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

DBRS has today confirmed the ratings on the Medium-Term Notes & Unsecured Debentures and Commercial Paper of Enbridge Pipelines Inc. (EPI or the Company) at “A” and R-1 (low), respectively, 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 following completion of its large multi-year capex program in Q2 2010, although below 2007 levels, and (3) the strong competitive position of the Enbridge/Lakehead crude oil pipeline system, the Canadian portion of which is referred to as the “Mainline.” 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).

(1) Effective July 1, 2011, EPI entered into the CTS (in effect until June 30, 2021), which provides for a joint tariff for volumes originating in western Canada that are transported on the Lakehead System. 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 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 compared with the previous agreements, under which the Mainline’s per barrel tolls would rise to compensate for reduced throughput.

The Company’s previous Incentive Tolling Settlement (ITS), which applied to the legacy portion of the Mainline’s system until year-end 2009, reduced regulatory uncertainty and protected EPI from volume risk, resulting in earnings stability. In May 2010, the National Energy Board approved an agreement between EPI and the Canadian Association of Petroleum Producers (CAPP) for a one-year ITS for 2010 (the 2010 ITS), which maintained volume protection for Mainline System revenues. The 2010 ITS increased the percentage of flow-through costs, retained 100% of cost savings, eliminated performance metrics included in the previous agreement and preserved an acceptable return for the Mainline.

(2) Mainline credit metrics, while relatively strong, remain below 2007 levels. EPI’s Mainline credit ratios deteriorated significantly in 2008 and 2009 as a result of its large capex program ($1.3 billion in 2008 and $1.5 billion in 2009) as the projects only began generating cash earnings and cash flow upon being placed in service on April 1, 2009 (the Line 4 Extension), and April 1, 2010 (Alberta Clipper Canada). While EPI made progress in restoring its key Mainline credit metrics in 2010, and is on track for further improvement in 2011 (including its cash flow-to-debt ratio to the top half of the 15% to 20% range and EBIT interest coverage ratio to the mid-three times range compared with 12.9% and 3.4 times in 2009), these levels remain well below the corresponding 2007 levels (25.3% and 5.2 times). DBRS’s analysis of EPI is focused on the Mainline’s financial statements, which include Line 4 Extension and Alberta Clipper Canada and exclude intercompany transactions (in place for capital efficiency purposes) and investments held in subsidiaries of EPI from the consolidated financial statements. The Mainline operations support all of EPI’s direct external debt and accounted for 55% of consolidated EPI earnings in the 12 months ending (LTM) September 30, 2011.

(3) From a business risk perspective, EPI benefits from strong demand for Western Canadian Sedimentary Basin (WCSB) crude oil in the U.S. Midwest (PADD II), supported by increasing crude oil production, rising pipeline throughput and its strong competitive position. Each of these factors contributes to earnings and cash flow stability. Further, EPI and its parent company, Enbridge Inc. (ENB), are developing additional projects, including intra-Alberta upstream liquids pipeline projects (e.g., Woodland Pipeline, Athabasca Pipeline and Waupisoo Pipeline expansions, Athabasca Twinning) to provide increasing volumes for delivery of WCSB crude oil to growing U.S. markets. DBRS notes that these projects would be developed and funded at ENB subsidiaries other than EPI.

EPI owns and operates the Canadian part (Enbridge System or Mainline) of the largest low-cost crude oil pipeline from the WCSB to major Canadian and PADD II markets. The Enbridge/Lakehead System has consistently provided the most economic route for WCSB producers shipping crude oil to PADD II/Chicago. In 2010, its volumes (2.2 million b/d) were equivalent to 76% of total WCSB crude oil production, providing about two-thirds of Canadian export capacity.

The Enbridge/Lakehead System is subject to competitive pressures from other pipelines originating in the WCSB and from alternative supply pipelines into areas it serves. According to a June 2011 study by the Canadian Association of Petroleum Producers (CAPP), total capacity of major crude oil pipelines exiting the WCSB has increased by 1.041 million b/d (up 43%) from 2.445 million b/d at year-end 2009 to 3.486 million b/d in 2011 with the commencement of Alberta Clipper and TransCanada PipeLines Limited’s (TCPL) Keystone Pipeline (Base Keystone). TCPL’s Keystone Gulf Coast Expansion Project, which would expand nominal capacity of Base Keystone to 1.1 million b/d and extend the pipeline to the U.S. Gulf Coast and currently faces serious challenges on the regulatory and environmental fronts, would represent significant additional competition to the Mainline upon completion, although commercial service is not expected until late 2014 at the earliest if U.S. regulatory approvals are obtained.

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.