DBRS Confirms Trans Québec & Maritimes Pipeline at A (low)

DBRS has today confirmed the Senior Unsecured Bonds rating of Trans Québec & Maritimes Pipeline Inc. (TQM or the Company) at A (low) with a Stable trend. The confirmation reflects the following factors:

(1) TQM continues to benefit from its stable, regulated operation on a cost-of-service basis, with no throughput risk. Continued stability is expected, with most of its revenues derived from a long-term commitment until 2018 from TransCanada PipeLines Limited (TCPL), one of its two 50% partners. The other 50% owner, Gaz Métro Limited Partnership (Gaz Métro), is the sole distributor of natural gas shipped within most of Québec. TCPL and Gaz Métro inc. (Gaz Métro’s general partner) are rated “A” by DBRS (Gaz Métro’s rating is currently Under Review with Developing Implications – please see the June 23, 2011, DBRS press release for details). TQM is part of the integrated TCPL Canadian Mainline pipeline system and, as such, acts as TCPL’s extension to reach both the Québec market and certain New England markets.

(2) TQM has an improved financial profile as a result of changes to its tolling methodology. In March 2009, the National Energy Board (NEB) set a 6.4% after-tax weighted-average cost of capital (ATWACC) return (with no explicit deemed capital structure) for each of 2007 and 2008 under TQM’s cost of capital application (the Decision). This was comparable to allowed returns on equity (ROEs) of 9.85% in 2007 and 9.75% in 2008 on a 40% deemed equity component, significantly improved from the previous parameters (allowed ROE of 8.46% in 2007 and 8.71% in 2008 on a 30% deemed equity component).

While the Decision applied only to TQM’s 2007 and 2008 tolls, it formed the basis for determination of TQM’s final 2009 tolls. In November 2010, the NEB approved TQM’s Settlement Agreement with respect to its annual revenue requirement for 2010, 2011 and 2012 tolls. DBRS believes that the Decision strengthened TQM’s financial profile and its position within its current rating category and recognized the potential for the Company’s business risk to rise over time (see below). As expected, the impact on TQM’s key credit metrics has been positive (e.g., debt-to-capital, cash flow-to-debt and EBIT interest coverage improved to 60%, 16.4% and 3.20 times, respectively, in 2010 from 69.9%, 12.5% and 2.37 times, respectively, in 2008).

(3) While the Company has no direct competition within Québec, TQM, as part of the integrated TCPL Canadian Mainline, faces competition from two major pipeline systems: (a) Alliance Pipeline (Alliance) and Vector Pipeline (Vector) for supply of western Canadian gas going into the U.S. Midwest and eastern Canada. Significant declines in natural gas production volumes in western Canada have driven up per unit tolls on the TCPL Canadian Mainline in recent years, raising tolls to the markets served along the TQM pipeline as well, and (b) higher volumes on Maritimes & Northeast Pipeline (M&NP), which extends from the east coast offshore Canada to Atlantic Canada and the U.S. Northeast, the latter of which has resulted in significantly lower volumes from TQM into Portland Natural Gas Transmission System (PNGTS) since completion of M&NP’s Phase IV expansion in January 2009.

(4) Natural gas is a secondary fuel source in its primary market compared with alternative fuels, particularly lower-cost residential hydroelectricity in Québec. Fuel oil is also extensively used in the province by industrial customers with fuel-switching capabilities. With weak natural gas demand in Québec as a result of a decline in economic activity and the lower volumes from TQM into PNGTS noted above, TQM experienced a significant decline in throughput in 2010 compared with 2009 levels, although this is expected to stabilize in 2011. TQM’s volumes could decline further over the medium to long term in light of higher demand in western Canada (resulting in lower volumes available for TQM), partly due to the gas-intensive nature of oil sands projects. Finally, TQM faces long-term bypass risk if significant shale gas development in Québec allows producers to flow natural gas directly into Gaz Métro’s distribution network. While the impact of these factors on TQM’s credit profile is somewhat mitigated by the regulated cost-of-service methodology and its long-term commitment from TCPL until 2018, the Company’s business risk profile could rise over time if the declining throughput trend were to continue over the medium to long term.

(5) All of TQM’s outstanding long-term debt is scheduled to mature prior to the expiry of the long-term commitment from TCPL in 2018. TQM has an $85 million revolving term loan agreement maturing in August 2016 ($67.9 million was outstanding as of March 31, 2011). The $75 million Series K Bonds mature in September 2014 and the $100 million Series L Bonds mature in September 2017.

However, TCPL must decide whether to extend 80% of the contract demand under the Transportation Service Agreement that expires on October 31, 2013. As that date approaches, market conditions could challenge the current tolling method if TQM volumes were to decline substantially. While TCPL would still be required to pay the full tolls under the cost-of-service methodology until 2018, refinancing of debt maturities beyond that date would require clarity with respect to the future nature of the tolling methodology.

Notes:
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.