TransCanada Swaps Show Keystone Serves as Oil Drop Buffer

Bonds of TransCanada Corp. are outperforming those of larger rival Enbridge Inc. as a court decision boosts speculation it will succeed in building the controversial Keystone XL pipeline from Alberta’s oil sands to the Gulf Coast.

Nebraska’s highest court cleared Keystone’s path through the state last week, sending the matter back to the U.S. State Department, where it has been under review since 2008. The cost of default protection on TransCanada bonds tumbled 20 basis points to 123, helping them to recover from the most-expensive level in 5 ½ years on Jan. 6. Enbridge, which is battling opposition to its pipelines through Western Canada and the rout in oil, is treated as if it had junk ratings by traders of credit-default swaps, according to data from Fitch Solutions.

“It improves the growth outlook for TransCanada,” David Lund, senior credit analyst at Thrivent Financial for Lutherans, which holds bonds of Enbridge and TransCanada, said by phone from Minneapolis Jan. 9 after the decision. “Because of its more stable operating trends, I’d expect TransCanada to outperform peers, and the court victory certainly helps them.”

TransCanada and Enbridge are racing to build conduits to bring landlocked Alberta oil to new markets including Asia. Canada, home to the world’s third-largest pool of reserves, is depending on proposed routes like Keystone XL to the Gulf Coast and Enbridge’s Northern Gateway to the Pacific and another pipeline linking Oklahoma to Texas to boost exports.

Borrowing Needs

A collapse in the price of oil, down more than 50 percent since June, could further complicate those plans by increasing borrowing costs in the bond market. The pipelines are opposed by environmental groups concerned they will worsen climate change and pose a risk to water supplies.

Enbridge, Canada’s largest oil-pipeline owner and issuer of corporate bonds, forecasts it will need as much as C$15 billion ($12.6 billion) of new debt to meet spending needs of C$44 billion through 2018 on new pipelines and power projects.

“The CDS market is very sensitive to news and any kind of negative or positive information that comes out about pushback they’re getting on various projects,” Diana Allmendinger, a New York-based director at Fitch Solutions, a unit of Fitch Group, said by phone on Jan. 9. “It’s almost inevitable that CDS on energy companies will receive a negative bias on concerns about oil prices.”

Rating Equivalent

Even though pipeline operators aren’t directly exposed to commodity prices, the slump in oil could lead to reduced production and less pipeline usage. It also raises the specter they won’t be able to demand the same toll charges as before of cash-strapped oil producers.

The cost to protect Enbridge bonds from default for five years surged to 268 basis points Jan. 9, the highest level since May 2009. The contracts imply a rating six levels below its actual grade of A- by Standard & Poor’s. Moody’s Investors Service rates Enbridge one level lower than S&P at Baa1.

“The market is treating this issuer as a below-investment-grade entity,” Allmendinger said. “Spreads on oil and gas companies on the whole have taken a hit due to falling oil prices, though CDS movement on Enbridge has significantly outpaced the broader sector over the same time period.”

One reason why traders may be penalizing Enbridge more than peers: the company’s decision last month to shift income-producing units into a trust to boost dividends. The cash-producing assets are now further away from bond-issuing entities, Thrivent’s Lund said.

‘Active Dialogue’

“We are aware of bondholder concerns since the announcement and have been in active dialogue with investors and will continue to communicate additional details as they develop,” Graham White, a spokesman at Enbridge, said Jan. 9 in an e-mail.

The plan sparked a rating review by S&P, which cited “a potential for financial metrics to weaken further due to the additional dividend expense” in a statement Dec. 4.

“Their strategy of shifting assets into underlying operating companies creates a challenge because you won’t have as many assets at the operating company level,” Lund said. “BB- certainly seems a little low, but if Enbridge drops down all its assets, then the parent company won’t be as highly rated as it is.”

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