DBRS Confirms Pacific Northern Gas Ltd. at BBB (low), Pfd-3 (low)

DBRS has today confirmed the Secured Debentures and Cumulative Redeemable Preferred Share ratings of Pacific Northern Gas Ltd. (PNG or the Company) at BBB (low) and Pfd-3 (low) respectively, both with Stable trends. The rating reflects PNG’s stable financial profile and the continued supportive regulatory environment in British Columbia. In August 2009, DBRS changed the trends on the debentures and preferred share ratings to stable from negative following the favourable regulatory decision which included a negotiated rate increase that incorporated the impact of the end of the Methanex termination payment amortization in October 2009. The full impact of the negotiated settlement and the subsequent regulatory decision to increase the low-risk utility benchmark return on equity (ROE) to 9.50% from 8.47% are both expected to be positive for PNG’s financial profile in the near to medium term.

PNG continues to maintain a stable credit profile with debt-to-capitalization under 50%, cash flow-to-debt of 17% and an EBIT coverage ratio of 2.6 times. While these financial metrics are generally consistent with those seen among higher-rated utilities in Canada, PNG’s rating remains low-investment grade due to its higher level of business risk, largely attributable to a challenging service territory. Economic conditions in the Western system remain challenging as many of the company’s industrial customers are engaged in the forestry sector which has been challenged globally. PNG has stated that prolonged decline in the forestry sector could negatively impact gas deliveries to lumber mills, as well as commercial and residential customers who directly or indirectly provide service to such mills. This weakness has been offset somewhat by growth in the Northeast service area, which has benefitted from strong activity in the oil and gas sector.

While DBRS expects that PNG will continue to maintain a stable financial profile, it also expects that the Company will continue to seek out prudent growth opportunities that will bring about diversification in such a way that its regulated debt-to-capital ratio remains at or below 50%. In pursuing that strategy, PNG recently announced the acquisition of the 9.8 MW McNair Creek “run of river” hydro-electric generation facility in British Columbia for $17 million. The acquisition cost will be funded by way of assumption of existing non-recourse debt of $9 million as well as utilization of PNG’s existing credit facilities for the remainder. The facility is located on the B.C. Sunshine Coast and has operated for more than five years, with generation sold under a long-term contract to B.C. Hydro. The transaction is expected to be accretive to earnings and cash flow positive in 2011. PNG’s debt-to-capital ratio is expected to increase to 50% from the current level of 45%, while its cash flow-to-debt and EBIT coverage metrics remain stable. The credit metrics are expected to remain adequate for the credit rating. Furthermore, DBRS expects PNG to continue to manage its dividend policy in light of its capex program and business risk profile in a way that preserves its financial and credit profile.

While the closure of West Fraser Timber Co. Ltd.’s Eurocan paper mill in Kitimat, B.C. is expected to negatively impact PNG’s Western service area, Euruocan is a much smaller industrial customer than Methanex. The Eurocan mill was closed in January 2010, however, West Fraser has not yet given PNG notice that it is cancelling transportation service.

In the longer term, the competitiveness of natural gas as a fuel and heating source still remains a focus for PNG in the Western service area; however, residential and commercial electricity rates are expected to rise in the near term according to B.C. Hydro’s Service Plan. The proposed electricity price increase and current low price gas environment are expected to keep PNG’s delivered natural gas rates competitive with electricity rates in PNG’s Western system.

While PNG continues to pursue the Kitimat to Summit Lake Looping Project (KSL), no commercial arrangements have been made, and the Company continues to expense its share of the development expenditure, which is immaterial. DBRS also notes that should PNG decide to proceed with KSL, the Company's structure and financial profile will likely change and implications for the credit rating will be evaluated at that time.

PNG’s liquidity remains adequate for the ratings, supported by three bank credit facilities totaling $55 million, which mature in 2011, and a $35 million five-year revolving term facility that matures in 2015.

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

The applicable methodology is Rating Utilities (Electric, Pipelines & Gas Distribution), which can be found on our website under Methodologies.

This is a Corporate rating.