DBRS Places Long-Term Debt and Preferred Share Ratings of TransCanada and Long-Term Debt Rating of NOVA Gas Transmission Under Review – Negative; Confirms TransCanada’s CP Ratings

DBRS has today placed Under Review with Negative Implications the Issuer Rating, long-term debt and preferred share ratings of TransCanada Pipelines Limited (TCPL), the preferred share rating of TransCanada Corporation (TCC) and the long-term debt rating of NOVA Gas Transmission Ltd. (NGTL), a wholly owned subsidiary of TCPL (see table below). Concurrently, DBRS has confirmed the Commercial Paper ratings of (1) TCPL and (2) TransCanada Keystone Pipeline, LP (guaranteed by TCPL and its wholly owned subsidiary, TransCanada PipeLine USA, Ltd.) both at R-1 (low) with Stable trends, due to the continuing strength of their short-term credit profile.

The rating actions follow the announcement that the National Energy Board (NEB) has released its decision (the Decision) on the Canadian Mainline 2012 Tolls Application and Restructuring Proposal (the Restructuring Proposal) submitted by TCPL’s parent, TCC, and reflect DBRS’s preliminary view that the Decision result is a structural change from the previous tolling methodology that is not consistent with the expectations that DBRS outlined in our press release on TCC dated November 22, 2012 (see below for details). DBRS believes that the Decision results in an increase in TCPL’s business risk and is likely to result in lower earnings and cash flow from the Canadian Mainline. The NGTL rating action reflects DBRS’s view that continued financial and liquidity support from TCPL is key to NGTL’s long-term debt rating. DBRS expects any downgrade of the above-noted ratings to be limited to one notch.

While the Decision does not disallow any Canadian Mainline investment from being recovered in tolls, the NEB introduced the concept that:

“…if larger-than-forecast cost deferrals were to occur, they could represent a materialization of the Mainline’s fundamental risk and costs could be disallowed. If costs were disallowed, it would not mean that TransCanada did not have a reasonable opportunity to recover costs, but rather that events did not turn out as forecast or that this opportunity was not seized by TransCanada. A potential outcome is that the Mainline would suffer a loss – just like any other business that faces competition.”

In addition, the Decision stated that:

“Our decision enables TransCanada to meet market forces with market solutions. It is TransCanada’s responsibility to ensure that the Mainline is economically viable… TransCanada must not look to regulation to shield the Mainline from its fundamental business risk. It must address the underlying competitive reality in which the Mainline operates.”

In our November 22, 2012, press release, DBRS confirmed the ratings noted in the table below (except for the NGTL rating, which was confirmed separately on August 2, 2012) and noted that the ratings and trends reflected a number of factors. Among these factors was the expectation that the impact of the Decision would be “such that the Company is allowed to continue to recover, and earn a reasonable rate of return on, all of the costs that were incurred in the construction of the Canadian Mainline.” As noted above, while full recovery is still possible, the Decision introduced significant uncertainty into the cost recovery concept, which DBRS views as an increase in business risk. DBRS further notes that despite continuing decline in the Canadian Mainline’s contribution to TCC’s earnings (14% in 2012, compared with 21% in 2009), it nonetheless remains an important contributor to TCC’s overall credit profile. In our November 22, 2012, press release, DBRS further noted that “any material change to [the Canadian Mainline’s] cost recovery and rate of return methodology would be an indication of increased business risk.”

In our August 2, 2012, press release, DBRS confirmed NGTL’s long-term debt rating at “A”, with a Stable trend, reflecting “NGTL’s strong credit profile, which is underpinned by its regulated pipeline operations with a growing investment base and financial and liquidity support from its parent – TCPL.”

DBRS acknowledges that, in recognition of the higher business risk of the Canadian Mainline relative to historical levels, the Decision provided increased discretion for TCC to set bid floors for Interruptible Transportation Service and Short Term Firm Transportation Service, as well as the potential to earn a higher return on equity of 11.5% for 2012 to 2017, much higher than the 8.08% applicable to 2012, if the transportation volumes forecast by TCC materialize. DBRS also recognizes that significantly lower firm service tolls on the Canadian Mainline support its cost competitiveness. DBRS will review the potential for TCC to use these provisions, among others, to mitigate the potential for lower earnings and disallowed costs at the Canadian Mainline.

DBRS notes that no rating action is being taken with respect to Trans Québec & Maritimes Pipeline Inc. (TQM, rated A (low) with a Stable trend). TQM is part of the integrated TCPL Canadian Mainline system. Most of its revenues are derived from a commitment until October 31, 2018, from TCPL, one of its two 50% partners. The other 50% owner, Gaz Métro Limited Partnership (Gaz Métro), is the sole distributor of natural gas shipped within most of Québec. Gaz Métro inc. (Gaz Métro’s general partner) is rated “A” with a Stable trend by DBRS. All of TQM’s outstanding long-term debt is scheduled to mature prior to the expiry of the commitment from TCPL in October 2018.

With respect to other natural gas and crude oil pipelines that are regulated by the NEB, DBRS notes that, while no other pipeline in Canada currently faces the same challenges as the Canadian Mainline, the Decision has set a precedent for potential outcomes in the event that the fundamentals of other pipelines deteriorate and the expected outcomes could be different than previously expected.

BACKGROUND
TCC is facing challenges in its Canadian and U.S. natural gas pipeline segments related to changing gas flows as a result of the emergence of large-scale shale gas production, particularly in various regions in the United States, which has resulted in depressed continental gas prices and declining production in western Canada. This trend in turn has had a disproportionately negative impact on Canadian Mainline volumes, thereby driving up tolls under the “modified” cost-of-service methodology to levels that result in minimal netbacks for natural gas producers. The average investment base continues to decline ($5.7 billion in 2012 compared with $6.2 billion in 2011 and $7.5 billion in 2006) due to the nature of its rate regulation and minimal growth capex. TCC’s Restructuring Proposal was intended to result in significant changes to the business structure and terms and conditions of service of the Canadian Mainline, but retained the concept that pipelines would continue to recover all costs and a reasonable rate of return.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

Commercial Paper issued by TransCanada Keystone Pipeline, LP is guaranteed by TransCanada PipeLines Limited and TransCanada PipeLine USA Ltd.

The applicable methodology is Rating North American Pipeline and Diversified Energy Companies (May 2011), which can be found on our website under Methodologies.