DBRS Confirms Pacific Northern Gas at BBB (low) and Pfd-3 (low)

DBRS has today confirmed the Secured Debentures and Cumulative Redeemable Preferred Share ratings of Pacific Northern Gas Ltd. (PNG or the Company) at BBB (low) and Pfd-3 (low), respectively, both with Stable trends. The rating reflects PNG’s stable financial profile and the continued supportive regulatory environment in British Columbia. The impact of the regulatory decision to increase the low-risk utility benchmark return on equity (ROE) to 9.50% and the British Columbia Utilities Commission’s (BCUC or the Commission) approval of PNG’s 2010 negotiated settlements continues to be positive for the Company’s financial profile.

While PNG maintains a stable financial profile, it still has a higher level of business risk when compared with other DBRS-rated utilities. Economic conditions in PNG’s Western system remain weak, but are showing signs of improvement, albeit at a slow pace. Signs of economic improvement in the region include Rio Tinto Ltd.’s (Rio Tinto) announcement of an additional $300 million investment on preconstruction activities for the US$2.5 billion proposed modernization of its aluminum smelter in Kitimat, B.C.; the proposed Phase 2 of a new container handling facility at the Port of Prince Rupert; and continued modest growth in the oil and gas sector in the Northeast system area.

The closure of the West Fraser Kitimat paper mill in 2010 resulted in some loss of customers in the region, which was offset by the increase in customers in the Northeast system service area. Despite the challenges in the Western system area, PNG has been able to maintain a stable customer base.

In the longer term, the competitiveness of natural gas as a fuel and heating source still remains a key focus for PNG, especially in the Western service area; however, residential and commercial electricity rates are expected to rise in the near term according to BC Hydro’s Service Plan. The proposed electricity price increase and current low gas price environment are expected to keep PNG’s delivered natural gas rates competitive with electricity rates in PNG’s Western system.

In March 2011, PNG completed the sale of its 50% stake in Pacific Trail Pipelines Limited Partnership (PTP) for a gross consideration of $30 million. The Company has declared special dividends of approximately $22 million, which represents all of the initial payment. A final cash payment of $20 million will be paid if the purchasers make a decision to proceed with the construction of the Kitimat LNG export facility in British Columbia. There is no guarantee that the final payment will be made.

Going forward, if the net proceeds from the second payment are retained and reinvested in the Company, this could have a longer-term positive impact on PNG’s creditworthiness. However, the extent of any credit impact will depend entirely on the amounts to be retained and how they are reinvested.

DBRS expects that the Company will continue to pursue expansion opportunities to diversify its business risk profile and increase utilization on its Western system, which both have the potential to increase PNG’s margins and lower the average cost of transporting gas for all customers. The Company also continues to evaluate and advance growth opportunities through electricity and renewable energy generation. In 2010, it acquired the 9.8 MW McNair Creek “run of river” hydroelectric generation facility in British Columbia for $17 million. It also recently formed Narrows Inlet Limited Partnership with Skookum Power Corp. to undertake an investment of up to $2.5 million to advance the Narrows Inlet Project to the start of construction. The $190 million project was awarded a 30-year energy purchase agreement with British Columbia Hydro & Power Authority (BC Hydro) in spring 2010. If the Partnership elects to proceed with funding construction, approximately $20 million of equity will be required from PNG. DBRS notes that there are no assurances that PNG will be successful in realizing value from this opportunity. However, it is expected that the Company will continue to take all prudent steps to manage and reduce its costs to remain competitive and ensure that earnings remain stable.

PNG’s debt-to-capital ratio is expected to remain at approximately 50% over the medium term while its cash flow-to-debt and EBIT coverage metrics remain stable for the current rating. DBRS requires that PNG maintain a credit profile that is stronger than its peers, to offset its higher business risk profile. Furthermore, we expect PNG to continue to manage its dividend policy in light of its capex program and business risk profile in a way that preserves its financial and credit profiles.

PNG’s liquidity remains adequate for the ratings, supported by three bank credit facilities totalling $55 million, which mature in 2012, and a $35 million five-year revolving term facility that matures in 2015.

Note:
All figures are in Canadian dollars unless otherwise noted.

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