TEXT-S&P raises Plains All American Pipeline ratings

Wed May 30, 2012 12:03pm EDT

Overview	
     -- U.S. midstream energy company Plains All American Pipeline     
has grown significantly in size and diversity, and we expect it will maintain
strong financial performance with appropriate financial management for the 'BBB'	
rating. Plains' recent acquisition of BP North America's Canadian natural gas 	
liquids business complements Plains' existing assets and is immediately 	
accretive to cash flow although it modestly increases exposure to commodity 	
prices.	
     -- We are raising Plains' corporate credit rating to 'BBB' with a stable 	
outlook. At the same time, we are raising the issue-level rating on Plains' 	
senior unsecured debt to 'BBB'.	
     -- The stable outlook reflects Plains' increasing size and asset 	
diversity, its fee-based activities that will continue to account for most 	
cash flows, its stable financial performance, and conservative financial 	
policy.	
	
Rating Action	
On May 30, 2012, Standard & Poor's Ratings Services raised its corporate 	
credit rating on Houston-based midstream energy company Plains All American 	
Pipeline L.P. to 'BBB' from 'BBB-'. At the same time, we raised the 	
issue-level rating on Plains' senior unsecured debt to 'BBB'. The outlook is 	
stable.	
	
Rationale	
We base the ratings upgrade on Plains' improved credit profile, resulting from 	
increasing size and asset diversity, its growing fee-based activities, and its 	
strong financial performance. The partnership has steadily increased its 	
scale, geographic footprint, and diversity of its assets through organic 	
capital spending projects and acquisitions that have been closely aligned with 	
its core competencies, and funded in a balanced manner. Plains' financial 	
performance has also improved as a result of advantageous commodity prices and 	
solid volume flows.	
	
We expect 2012 debt to EBITDA on an adjusted basis (excluding short-term debt) 	
below 3.5x, continuing its recent strong financial performance. Long-term debt 	
to EBITDA was about 3.6x on a trailing 12-month basis as of March 31, 2012. 	
This ratio excludes Plains' short-term bank debt to the extent short-term 	
hedged inventories cover the borrowing. Including the short-term borrowing, 	
debt to EBITDA was 4.1x as of March 31, 2012. As noted below, we look at both 	
ratios but place less emphasis on Plains' metrics that include short-term 	
debt. However, we also note that the metrics have benefited from robust cash 	
flows in its supply and logistics segment that may not be sustainable. We use 	
more conservative projections for this segment, recognizing its inherent 	
volatility, although a base level of cash flow is assumed based on the 	
partnership's gathering business at more normalized levels. In 2011, the 	
supply and logistics business outperformed and revenues more than doubled to 	
$2.05 per barrel from 90 cents per barrel. This was primarily driven by 	
favorable pricing differentials, as well as other market-related 	
opportunities. We do not assume these market opportunities to be permanent and 	
project that cash flows from this segment will decline in the future. 	
Liquidity remains adequate, with Plains demonstrating its ability to access 	
both the debt and equity markets with sizable issuances of $1.25 billion and 	
$455 million, respectively, in recent months.	
	
In addition, recent acquisitions and growth projects complement Plains' 	
existing business, are accretive to cash flow, and offer future expansion 	
opportunities at attractive multiples. The BP acquisition in particular 	
introduces additional commodity exposure. However, we believe it is modest 	
relative to Plains' overall size at less than 10% of cash flow, and that 	
portions of the business, including transportation, storage, and 	
fractionation, could be fee-based if unbundled from the integrated business. 	
The company funded its BP acquisition in a balanced manner by issuing senior 	
unsecured debt totaling $1.25 billion, and simultaneously entering into an 	
equity distribution agreement to raise up to $300 million of equity per year. 	
The partnership also demonstrated a willingness to significantly prefund by 	
raising equity. 	
	
Standard & Poor's bases its ratings on Plains on a business risk profile we 	
designate as "strong" and a financial risk profile we designate as 	
"significant". The business risk profile reflects the partnership's large and 	
diverse network of pipelines and terminals, which provides stable cash flow, 	
and management's good track record of funding expansion capital projects and 	
acquisitions in a balanced manner. The financial profile reflects the inherent 	
cash flow volatility in its supply and logistics business segment, and the 	
master limited partnership (MLP) structure, which gives Plains incentive to 	
grow through capital expansions and pay out the vast majority of available 	
cash flow to its unitholders each quarter.	
	
As an MLP, Plains requires consistent cash flow to meet its targeted 	
distributions. Assuming modest growth in the transportation and facilities 	
segments, more normalized supply and logistics earnings, and a conservative 	
contribution from its acquisitions, we expect Plains to generate about $1.7 	
billion to $1.8 billion of EBITDA in 2012, with about $300 million in 	
projected interest expense and about $160 million in maintenance capital. As a 	
result, we expect distribution coverage of about 1.3x, which has historically 	
ranged from 1.1x to more than 1.5x. During volatile markets, the marketing 	
division has historically performed well, allowing the partnership to generate 	
stronger-than-expected cash flows that it in turn has reinvested in the 	
business.	
	
The company's strengths include:	
     -- Stable cash flows in core transportation and facilities business lines;	
     -- Competitive geographic position, particularly in the PADD II (Midwest 	
region); 	
     -- Sizable terminal and storage operations in Cushing, Okla., the 	
delivery point for the New York Mercantile Exchange-traded West Texas 	
Intermediate crude oil; and	
     -- The conservative financial policy has driven debt to EBITDA below 4x 	
while maintaining earnings growth.	
	
Weaknesses include:	
     -- A significant amount of profits come from the supply and logistics 	
business, which includes some trading operations that can be volatile; 	
     -- Exposure to volume declines in all three segments where revenues 	
generally do not have take-or-pay or cost-of-service provisions; and	
     -- Strong incentives, as an MLP, to distribute essentially all cash after 	
debt service and maintenance capital spending.	
	
Plains operates in three broad business segments: transportation (over 40% of 	
our expected 2012 adjusted EBITDA), facilities (about 30%), and supply and 	
logistics (under 30%). Under normalized (or "baseline") market conditions, we 	
expect the stable transportation and facilities segments to generate roughly 	
three-quarters of consolidated EBITDA, noting that this percentage can be 	
significantly lower when the supply and logistics business outperforms. 	
	
The steady cash flow from the transportation and facilities segments is 	
favorable to Plains' credit profile. In these segments, Plains generates fees 	
for transporting crude oil and refined products through pipelines and 	
gathering systems, and for storage, terminal, and throughput services 	
involving crude oil, refined products, and liquefied petroleum gas (LPG). 	
Plains also includes its small, but growing, natural gas storage business in 	
the facilities segment. The natural gas storage business is housed at PAA 	
Natural Gas Storage L.P., a separate, publicly traded MLP of which Plains is 	
the general partner and owns the majority of the limited partnership units. 	
For year-end 2012, we expect higher volumes in the transportation segment on 	
the Basin and Permian systems, partially offset by lower volumes on the 	
Capline systems. The company has announced a number of growth projects, 	
including expansions in the Mid-Continent, Basin, South Texas, and Bakken 	
regions.	
	
The supply and logistics segment, formerly known as marketing, is more 	
volatile, and we typically discount revenue assumptions from unpredictable, 	
arbitrage-driven activities. In this segment, Plains purchases and resells 	
crude oil, stores inventory during contango market conditions (i.e., an upward 	
forward pricing curve), and exchanges crude oil of certain specifications for 	
that of others. Plains leverages its physical infrastructure--including its 	
strategic storage and terminal facilities in Cushing, Okla.--and its many 	
customer and supplier relationships to capitalize on market inefficiencies. 	
This segment tends to perform well during volatile markets, but still 	
generates a base level of cash flow during flat markets, primarily from its 	
crude oil lease-gathering operations.	
	
Marketing is a high-volume, low-margin business that entails significant use 	
of derivatives contracts. Therefore, the risks of unforeseen events, such as 	
disruptions in expected crude oil supply or a lapse in personnel's adherence 	
to the company's policies, somewhat weigh on the credit rating. Limitations on 	
open positions and oversight controls appear adequate for managing the risks 	
involved, partially mitigating this concern. The company's policy is to 	
balance its purchases and its sales or future delivery obligations with 	
back-to-back transactions that eliminate price risk, while actively managing 	
counterparty credit risk.	
	
Plains' short-term debt primarily relates to hedged crude oil inventory 	
purchases for their contango and waterborne crude programs, and hedged LPG 	
inventory purchases in advance of the heating season. This debt can be 	
volatile from quarter to quarter and is essentially self-liquidating because 	
Plains pays down the debt as it sells the associated hedged volumes. 	
Therefore, we place less emphasis on credit ratios that include short-term 	
debt. However, we do not view the cash flow associated with many of these 	
market-related activities as repeatable and do not assume such cash flows in 	
our forecasts.	
	
Liquidity	
We consider Plains' liquidity to be "adequate" under our corporate liquidity 	
methodology. We expect Plains' sources will exceed uses by at least 1.2x 	
during the next 12 months, although other factors--such as the partnership's 	
recently announced equity distribution agreement with Citigroup to raise up to 	
$300 million of equity per year, its demonstrated ability to raise funding in 	
the capital markets as needed, and its ability to reduce discretionary capital 	
spending in the event of funding disruptions--could improve liquidity further. 	
Pro forma sources of liquidity include funds from operations of about $1.47 	
billion and revolver availability plus cash of about $1.39 billion. Plains 	
renewed its credit facilities in August 2011 and now has a $1.6 billion 	
committed revolving credit facility maturing in August 2016 and a $450 million 	
committed revolving credit facility at its natural gas storage subsidiary PNG 	
maturing in August 2016. The revolver availability and our sources calculation 	
does not include the $850 million annual committed hedged inventory facility, 	
which will mature in August 2013, and the PNG credit facility. In addition, 	
the company terminated the $500 million 364-day senior unsecured facility that 	
was scheduled to mature in January 2012.	
	
Key uses include our assumption of about $1.1 billion in capital spending 	
(including maintenance expenditure but excluding PNG spending) and 	
distributions of about $800 million. As of Mar. 31, 2012, Plains was in 	
compliance with its covenants, and we expect the partnership will remain in 	
compliance through 2012.	
	
Outlook	
The stable outlook on the rating reflects Plains' size and asset diversity, 	
the majority contribution of fee-based activities to Plains' cash flow, and 	
our expectation that management will continue to target leverage below 4x. We 	
also expect that any future acquisitions will not materially change the 	
partnership's key credit ratios or business profile. We could lower the 	
ratings if we expect that the ratio of adjusted long term debt to baseline 	
EBITDA will rise toward 4.5x on a sustained basis or if the partnership makes 	
an acquisition that increases overall cash flow volatility or its business 	
risk. An upgrade is unlikely at this time, but could occur if the partnership 	
increases the proportion of revenue coming from its stable, fee-based pipeline 	
business while mitigating volumes risk and maintaining a conservative 	
financial policy such that we expect debt to EBITDA to remain below 3.5x on a 	
sustained basis.	
	
Related Criteria And Research	
     -- Key Credit Factors: Criteria For Rating The Global Midstream Energy 	
Industry, April 18, 2012	
     -- Standard & Poor's Standardizes Liquidity Descriptors For Global 	
Corporate Issuers, July 2, 2010	
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009	
	
Ratings List	
Rating Raised	
                                        To                 From	
Plains All American Pipeline L.P.	
 Corporate Credit Rating                BBB/Stable/--      BBB-/Positive/--	
  Senior Unsecured                      BBB                BBB-	
	
PAA Finance Corp.	
 Senior Unsecured                       BBB                BBB-	
	
Pacific Energy Finance Corp.	
 Senior Unsecured                       BBB                BBB-	
	
Pacific Energy Partners L.P.	
 Senior Unsecured                       BBB                BBB-
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