could result in lower earnings and cash flow for EPI in the event of material disruption in service availability on the Canadian Mainline or the loss of significant volumes to alternative pipelines due to lower-than-expected end-user demand. For example, TransCanada Corporation’s Keystone Pipeline (Base Keystone) is currently in operation and Keystone Gulf Coast Expansion Project (Keystone XL) is expected to be in operation in late 2013. While DBRS considers this risk to be manageable, the CTS nevertheless results in increased business risk to EPI compared with the current agreements, under which Canadian Mainline tolls would increase to compensate for reduced throughput.

From a business risk perspective, EPI benefits from strong demand for western Canada sedimentary basin (WCSB) crude oil in the U.S. Midwest (PADD II), supported by increasing crude oil production, rising pipeline throughput and the current cost-of-service tolling methodology (the latter expected to be replaced by the CTS effective July 1, 2011). Each of these factors contributes to earnings and cash flow stability. The Line 4 Extension and Alberta Clipper Canada projects, completed during 2010, are currently regulated under the long-term cost-of-service rolled-in tolling methodology, protecting EPI against volume risk, property taxes and power costs, but these would also be replaced by the CTS.

EPI’s current Incentive Tolling Settlement (ITS), which applied to the legacy portion of Canadian Mainline’s system until year-end 2009, reduced regulatory uncertainty and protected EPI from volume risk, resulting in earnings stability. In May 2010, the NEB approved an agreement between EPI and the Canadian Association of Petroleum Producers (CAPP) for a one-year ITS for 2010 (the 2010 ITS), which maintained volume protection for Canadian Mainline revenues. The 2010 ITS increased the percentage of flow-through costs, retained 100% of cost savings, eliminated performance metrics included in the previous agreement and preserved an acceptable return for Canadian Mainline.

EPI owns and operates the Canadian portion (Canadian Mainline) of the largest low-cost crude oil pipeline from the WCSB to major Canadian and PADD II markets. The Enbridge/Lakehead System has consistently provided the most economic route for WCSB producers shipping crude oil to PADD II/Chicago. Despite recent expansions, its share of Canadian export capacity has declined from about three-quarters to about two-thirds due to completion of Base Keystone in Q1 2011. This could drop to about 60% upon completion of Keystone XL. However, given favourable market conditions, PADD II is likely to remain the preferred market (generating the highest netbacks) for WCSB producers over the medium term versus the U.S. Rocky Mountains (PADD IV) or the U.S. Pacific Northwest (PADD V).

DBRS notes that no rating actions are being taken with respect to the ratings of EEP, Enbridge Gas Distribution Inc., Enbridge Income Fund, Alliance Pipeline Limited Partnership or Alliance Pipeline L.P.

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