DBRS Confirms Alliance Pipeline L.P. at A (low)

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

The rating confirmation reflects Alliance USA’s increased and predictable cash flow, underpinned by the competitive pipeline system and take-or-pay contracts that cover 100% of the pipeline’s base capacity and a new additional contracted capacity of 80 million cubic feet/day (mmcf/d) with Pecan Pipeline (North Dakota), Inc. The Pecan Pipeline contract is a ten-year firm capacity commitment that expires in 2020. Key factors supporting the current rating are: (1) the 15-year transportation agreements (expire December 2015) with shippers (90% of which have investment-grade ratings). The contracts contain a minimum firm capacity of 1,325 mmcf, providing predictable cash flow through the life of the contracts; (2) declining debt levels as the debt is amortized and is paid for with 70% of depreciation expense; and (3) Alliance’s efficient pipeline system (the System), which 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 run on extra capacity beyond the base level (21% in 2010 and 2009), which enhances its competitiveness as shippers only have to pay for incremental fuel costs on these authorized overrun services. This supports Alliance’s ability to obtain reasonable contracts after expiry of the original contracts.

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

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 Inc. and Veresen Inc.) are based on estimated net income for the year plus 30% of depreciation expense included in the tolls. The remaining 70% of depreciation is used to pay the amortized amount of the Notes, which is between $60 million and $70 million per year over the next five years.

As a result of debt amortization, Alliance USA’s debt levels have been gradually reduced. At the end of H1 2011, the debt-to-capital ratio decreased to a moderate level at 49.6% (2006: 56.7%); the debt service coverage ratio (DSCR) remained strong at 1.84 (times (x)) (1.25x required by the covenant). In addition, Alliance USA’s liquidity remained solid, with $3.7 million in cash and $58.5 million in available credit facility, which was sufficient to fund short-term working capital needs.

Given the expected future cash flow levels, DBRS believes that Alliance USA will likely continue to generate more than sufficient cash flow to service the required amortized debt amount. The fact that Alliance can only make cash distributions to its owners as long as the DSCR remains above 1.25x provides a strong protection to the debt holders.

Despite these strengths, Alliance faces a few challenges: (1) earnings were on a declining trend prior to the Pecan Pipeline contract. The decline reflected the impact of the depreciating rate base. Recently, earnings from the incremental contracted capacity with Pecan Pipeline helped to offset this impact. Going forward, in the absence of additional contracted capacity or major capital investment, Alliance’s earnings and cash flow will continue to be affected by its declining rate base. (2) There are uncertainties associated with contracts after 2015, as only 8% of original shippers decided to extend contracts through 2016. Future competition or adverse economic conditions at the time Alliance negotiates new contracts could force Alliance to realize lower earnings than the current agreements, although currently this is not expected. (3) Although DBRS assesses the credit quality of Alliance USA on a standalone basis, due to cross default provisions between Alliance USA and Alliance Canada, DBRS believes that a change in the creditworthiness of Alliance Canada could affect the credit quality of Alliance USA and vice versa.

Note:
All figures are in U.S. 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.