Post-Enron scandal to cause shift in pipeline customers, Fitch says

US natural gas pipeline companies are apt to find utilities having high credit ratings and major integrated oil companies re-emerge as their primary customers, analysts with Fitch Inc. forecast.

By OGJ editors

HOUSTON, Oct. 29 -- US natural gas pipeline companies are apt to find utilities having high credit ratings and major integrated oil companies re-emerge as their primary customers, analysts with Fitch Inc. forecast.

Pipeline companies find themselves facing liquidity issues and regulatory uncertainties in the wake of the Enron Corp. scandal and resulting credit downgrades of merchant energy companies overall.

"In the past, Fitch has expressed some concern regarding a shift in the profile of a typical pipeline capacity holder to lower rated energy marketers and traders and independent power producers," said Hugh Welton and Ralph Pellecchia in a recent report.

"However in today's new environment, many energy merchants are expected to relinquish this capacity as part of overall efforts to downscale energy marketing and trading activities and preserve liquidity," the analysts said.

Although natural gas end-user dynamics are unlikely to change, they identified three trends likely to influence the credit quality of US natural gas pipeline companies in the near to intermediate term:
-- The negative overhang of parent company-level credit problems and liquidity issues.
-- Increasing regulatory risk and oversight.
-- Evolving counterparty credit risk.

Parent company credit issues
"There has been a decidedly negative tone to Fitch's rating actions in the gas pipeline sector over the past 12 months, with most rating and/or outlook changes directly linked to parent-company rating actions," Welton and Pellecchia said.

They blamed an "adverse market sentiment" toward energy marketing and trading, a severe credit crunch, ongoing litigation, and regulatory investigations for contributing to the credit problems.

For instance, many parent companies "operating in the energy merchant space" have watched their credit ratings fall into non-investment grade territory.

"Individual pipeline companies hit the hardest by these factors include subsidiaries of Enron, Williams Co. Inc., and CMS Energy Corp.," Welton and Pellecchia said.

If a pipeline is sold to a more highly rated company, then the pipeline's rating improves, as was the case with Northern Natural Gas Co., Omaha, Neb. Fitch raised Northern Natural's rating on Sept. 24 to BBB+ from B. The upgrade came after Dynegy Inc., Houston, sold Northern Natural to MidAmerican Energy Holdings Co., Des Moines, Iowa (OGJ Online, July 30, 2002).

Except for Enron, Fitch has not seen any evidence of overleveraging of a pipeline subsidiary that was attributable to parent company issues. But the Federal Energy Regulatory Commission is exploring whether to restrict parent-subsidiary financial relations.

"Specifically, under the FERC proposal, in order for a pipeline affiliate to enter into cash management or money pools with its parent, the parent and pipelines would have to be rated investment grade and the pipeline must maintain a minimum 30% equity ratio," Welton and Pellecchia said.

Increasing regulatory risks
FERC Administrative Law Judge (ALJ) Curtis L. Wagner said El Paso Corp. pipeline affiliate El Paso Natural Gas Co. (EPNG) exercised market power by withholding volumes of transmission power from California delivery points. The ALJ recommendation is to go before a full FERC hearing by Dec. 31 (OGJ, Sept. 30, 2002, p. 42).

"The EPNG allegation is noteworthy as it has unexpectedly shifted the center of blame for the California energy crisis away from the unregulated energy merchant sector to a regulated gas pipeline company," Welton and Pellecchia said.

Traditionally, FERC takes a "relatively light-handed approach" regulating the interstate natural gas pipeline sector, they noted, adding that FERC caps rates on the upside while offering no safety net on the downside. This is unlike utilities, which are granted regulatory protection by their respective state commissions.

"Fitch believes that the ALJ recommendation in the EPNG case adds a whole new element of regulatory risk to the pipeline sector. First and foremost, the recommendation creates significant negative overhang in the capital markets, a factor that could impair the ability of pipelines to refinance and/or fund capital expenditures, including expansion projects," Welton and Pellecchia said. "Moreover, the potential for an adverse ruling in the EPNG case is likely to frustrate ongoing efforts by several distressed (or bankrupt) energy merchants to divest pipeline assets."

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