DBRS Confirms Enbridge Inc. at A (low) and R-1 (low), Stable Trends

DBRS has today confirmed the Medium-Term Notes & Unsecured Debentures, Commercial Paper and Cumulative Redeemable Preferred Shares ratings of Enbridge Inc. (ENB or the Company) at A (low), R-1 (low) and Pfd-2 (low), respectively, all with Stable trends. The ratings reflect (1) implementation of the Competitive Tolling Settlement (CTS) effective on July 1, 2011, (2) improvement in the Company’s credit metrics since the year-end 2008 low point and (3) a relatively strong business risk profile.

(1) Effective July 1, 2011, Enbridge Pipelines Inc. (EPI, 100% owned by ENB) entered into the CTS (in effect until June 30, 2021), which provides for a joint tariff for liquids volumes originating in western Canada transported on the Lakehead System. EPI owns the Canadian portion (Mainline) of the Enbridge/Lakehead crude oil pipeline system. The U.S. Lakehead Pipe Line System (Lakehead System) is owned indirectly through EPI’s 23.8% interest in Enbridge Energy Partners, L.P. (EEP). The Mainline accounts for approximately one-third of ENB’s earnings. EPI and EEP entered into the International Joint Tariff (IJT) agreement, which ensures that the joint tariff revenues are allocated based on the existing Lakehead System rate structures, with no direct impact to the latter’s toll revenues. Therefore, any shortfall in toll revenues (e.g., as a result of lower throughput) under the CTS for the Lakehead System as compared with its existing agreements could potentially reduce the toll revenues available to the Mainline. Consequently, the CTS introduced volume and operational risks to the Mainline through a fixed-toll methodology (based on tolls of US$3.85 per barrel of heavy crude oil from Hardisty, Alberta, to Chicago, Illinois, adjusted by 75% of the Canadian Gross Domestic Producer Implicit Price Index for the remaining nine years of the settlement) as opposed to the previous cost-of-service method.

Although mitigated by certain minimum-volume thresholds, the CTS could potentially result in lower earnings and cash flow for EPI (and, to a lesser extent, for ENB) in the event of material disruption in service availability on the Mainline or the loss of significant volumes to alternative pipelines resulting from lower-than-expected end-user demand. While DBRS considers this risk to be manageable, the CTS nevertheless results in increased business risk to EPI (and, to a lesser extent, for ENB) compared with the previous agreements, under which the Mainline’s per barrel tolls would rise to compensate for reduced throughput.

(2) The improvement in ENB’s credit metrics since the year-end 2008 trough reflects rising earnings and cash flow from projects placed in service combined with lower capex and investments that have led to smaller free cash flow deficits and financing requirements over the subsequent 33-month period. Net proceeds from the issuance of preferred shares in late Q3 2011 ($0.5 billion) and of common equity in the form of reinvested dividends ($0.6 billion since year-end 2008) reduced the Company’s incremental debt financing needs relative to previous levels. ENB’s credit metrics in the nine months ending September 30, 2011 (9M 2011) were stronger than in 9M 2010, reflecting higher net income (before extraordinary items) and the full period benefit of cash earnings from two major projects placed into service in 2010 (the Alberta Clipper Project (Alberta Clipper) on April 1, 2010, and Southern Lights Diluent Import Pipeline (Southern Lights) on July 1, 2010) compared with cash earnings since the in-service dates and non-cash allowance for equity funds used during construction (AEDC) and all of the associated debt in 9M 2010.

Excluding sponsored vehicles (i.e., EEP and Enbridge Income Fund (EIF)), ENB has planned capex of $17.7 billion from 2011 to 2015 ($2.9 billion was spent during 9M 2011), likely resulting in significant free cash flow deficits. Consequently, DBRS believes that the current capex plans, combined with the Company’s strategy for funding cash flow deficits with a significant portion of debt, could have a negative impact on the Company’s credit metrics during the early years of the current plan. However, DBRS expects that any such potential weakness would be shallower than experienced in the 2008–2009 period as a result of a shorter average construction period and lower average construction costs for the current portfolio of projects.

(3) ENB’s low-risk, mostly regulated operations provide approximately 85% to 90% of the Company’s earnings. ENB derived approximately one-quarter of its segment earnings for the LTM September 30, 2011, from entities with no external debt, providing a stream of unencumbered dividends to the Company. The remaining three-quarters of segment earnings are derived mostly from entities with low-risk, regulated operations that generate stable earnings, including Enbridge Gas Distribution Inc. (EGD), EPI and EEP) accounting for a combined 59% of segment earnings, which also provide a steady stream of dividends to ENB.

Excluding sponsored vehicles, ENB is targeting in excess of a 10% compounded annual growth rate (CAGR) on earnings per share (EPS) from 2011 to 2015. Half of total capex is related to liquids pipelines projects (supported by long-term contracts), with the balance relatively equally allocated to (a) gas pipelines and processing; (b) electric power, international and other (including green energy) and (c) gas distribution. While DBRS expects the Company’s business risk profile to remain relatively strong, DBRS views the green energy projects, which are subject to volume risk and operating and maintenance (O&M) cost increase exposure (following expiry of initial fixed-price O&M contracts), as having moderately higher business risk, although partly mitigated by long-term contractual arrangements.

ENB also continues to expand through acquisitions: (1) During Q4 2011, ENB agreed to acquire a combined 71% interest in phases 1 and 2 of the Cabin Gas Plant Development (Cabin), which together will be capable of processing 800 million cubic feet per day (mmcf/d) of natural gas in the Horn River Basin. ENB has agreed to pay $300 million upon closing, expected in December 2011. Upon completion of phases 1 and 2, ENB’s total investment is expected to be approximately $1.1 billion. Cabin (Canadian natural gas processing) represents a new business activity for ENB. (2) In November 2011, ENB agreed to acquire a 50% interest in the Seaway Crude Pipeline System (Seaway) for US$1.15 billion. Closing is expected by early 2012. Pending regulatory approval, ENB and its 50% partner, Enterprise Products Partners L.P. (Enterprise), plan to reverse the flow of Seaway, build a 45-mile pipeline link to Enterprise’s Houston terminal, and increase Seaway’s capacity at an expected cost of US$300 million. DBRS views Cabin and Seaway as having moderately higher business risk than ENB’s current portfolio mix.

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.