DBRS Confirms Alliance Pipeline Limited Partnership at A (low) and BBB (high)

DBRS has today confirmed the Senior Secured Notes and Senior Unsecured Notes of Alliance Pipeline Limited Partnership (Alliance Canada or the Partnership) at A (low) and BBB (high), respectively, both with Stable trends. Alliance Canada is the Canadian portion of the Alliance Pipeline System (collectively; Alliance), which includes U.S. portion Alliance Pipeline L.P. (Alliance USA – see separate press release).

The rating confirmation reflects Alliance Canada’s ability to generate strong and predictable cash flow to service the amortization amount of the debt and interest. Strong cash flow has been underpinned by the competitive pipeline system and take-or-pay contracts that cover 100% of Alliance’s pipeline base capacity. All of the firm capacity is contracted with shippers that possess strong credit profiles, with 90% of the shippers having investment-grade ratings. In addition, Alliance USA’s and Alliance Canada’s pipeline system (the System) benefits from its efficient operations since it can ship liquids-rich natural gas (gas plus liquids in one pipeline under high pressure) under one toll, enhancing netbacks for shippers compared with competing pipeline systems that can ship only dry gas. The System can also offer extra capacity (at approximately 21% in 2010 and 2009) beyond the base level, which enhances its competitive tolls as shippers only have to pay incremental fuel costs on these authorized overrun services. This supports Alliance’s ability to obtain new contracts after the original contracts expire in 2015.

Alliance is expected to evolve into a mature conventional pipeline system (as opposed to the current bullet pipeline), which would provide a broader range of services, connection points and feeder capabilities. Over the past few years, the System has added two key projects: the 2008 northeast British Columbia expansion (BC Expansion) and the connection to the Pecan Pipeline (Pecan Interconnection) in 2010 to reach the gas-rich basins in the Bakken formation.

The BC Expansion has added receipt-only service capacity of 150 mmcf/d (million cubic feet per day), whereas the Pecan Interconnection has provided additional capacity of 80 mmcf/d and is under a ten-year contract. Currently, Alliance has two key proposed projects: (1) the 37-mile Fort St. John Lateral Pipeline project, which would accommodate the receipt of increased “sweet” natural gas volumes in the northeast British Columbia and northwest Alberta regions. (2) The 77-mile Tioga Lateral Pipeline project (capacity: 120 mmcf/d), which would connect natural gas production from the Williston Basin to the System in North Dakota. These two proposed projects have not been finalized with respect to investment amounts or financing strategies.

The Partnership’s cash distributions to its two 50/50 owners (Enbridge Income Fund and Veresen Inc.) are based on estimated net income for the year and 30% of depreciation expenses included in the tolls. The remaining 70% of depreciation is used to pay the amortized amount of the notes, which is in the $78 million to $88 million range per year. Under the Common Agreement, Alliance’s debt service coverage ratio (DSCR) must be at least 1.25 times (x) before Alliance can make cash distributions to its owners. Over the past ten years, Alliance Canada’s DSCR has been strong at or near 2.00x. Given the nature of transportation contracts with the shippers, DBRS expects Alliance Canada to continue to generate strong cash flow and maintain its DSCR in line with historical levels through the end of the contracts. In addition, Alliance Canada’s liquidity remained strong as at June 30, 2011, with over $34 million in cash, $118 million in available credit facility and moderate short-term financing requirements.

Despite these strengths, Alliance Canada’s financing flexibility is limited by its high debt levels. The debt-to-capital ratio remained relatively high at 68.1% at the end of H1 2001 (64% on a senior secured debt basis), and was close to the 70% maximum senior debt leverage level in the covenant. As Alliance Canada is seeking to become a conventional pipeline, large capital expenditures may be expected over the medium term, which could place pressure on the balance sheet. Furthermore, earnings have been affected by a depreciating investment base, as the System is depreciating over time. There are also uncertainties associated with transportation contracts after 2015, as only 8% of original shippers decided to extend contracts through 2016. Future competition or adverse economic conditions could force Alliance to realize lower earnings and cash flow than the current contracts (although currently this is not expected). Although DBRS assesses the credit quality of Alliance Canada on a standalone basis, due to cross default provisions between Alliance Canada and Alliance USA, DBRS believes that a change in the creditworthiness of Alliance USA could affect the credit quality of Alliance Canada and vice versa.

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.