DBRS Limited (DBRS Morningstar) confirmed Enbridge Pipelines Inc.’s (EPI or the Company) Issuer Rating and Senior Unsecured Notes rating at “A” and its Commercial Paper 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 or Mainline), the Canadian portion of which (the Canadian Mainline) is owned by EPI; (2) DBRS Morningstar's expectation that, under the newly negotiated settlement (the Settlement), operating results will remain supportive of EPI's key credit metrics despite likely being reduced from very strong levels under the currently effective Competitive Tolling Settlement (CTS), while enhancing the Mainline's competitiveness through a lower toll for shippers than under the CTS; and (3) the mature nature of the Canadian Mainline operations' results in very low capital expenditures (capex) requirements, resulting in substantial financial flexibility since EPI placed the Canadian portion of the Line 3 Replacement (L3R) Program into service on December 1, 2019.
The Enbridge/Lakehead System has consistently provided the most economic route for Western Canadian Sedimentary Basin producers shipping crude oil to the U.S. Midwest/Chicago and has transported about two-thirds of Canadian crude oil exports into the U.S. The Canadian Mainline generated 93% of EPI’s DBRS Morningstar-adjusted segment EBITDA in 2022.
The CTS, which expired on June 30, 2021, but remains in effect on an interim basis, provides for a joint toll for volumes originating in Western Canada that are also transported on the U.S. Lakehead Pipe Line System (the Lakehead System). Under the International Joint Tariff 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.
Although mitigated by certain minimum-volume thresholds, the CTS could result in lower earnings and cash flow for EPI as the 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, or higher shipments by competing pipelines or by rail.
On May 4, 2023, Enbridge Inc. (rated BBB (high) with a Stable trend by DBRS Morningstar and the 100% owner of EPI) announced that it had reached an agreement in principle on the Settlement with shippers for incentive tolls on the Mainline. The Settlement covers both the Canadian Mainline and the Lakehead System over a 7.5-year term through 2028.
DBRS Morningstar estimates that, had the Settlement been in effect in 2022, the Hardisty to Chicago Heavy Barrel Toll would have been approximately 14% lower than it was under the CTS (USD 5.40 per barrel), with the Canadian Mainline bearing the brunt of the toll reduction.
Consequently, DBRS Morningstar expects weaker EPI earnings and cash flow in 2023, and potentially in 2024 as well, compared with 2022, based on the nature of the toll settlement reached with Canadian Mainline shippers and the pace of ramp-up of the Government of Canada’s (rated AAA with a Stable trend by DBRS Morningstar) Trans Mountain Pipeline Expansion Project operations beginning in Q1 2024. EPI's earnings and cash flow are likely to partially recover in 2025. However, even in this scenario, DBRS Morningstar expects EPI's credit metrics to remain supportive of the current ratings. DBRS Morningstar also notes that the lower toll under the Settlement will enhance the competitiveness of the Mainline.
Finally, EPI’s financial profile was strengthened upon completion of the large construction program for the Canadian L3R and its placement into service on December 1, 2019. Incremental cash flow from the project, combined with the significant decline in future capex requirements, provides EPI with substantial financial flexibility. While EPI continues to pay large dividends to its parent, balance-sheet leverage has been maintained near its targeted range.
Over the medium term, DBRS Morningstar believes that a positive rating action is unlikely. A negative rating action is also unlikely but could occur if approval of the new Settlement were to result in a larger than currently expected negative impact on EPI's credit metrics on a sustained basis.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).
All figures are in Canadian dollars unless otherwise noted.
DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Companies in the Pipeline and Midstream Energy Industry (November 3, 2022; https://www.dbrsmorningstar.com/research/404917)
-- DBRS Morningstar Global Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (February 24, 2023; https://www.dbrsmorningstar.com/research/410196)
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.
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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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