Canada’s Pipeline Transportation System 2016
Financial Integrity of Pipeline Companies
The tolls discussed in the previous sections are designed to allow pipeline companies to recover capital and operating costs, service debt, and provide a return to its investors. Financial aspects of pipeline companies, such as debt and equity metrics, are important to maintaining their systems, attracting capital to build new infrastructure, and meeting the market’s evolving needs.
The following sections review and discuss factors relevant to the pipeline transportation system’s financial integrity.
A common equity ratio is the percentage of common equity in a company's capital structure.Note 19 This ratio is related to a company's financial risk, which is associated with a company's use of debt. Holding other things constant, higher common equity ratios decrease financial risk by increasing the likelihood of a company being able to meet its financial obligations, including debt service.
Deemed Common Equity Ratios
When the Board approves a Group 1 company's tolls in the absence of a negotiated settlement, it typically approves a return on equity (ROE) and a deemed common equity ratio for the regulated entity. Parent companies often have a variety of business lines consolidated into one capital structure. However, the Board deems an appropriate common equity ratio for the assets which it regulates.Note 20
Alternatively, some Group 1 pipeline companies negotiate a comprehensive tolls settlement with their shippers that does not expressly identify a capital structure and return on equity.Note 21 In these instances, the Board considers the overall settlement for approval.
Where available, the deemed common equity ratio for NEB Group 1 pipeline companies from 2008 to 2014 are shown in the appendix in section 11. These ratios have not changed since 2011.
Return on Common Equity
For NEB-regulated pipeline companies, ROE is determined through either adjudication or negotiation. Actual ROEs achieved by the pipeline companies may vary for numerous reasons such as throughput changes, incentives, profit-sharing mechanisms, and cost variances.
The achieved ROE for several NEB-regulated pipeline companies from 2008 to 2014 are shown in the appendix in section 11. ROE as determined by the RH-2-94 formula is also included for reference.Note 22
Actual ROEs are filed with the NEB for most Group 1 companies, while some companies are operating under negotiated settlements and are not required to report actual ROE. NEB staff examine actual ROE patterns, operations spending, maintenance, and feedback from shippers to identify any returns that may be inappropriate or could potentially result in unjust tolls.
Financial risk is based on a company's use of debt and other obligations where fixed payments are used. This differs from business risk, which is attributed to the nature of a particular business activity and, for pipelines, typically includes supply, market, regulatory, competitive, and operating risks.
Financial risk increases as the proportion of debt and interest payments increases relative to equity and cash flow. A company's financial risk may be described by ratios such as interest coverage, fixed-charges coverage, and cash flow-to-total debt and equivalents.
Interest and Fixed-Charges Coverage Ratios
An interest coverage ratio describes a company's ability to make interest payments and repay its debt obligations. It is defined as earnings before interest and taxes divided by interest charges. Similarly, a fixed-charges coverage ratio describes the ability to make interest payments and repay debt obligations, and additionally considers some of the other fixed payments a company is obligated to make. It is defined as earnings before interest, fixed charges, and taxes, divided by interest and fixed charges. Higher ratios indicate a higher likelihood the company will meet its obligations and may indicate greater borrowing capacity.
The fixed-charges coverage ratios for some NEB-regulated pipeline companies or pipeline systems, as calculated by DBRSNote 23, are shown in the appendix in section 11. In 2014, the average fixed-charges coverage ratio for these companies was 4.3, up from 2.7 in 2010. This indicates that, on average, the ability of these companies to pay fixed charges from earnings was higher in 2014 than in 2010. The difference can mostly be attributed to the reduction of debt by Express and Trans-Northern. Average fixed-charges coverage ratios of Alliance, Enbridge, M&NP, NGTL, Trans Québec & Maritimes Pipeline (TQM), Westcoast and the TransCanada Mainline increased by 9% over the same period.
Cash Flow-to-Total Debt and Equivalents Ratio
The cash flow-to-total debt and equivalents ratio is another way of describing a company's ability to meet its debt obligations and fixed payments. It is defined as operating cash flow divided by total debt and debt equivalents. Again, higher ratios indicate an increased likelihood of a company being able to meet its obligations and indicate greater borrowing capacity.
The cash flow-to-total debt and equivalents ratios for some NEB-regulated pipeline companies or pipeline systems, as calculated by DBRS, are shown in the appendix in section 11. The average ratio for these companies was 30% in 2014, up from about 18% in 2010. The rising trend of debt service coverage ratios is primarily due to continued debt reduction. As a notable example, Express increased its cash flows from $75 million in 2010 to over $175 million in 2014 while simultaneously reducing its total debt from $300 million to under $185 million. Conversely, Enbridge’s debt service coverage ratios have declined, which is partly why Standard & Poor's (S&P) recently downgraded its credit rating from A- to BBB+.
In Canada, pipeline company credit ratings are generally determined by three independent credit rating agencies: DBRS, S&P, and Moody's. Not all pipeline companies are rated by each agency. Credit ratings provide an assessment of the probability a debt issuer will live up to its obligations and provides an indication of the financial integrity of the rated company.
A company's credit rating generally reflects the consolidated operations of the entire company, not just the regulated portion. Consequently, the credit ratings for companies such as Enbridge, TransCanada, and Westcoast, which have both regulated and non-regulated operations, may be influenced by their non-regulated lines of business. Credit ratings are also somewhat subjective in that a company's ratings are the expert opinion of the credit rating agency and the same company may receive different ratings from different agencies. The appendix in section 12 compares the rating scales for DBRS, S&P, and Moody's.
The credit ratings for most Group 1 pipeline companies are shown in the appendix in section 12. All remained investment grade, but some companies’ ratings were downgraded between 2010 and 2015.
- In March 2011, DBRS downgraded Enbridge Pipelines to “A” from “A(high)”, which followed the announcement by Enbridge of a 10-year Competitive Toll Settlement for its Canadian Mainline.
- In June 2013, TCPL’s unsecured debentures rating, as well as NGTL’s medium-term notes and unsecured debentures rating, were downgraded to “A(low)” from “A”. The NGTL downgrade reflects DBRS’s view that continued financial and liquidity support from TCPL is key to NGTL’s long-term debt rating.
- In October 2015, Alliance Pipeline Limited Partnership’s rating was downgraded two notches from “A(low)” to “BBB”. The original 15-year contracts that underpinned the pipeline’s construction expired in November 2015. Alliance has re-contracted the majority of the pipeline’s capacity, but 60% of the new shippers are not of investment grade credit quality. This exposes Alliance to greater counterparty risk compared to the original contracts, of which 85% were signed with investment grade shippers. In the rating downgrade, DBRS also referred to Alliance’s credit concentration risk and the shorter duration of contracts.
S&P credit ratings for several Group 1 pipeline companies are shown in the appendix in section 12. All remained investment grade, but some companies’ ratings were downgraded between 2010 and 2015.
- In November 2013, S&P downgraded Westcoast to a “BBB” rating from “BBB+” following the same downgrade of its parent, Spectra Energy Corp. These actions reflected corporate restructuring (i.e. drop-down of some of Spectra’s U.S. assets to another subsidiary). S&P saw this as weakening Spectra’s credit quality, as its creditors were now one step away from assets with stable cash flow.
- In June 2015, S&P lowered its ratings on several Canadian Enbridge companiesNote 24, with Enbridge Pipelines’ long-term debt rating changing from “A-“ to “BBB+”. S&P viewed Enbridge’s financial risk profile as “aggressive”, referring to declining cash flow from operations and $40 billion in capital spending planned before 2020.
Moody’s rating histories for several Group 1 pipeline companies are provided in the appendix in section 12. All remain investment grade, but some companies’ ratings were downgraded between 2010 and 2015.
- Moody’s downgraded Alliance’s credit rating in 2014 and again in 2015, for similar reasons to those that prompted DBRS’s rating downgrade. In its 2015 announcement, Moody’s noted that the downgrade was only one notch due to progress Alliance made re-contracting throughput volumes on the pipeline.
- In June 2015, Moody’s downgraded the credit rating of Enbridge Inc. (the parent company of Enbridge Pipelines) from “Baa1” to “Baa2”. Moody’s viewed Enbridge’s changes to its corporate structure and distribution policy as a shift toward favoring shareholders at the expense of creditors.
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