DBRS Confirms Inter Pipeline Fund at BBB (high)

DBRS has today confirmed the Unsecured Medium Term Notes rating of Inter Pipeline Fund (IPF) at BBB (high) with a Stable trend.

The confirmation reflects the following factors: (1) Successful completion of the $1.85 billion expansion project at its subsidiary, Inter Pipeline (Corridor) Inc. (Corridor, concurrent confirmation at “A” and R-1 (low), both with Stable trends, see separate press release); (2) DBRS’s expectation that certain refinancing risks (detailed below) will be addressed in a satisfactory and timely manner; and (3) DBRS’s belief that IPF’s financial and business risk profiles will remain within the parameters of its rating following the recent agreement to acquire DONG Energy Oil Terminals (DEOT), which owns four petroleum storage terminals in Denmark, from a subsidiary of DONG Energy A/S, one of the largest energy groups in northern Europe, for EUR 354 million, or approximately $500 million. The acquisition, which is expected to be immediately accretive to cash flow, is expected to close in October 2011. (See DBRS press release dated June 20, 2011 for details.)

(1) The Corridor expansion entered commercial service on January 1, 2011, at an estimated cost of $1.85 billion, slightly above the original $1.8 billion estimate due to higher than expected non-controllable costs such as line fill and final tank construction cost adjustments added to rate base. On that date, expansion construction costs were added to the rate base and Corridor began to receive incremental revenue. Corridor’s rate base more than tripled relative to the previous level.

IPF expects incremental EBITDA of approximately $145 million per year from the Corridor expansion (equal to 39% of 2010 consolidated EBITDA). IPF’s business risk profile has improved as low-risk Corridor earnings have become a larger part of IPF’s operations, offsetting the negative impact of the fully debt funded Corridor expansion on IPF’s credit metrics. Corridor is supported by a long-term cost-of-service firm service agreement (FSA) with quality shippers.

In early January 2011, Corridor’s debt-to-capital ratio was restored to pre-expansion levels as a result of IPF’s $460 million equity injection into Corridor, the newly constructed assets were added to rate base and Corridor’s increased revenue requirement under the Firm Service Agreement (FSA). The IPF equity contribution was used to repay advances under the two “recourse to IPF” tranches of Corridor’s revolving credit facility.

While IPF’s consolidated credit ratios were weakened by the Corridor expansion, the Corridor debt (other than the equity contribution portion repaid in Q1 2011) is non-recourse to IPF, mitigating the impact on IPF’s financial profile. Consequently, DBRS’s focus is on IPF’s non-consolidated credit ratios. IPF issued equity over time in order to partly offset the negative impact of the Corridor expansion on IPF’s credit metrics. Additionally, IPF has maintained a conservative payout ratio (73% for the last 12 months (LTM) ending March 31, 2011, based on cash available for distribution (DBRS defined), although its target is 90%). These factors allowed IPF to position its balance sheet and liquidity to accommodate the required equity injection.

(2) While IPF and Corridor face material refinancing risk over the near to medium term, DBRS considers it to be manageable and expects it to be addressed well in advance of the maturity dates.

(a) IPF faces refinancing risk on its credit facility, which matures in September 2012. IPF had $484 million of availability on its credit facility as at March 31, 2011. However, on a pro forma basis, IPF’s plan to initially fund its pending $500 million DEOT acquisition with available sources of credit, including its credit facility upon closing in October 2011 (supported by re-introduction of its Premium Dividend Reinvestment Plan (DRIP) in July 2011 (which has historically raised $10 million to $12 million per month)) would reduce IPF’s effective availability to a minimal level. DBRS expects IPF to access the capital markets within a reasonable time frame in order to refinance some of its bank debt, thereby restoring its liquidity position to a more acceptable level.

(b) In August 2012, the two “non-recourse to IPF” tranches of Corridor’s revolving credit facility (combined total availability of $1.654 billion) will come due. DBRS expects that Corridor will re-finance a portion of these amounts with long-term debt in advance of the maturity date, with the balance to be funded on an ongoing basis by a scaled-back commercial paper (CP) program that is 100% backstopped by committed credit facilities.

(3) DBRS estimates that, on a pro forma basis as at March 31, 2011, the DEOT transaction would initially (excluding the impact of the Premium DRIP re-introduction) increase IPF’s non-consolidated debt-to-capital to 52% from 42% and reduce its cash flow-to-debt ratio to 21% from 34%. However, DBRS estimates that inclusion of a full-year contribution from Corridor’s expansion, rather than the one-quarter of results included to date, would result in a non-consolidated cash flow-to-debt ratio in the mid-to-high 20% range. This is consistent with DBRS’s expectation at the time of its July 20, 2010 upgrade of IPF’s rating to BBB (high) from BBB given DEOT’s largely fixed revenue stream through contracts with initial terms ranging from three to five years with integrated oil companies and major petroleum traders.

The acquisition doubles the size of IPF’s fee-based European Bulk Liquids Storage segment EBITDA from 8% to 16% on a pro forma basis in Q1 2011. IPF continues to generate the majority of its EBITDA from its Conventional Oil Pipelines and Oil Sands Transportation segments (a combined 57% and 52% prior to and pro forma the transaction, respectively), while the NGL Extraction segment drops marginally from 35% to 32% of EBITDA (including commodity-based EBITDA from 25% to 23%).

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

The applicable methodology is Rating North American Pipeline and Diversified Energy Companies , which can be found on our website under Methodologies.