DBRS Downgrades Long-Term Debt Ratings of TransCanada and NOVA Gas Transmission to A (low), Stable Trend; Confirms TransCanada’s CP and Preferred Share Ratings

DBRS has today downgraded the Issuer Rating and Unsecured Debentures & Notes rating of TransCanada PipeLines Limited (TCPL) to A (low) from “A”, the Junior Subordinated Notes rating of TCPL to BBB from BBB (high) and the Medium-Term Notes & Unsecured Debentures rating of NOVA Gas Transmission Ltd. (NGTL), a wholly owned subsidiary of TCPL, to A (low) from “A”, all with Stable trends. 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 has also confirmed the preferred share ratings of TCPL and of TransCanada Corporation (TCC, TCPL’s parent company) at Pfd-2 (low) with Stable trends, reflecting DBRS’s belief that the existing ratings are already conservative relative to TCPL’s Issuer Rating and that DBRS views it as unlikely that any debt instruments will be issued at TCC. These actions remove all of the above-noted ratings from Under Review with Negative Implications where they were placed on March 28, 2013.

Finally, DBRS has confirmed the Commercial Paper (CP) 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 DBRS’s review of the National Energy Board’s (NEB) dismissal (the Recent Decision) of TCC’s May 1, 2013, application for review and variance (R&V) of the NEB’s March 27, 2013, decision (the Original Decision) relating to TCC’s 2012-2013 restructuring proposal for tolls and service on its Canadian Mainline. The NEB has set up a separate process for consideration of certain tariff revisions that were included in TCC’s R&V application, although DBRS does not expect that the result of this process will result in fundamental changes to the new regulatory framework. While TCC is considering its future options, including potential appeal, DBRS does not expect the full throughput protection of the previous tolling methodology to be reinstated.

In DBRS’s view, the NEB’s Recent Decision confirms DBRS’s preliminary view that the Original Decision would result in a structural change from the previous tolling methodology that is inconsistent with the expectations that DBRS outlined in its press release on TCC dated November 22, 2012. DBRS believes that the Recent Decision results in an increase in TCPL’s business risk and is inconsistent with the regulatory framework under which the Canadian Mainline was constructed and has been operating under for several decades.

In its 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 [TCPL] 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.” While full recovery is still possible, the Original Decision introduced (and the Recent Decision retained) 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. 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.”

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. DBRS also recognizes that significantly lower firm service tolls on the Canadian Mainline support its cost competitiveness. DBRS further acknowledges the potential for TCC’s proposed Energy East Pipeline, which would convert a portion of the Canadian Mainline to crude oil service, to reduce the potential for unrecovered Canadian Mainline costs over the medium term. DBRS has concluded, however, that these factors do not change DBRS’s overall conclusion of an increase in business risk as a result of the NEB decisions.

Finally, TCC’s financial profile remains reasonable, as capex has been lower than previously anticipated due to the Keystone XL delay, partly offsetting weaker earnings and cash flow in 2012. DBRS believes that the recent weakness in credit metrics, compared with prior periods, was partly due to factors that are not likely to reoccur on an ongoing basis, including the Sundance A power purchase agreement (PPA) force majeure, the increased planned outage days at Bruce Power’s Unit A3 and A4 and the lower-than-expected capacity payments at the Ravenswood natural gas and oil-fired generating facility. DBRS notes that Bruce Power’s Unit 1 and Unit 2 were both placed into commercial service during Q4 2012 following a significant refurbishment program. The Company will likely experience a significant free cash flow deficit once capex on Keystone XL gets underway, if approved, likely resulting in a moderately negative impact on credit metrics prior to improvement in subsequent years as some projects are placed into service and begin to generate cash flow.

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.