DBRS Downgrades Alliance Pipeline L.P.

DBRS Limited (DBRS) has today downgraded Alliance Pipeline L.P.’s (Alliance USA, Alliance or the Company) Senior Secured Notes rating to BBB from A (low). The trend on the rating is Stable. The current rating action removes the rating from Under Review with Negative Implications where it was placed on June 19, 2015 (please see DBRS press release for details).

The Alliance rating downgrade is consistent with DBRS’s expectations and is based on the review of the Company’s final shipping group and its new service offering and tolls as approved by the Federal Energy Regulatory Commission and the National Energy Board. Following the review, DBRS continues to believe that the Company’s credit risk profile is weakened by the lower shipper credit quality, credit concentration risk and the shorter duration of contracts. DBRS notes that Alliance has re-contracted all available capacity up to its firm capacity of 1.467 billion cubic feet per day in 2016, covering 97% and 94% in 2017 and 2018, respectively. DBRS estimates that the majority of the new firm take-or-pay contracts have a three- to five-year term, with one shipper on a seven-year contract, and nearly 60% of the shippers being in the non-investment-grade category. No new investment-grade shippers have contracted capacity on the pipeline beyond the five-year period. Furthermore, a single non-investment-grade shipper has contracted for a seven-year period covering up to approximately 38% of the pipeline’s firm capacity, and an additional 12% is contracted by two non-investment-grade shippers for a five-year term, exposing the Company to significant credit concentration risk. Although a majority of the non-investment-grade shippers are required to post collateral, the collateral does not cover more than 90 days’ obligations under the new shipping contracts, exposing Alliance to a potential loss of earnings should the shippers be unable to fulfill their obligations. The new take-or-pay contracts replace the 15-year firm take-or-pay transportation contracts that expire on November 30, 2015, and covered 100% of the pipeline’s capacity, with approximately 85% of the shippers having investment-grade ratings that previously provided strong support to the Company’s credit risk profile.

Western Canadian natural gas liquids (NGL) prices are expected to remain depressed in the medium term because of the abundant supply. Alliance is therefore well positioned to ship the excess gas to the higher-priced Chicago market, which supports the current high utilization rate of the pipeline. However, a number of factors could pose a challenge to contract future capacity on Alliance: (1) New pipeline projects, fractionation plants, recent pipeline reversals and interconnects in the United States are leading to cheaper Marcellus gas being shipped to the Midwest and Sarnia markets, increasing price competition that could affect netbacks for producers. (2) NGL production from Marcellus and Utica is forecast to increase, and this could result in Gulf Coast prices weakening further because of increased pipeline connectivity in the region. (3) The expansion of existing pipelines in the Montney and the commissioning of some of the large B.C. NGL export projects in the next five years are expected to create take-away capacity for higher natural gas flows to the west and could affect utilization of the pipeline’s capacity to transport to the east. DBRS notes that the re-contracting risk is accentuated because a substantial amount of the combined debt outstanding beyond 2020 (Alliance Canada and Alliance USA, approximately $800 million).

DBRS expects that the new shipping contracts from December 1, 2015, will affect the Company’s financial profile. Under the new service offering, Alliance will be transitioning from the previous cost-of-service regime, which allowed for pass-through of all prudently incurred costs and a return on deemed equity, to a negotiated fixed-toll market-based model whereby the Company assumes revenue and cost risk that could result in earnings volatility. Furthermore, operating cash flows are expected to be weaker, as the new tolls are approximately 25% lower compared with current tolls; however, some of the impact is expected to be offset through a combination of reduced operating costs and the incremental cash flows from higher tolls on seasonal and interruptible services (covering approximately 300 million cubic feet per day) compared with the previous authorized overrun service, which required shippers to pay only applicable fuel cost. The Stable trend on the ratings reflects DBRS’s expectation that Alliance will maintain a reasonable credit profile with financial metrics improving in the medium term, as the Company has a modest capital expenditure program and a majority of the debt is fully amortizing with a manageable repayment schedule. The senior secured debt at both Alliance USA and Alliance Canada contains cross-default provisions whereby an event of default by one entity constitutes an event of default by the other.

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.

The applicable methodologies are Rating Companies in the Pipeline and Diversified Energy Industry (January 2015) and DBRS Criteria: Guarantees and Other Forms of Explicit Support (February 2015), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.