DBRS Downgrades Pembina Pipeline Corporation to BBB, Stable Trend

DBRS has today downgraded the Senior Unsecured Notes and the 7.38% Senior Secured Notes ratings of Pembina Pipeline Corporation (Pembina or the Company) from BBB (high) to BBB. The trend is Stable. This action removes the ratings from Under Review with Negative Implications, where they were placed on January 16, 2012, following the announcement that Pembina had agreed to acquire all of the outstanding shares of Provident Energy Ltd. (Provident) (the Acquisition).

The current rating action follows recent approval of the Acquisition by Provident’s shareholders. The Acquisition will be completed through an exchange of shares under which Provident shareholders will receive 0.425 of a common share of Pembina for each Provident share held. In addition, Pembina will assume $550 million of debt from Provident. The completion of the Acquisition is subject to final approval by the Toronto Stock Exchange, and is expected to formally close on April 2, 2012.

The downgrade largely reflects DBRS’s view that the Acquisition will materially increase Pembina’s business risk profile upon completion. While DBRS acknowledges that the share-exchange nature of the Acquisition results in improved pro forma credit metrics for Pembina, DBRS believes that the potential for increased credit metric volatility, combined with the increased business risk level, is consistent with the BBB rating.

DBRS believes that the downgrade is appropriate given the material increase in Pembina’s business risk following acquisition of the higher-risk Provident businesses. DBRS notes that a majority of Provident’s assets are in the natural gas liquids (NGL) midstream business consisting of the extraction, gathering, transportation, storage, fractionation and marketing of NGL, a material portion of which is exposed to fractionation spread/commodity price risk.

In 2011, Pembina’s EBIT was derived approximately 60% from conventional and oil sands pipelines and approximately 40% from its gathering and processing and terminals and storage operations, with most EBIT from the latter generated by long-term contracts and/or on a fee-for-service basis, with minimal market risk exposure. Following the Acquisition, DBRS expects that a material proportion of the combined entity’s EBIT will come from operations with fractionation spread/commodity price risk exposure. While DBRS acknowledges that Pembina intends to continue with Provident’s ongoing hedging programs, Pembina will likely remain exposed to these risks over the medium term as hedges are subject to rollover risk.

DBRS also assessed Pembina’s long-term business and risk management plans and notes that the Company’s exposure to fractionation spreads is expected to decline on a proportional basis over time, as incremental earnings from new projects in the midstream sector are expected to be on fee-for-service terms or a long-term contract basis. In addition, the Company will have the option to move its portfolio of contracts to a higher fee-for-service mix as existing Provident contracts expire, although this is likely to be a gradual process.

The Stable trend reflects DBRS’s expectation that the Company will work toward increasing the proportion of its EBIT that comes from fee-for-service activities and that it will fund any free cash flow deficits with a prudent mix of debt and equity financing. The Acquisition is earnings and cash flow accretive immediately, which, combined with its share-exchange nature, should provide support the Company’s key credit metrics such as cash flow-to-debt and interest coverage ratios.

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 the DBRS website under Methodologies.