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

DBRS Limited (DBRS Morningstar) confirmed Enbridge Pipelines Inc.’s (EPI or the Company) Issuer Rating and Medium-Term Notes & Unsecured Debentures rating at “A” and its Commercial Paper (CP) rating at R-1 (low), all with Stable trends. The rating actions reflect (1) the strong competitive position of the Enbridge System/U.S. Lakehead Pipe Line System (Enbridge/Lakehead System), the Canadian portion of which (the Canadian Mainline) is owned by EPI; (2) strong results to date under the 10-year Competitive Tolling Settlement (CTS) expiring on June 30, 2021, despite current declines attributable to effects from the Coronavirus Disease (COVID-19) pandemic and the concurrent crude oil price war between OPEC, led by Saudi Arabia, and Russia; (3) expected completion of a successor agreement to the CTS on terms that maintain the Enbridge/Lakehead System’s strong competitive position; and (4) expected maintenance of its credit metrics at levels consistent with the current ratings.

The Enbridge/Lakehead System has consistently provided the most economic route for Western Canadian Sedimentary Basin (WCSB) producers shipping crude oil to U.S. Midwest (PADD II)/Chicago and has transported about two-thirds of Canadian crude oil exports into the United States. Approximately 70% of WCSB oil sands production can be transported to connections with the Enbridge/Lakehead System. The Canadian Mainline generated 92% of EPI’s DBRS Morningstar-adjusted segment EBITDA in the last 12 months (LTM) ending March 31, 2020. EPI’s ratings continue to be based on the business and financial risk profiles of its regulated Canadian Mainline, which fully supports EPI’s direct external debt.

The CTS provides for a joint toll for volumes originating in Western Canada that are also transported on the Lakehead System. Under the International Joint Tariff (IJT) agreement, joint tolls are allocated based on the existing Lakehead System rate structures; therefore, any shortfall in tolls (e.g., caused by lower throughput) under the CTS could reduce tolls for the Canadian Mainline. The Canadian Mainline has benefited in recent years from rising throughput caused by growing crude oil production, Canadian Mainline capacity additions and delayed approvals of competing pipeline projects. While the current coronavirus pandemic has resulted in significant declines in Canadian Mainline throughput in Q2 2020, and to date in Q3 2020, DBRS Morningstar expects the negative impact to be relatively temporary as crude oil deliveries recover towards Q1 2020 levels by the end of 2020.

DBRS Morningstar notes that the CTS results in volume and operational risks to the Canadian Mainline through its fixed-toll methodology. Although mitigated by certain minimum-volume thresholds, the CTS could result in lower earnings and cash flow for EPI as direct owner of the Canadian Mainline in the event of material disruption in service availability on the Canadian Mainline, loss of significant volumes caused by lower-than-expected end-user demand (as experienced during the current coronavirus pandemic) or higher shipments by competing pipelines or by rail.

DBRS Morningstar notes that EPI is currently in the regulatory process for a new Enbridge/Lakehead System contractual tolling arrangement to replace the CTS in mid-2021 that would, if approved, reduce EPI’s exposure to volume risk through the implementation of long-term take-or-pay contracts covering 90% of pipeline capacity.

DBRS Morningstar expects EPI’s credit metrics to remain consistent with the current ratings as it benefits from placement of the Canadian portion of the Line 3 Replacement (L3R) Program into service on December 1, 2019, and awaits completion of the U.S. portion of L3R (U.S. L3R) by Enbridge Energy Partners, L.P. (EEP; rated BBB (high) with a Stable trend by DBRS Morningstar). The $4.9 billion Canadian portion was funded in a manner consistent with the Company’s Canadian Mainline capital structure target of 55% debt and 45% equity. As of March 31, 2020, EEP had spent approximately USD 1.4 billion on the U.S. L3R (which currently has a total cost estimate of USD 2.9 billion subject to potential cost increase, given ongoing delays). Costs of the full L3R program will be recovered through a 15-year toll surcharge mechanism under the CTS. Canadian Mainline’s average toll in U.S.-dollar terms currently benefits from the temporary surcharge added to the Canadian portion of the toll on December 1, 2019, and will benefit from the permanent toll increase once the U.S. L3R is placed into service, likely in the second half of 2021.

Over the medium term, DBRS Morningstar believes that a positive rating action is unlikely. A negative rating action is also unlikely, but could occur over the medium term if EPI’s credit metrics weaken substantially below current levels on a sustained basis. This could potentially occur if the negative effects on crude oil supply and demand related to the coronavirus pandemic and crude oil price war persist over a longer period of time than currently anticipated and/or if the successor agreement to CTS is less favourable to the Canadian Mainline’s competitive position combined with placement into service of both major competing pipeline projects as early as 2023. Such a scenario could result in the Canadian Mainline becoming a “swing pipeline” in the event of stagnant industry volumes as shippers would be more likely to continue shipping on pipelines upon which they have made contractual take-or-pay commitments than pipelines without such commitments.

ESG Considerations
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodologies are Rating Companies in the Pipeline and Diversified Energy Industry (November 26, 2019), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), and DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 10, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at [email protected].

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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