Morningstar DBRS Assigns Issuer Rating and Senior Notes Credit Rating of A (low) to Coastal GasLink Pipeline Limited Partnership

DBRS Limited (Morningstar DBRS) assigned an Issuer Rating of A (low) to Coastal GasLink Pipeline Limited Partnership (CGL or the Issuer), and a credit rating of A (low) to the $7.2 billion fixed-rate, first-lien senior secured Senior Notes (the Senior Notes) issued by CGL. All trends are Stable. The Senior Notes are issued to refinance the $8.2 billion construction loan that helped pay the capital costs of constructing the Coastal GasLink pipeline, a $14.4 billion, 670-kilometre (km), 2.1-billion-cubic-feet-per-day (bcf/d) natural gas pipeline. Future bond issuances in the series, intended to refinance an anticipated additional loan for the planned Cedar expansion project, are also considered in the credit rating. The Issuer is formed as a single-purpose, limited partnership established to develop and operate the Coastal GasLink Pipeline System and related facilities (the Pipeline or the Project). Series A to I of the Senior Notes will be interest only with staggered maturity dates, whereas Series J and K will amortize to mature by 2049. Although the credit rating is currently assigned to the initial series of Notes, it is based on an assessment of the credit and default risks of the entire proposed refinance program, including the revolving bank facility intended to be put into place and drawn upon to pay down the Senior Notes as they mature over a 25-year period.

Phase 1 consisted of constructing the natural gas pipeline and related facilities that will deliver natural gas from northeastern BC to the LNG Canada liquefied natural gas export facility (the LNG Canada Facility), currently under construction near Kitimat, BC, with an initial capacity of 14 million tons per year. The Pipeline was constructed and will be operated by CGL, which is indirectly owned by TC Energy Corporation (TC Energy) via TransCanada PipeLines Limited (rated BBB (high) with a Stable trend by Morningstar DBRS), Alberta Investment Management Corporation, and National Pension Service of Korea via an investment vehicle managed by Kohlberg Kravis Roberts & Co., L.P. (collectively, the Sponsors). The Cedar expansion, which is expected to reach Financial Investment Decision (FID) sometime in 2024 with construction to commence thereafter, will add another 0.4 bcf/d of capacity.

The A (low) credit ratings are underpinned by (1) the expected highly predictable cash flows under the long-term revenue contracts, (2) the Project's essentiality, (3) high credit quality counterparties, and (4) expected straightforward and routine operations undertaken by a qualified operator/Sponsor. The credit ratings are constrained by the (1) construction risks around the Cedar expansion, (2) complexity and exposure to interest rate risk in the refinancing structure, (3) potential uncertainty around unresolved land claims with Indigenous groups, and (4) residual ramp-up risk. Further, until the Cedar expansion project has reached FID, a material change in the terms of the expansion could affect the credit rating.

CGL will use the net proceeds of the Senior Notes to repay the Phase 1 construction loan. The refinance of the Cedar construction loan is explicitly built into the refinancing plan through two planned additional issuances in the latter part of the decade. Bond issuance amounts in excess of this, required to refinance both loans, are subject to a credit rating agency confirmation (RAC), reducing the risk of over-leveraging the Project. Morningstar DBRS views there are adequate provisions to manage interest-rate and refinancing risks on the Cedar loan.

CREDIT RATING DRIVERS
A credit rating upgrade is unlikely given the overall complexity of the transaction, particularly the uncertainties around the Cedar expansion, the proposed refinancing structure, and current lack of operating history related to the ramp-up and commissioning risks of Phase 1.

A negative credit rating action may be triggered by a material increase in any risk factor outlined, including material underperformance in either Phase 1 operations or execution of the Cedar expansion, or interest rate risk during either the Cedar refinance period or paydown of the refinance debt and debt-smoothing facility.

FINANCIAL OUTLOOK
The Project is expected to generate stable cash flows from its cost of service (COS), take-or-pay arrangement backed by creditworthy Anchor Shippers. The ability to pass-through all operating and maintenance costs reduces the Project's exposure to sustained cost increases; although, net cash flow variability in any one year may still occur from operating cost overruns (which are recoverable in the following year). Potential exposure to Anchor Shipper credit risk is mitigated by provisions in the tolling agreements that ensure the full amounts are paid even when a Shipper is in default.

Shippers will continue to make cash allowance for funds used during construction, payments that cover operating costs, and Phase 1 loan-interest payments until toll revenue payments begin, for an initial contract term of 25 years. Net operating cash flow generated from the toll payments will serve to supplement any refinance bond issuance and will thereafter be used to pay down the refinance debt. Revenue from the Cedar expansion is expected to begin in the latter half of the decade.

Once in operation with both loans fully refinanced, the refinance debt plan is structured to pay down the refinance bonds via a Debt Smoothing Facility (DSF) that will be drawn to pay maturing bullet bonds. Both the DSF and the amortizing bonds will be paid down using operating cash flow, and are structured in the Sponsor case to achieve a target flat debt service coverage ratio (DSCR) of 1.21 times (x). Rating case assumptions result in a flat DSCR of 1.28x because of the lower amount of debt raised to restrict the amount of debt to what is needed to refinance the loans only, combined with interest rate buffers added.

CREDIT RATING RATIONALE
(1) High quality and highly predictable cash flows underpinned by the Transportation Services Agreements
The credit rating is supported by Morningstar DBRS' view of the high quality and highly predictable cash flows stemming from the Project's commercial structure as a COS, take-or-pay contract, and pass-through of virtually all operating and maintenance costs, with operating cost overruns generally subject to true up the following year, thus mitigating the risk of long-term cost overruns. Service-level performance standards, while stringent, are deemed by the Independent Engineer to be market-standard and highly achievable, bolstered by the experience and track record of TC Energy as operator.

(2) Critical infrastructure project linking Western Canadian natural gas to key Asian markets
The Western Canadian Sedimentary Basin (the basin) is currently the second-largest natural gas producing region in North America, and the Pipeline is an integrated part of the $40-plus billion LNG Canada project, and is the sole transportation pipeline supplying natural gas from the basin to LNG Canada's liquefaction facility in Kitimat. Long-term liquified natural gas (LNG) demand from Asian markets is projected to remain strong over the life of the financing, evidenced by four of the five Anchor Shippers being Asian shippers (with several being notably state-owned or state-affiliated), providing strong mitigation of stranded asset risk.

(3) High credit quality Anchor Shippers
The five Anchor Shippers that are the shareholders/partners in the LNG Canada consortium are also global leaders in the LNG market, representing nations with strong long-term LNG demand and possessing good credit quality profiles in the high investment-grade range.

(4) Expected routine operations with a strong operator
TC Energy is a considered a leader in the development and operation of energy infrastructure with a utility-like business model. It operates one of North America's largest natural gas pipeline networks, encompassing some 93,300 km of pipelines, that supplies 25% of natural gas consumption in North America. Morningstar DBRS views this operating track record and history to be an important aspect of the creditworthiness of the Project.

Challenges
(1) The Cedar expansion
The expansion introduces construction risk because of shared collateralization and risk of cross default between the Phase 1 Pipeline with the Cedar expansion financing; potential exposure to the credit of the Sponsors, particularly TC Energy, during the construction period of the expansion; and potential risks from the construction and commissioning of the expansion, which have to be done in parallel with Phase 1 operations. Morningstar DBRS views these risks as being mitigated through conservative cost and schedule estimates, provisions of the Expansion Project Development Agreement, Sponsor equity commitments, and Sponsor cure provisions.

(2) Refinancing structure
The bond financing structure is more involved than usually seen in project financings, and exposes the structure to interest rate risk both from underlying Government of Canada bond rates and CORRA rates, and potential risk of market disruption. Based on sensitivity analysis, Morningstar DBRS believes that the structure is capable of absorbing higher interest rates up to 400 basis points (subject to any additional debt that CGL may issue, which is in turn the subject of a RAC).

(3) Potential transfer of McLeod Lake Indian Band (MLIB) lands
Part of the expansion is situated on land that could be the subject of a land claim, whereby full ownership could potentially transfer from BC to the MLIB Indigenous group over the course of the Project. The Sponsors have presented a legal memo to the effect that the land tenure payments (i.e., lease payments) that currently go to the Province of British Columbia would instead go to MLIB if the land transfer is effected, and that land transfer program is designed to keep tenure holders whole.

(4) Phase 1 commissioning and ramp-up risks
A small element of commissioning and ramp-up risk remains, including a residual exposure to the Sponsors credit risk until LNG Canada's facility has reached completion. In addition, CGL is still liable for penalties during the commissioning period of the LNG Canada Facility if required commissioning gas is not delivered during this period. This phase will not begin until the LNG Canada Facility is ready to accept gas, making the Project's successful completion of this milestone and removal of this residual risk exposure somewhat dependent on the schedule of a third party.

Once in operations, CGL must demonstrate successful ramp-up to contracted capacity and sustained failure to complete the ramp-up will eventually result in a breach of service-level requirement specifications.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030.

RATING DRIVER FACTOR AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of Rating Drivers
In the analysis of CGL, the Rating Driver factors listed in the methodology are considered in the order of importance.

(B) Weighting of FRA Factors
In the analysis of CGL, the FRA factors listed in the methodology are considered in the order of importance.

(C) Weighting of the BRA and the FRA
In the analysis of CGL, the FRA carries greater weight than the BRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Project Finance (April 15, 2024),
https://dbrs.morningstar.com/research/431188

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 info-DBRS@morningstar.com.

The credit ratings were initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for these credit rating actions.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with these credit rating actions.

These are solicited credit ratings.

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

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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