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Risk Factors
The Fund’s business activities are subject to execution, market price, credit and operating risks. The Fund has formal risk management policies and risk management systems designed to mitigate these risks.
- Tax Fairness Plan
- Regulation And Legislation
- Financing Capacity & Liquidity
- Debt Covenants
- Interest Rate Risk
- Supply And Demand
- Operating Risk
- Material Debt
- Fluctuations In Distributions
Tax Fairness Plan
On June 22, 2007, the “Tax Fairness Plan” income trust taxation legislation, Bill C-52, achieved Royal Assent. Under the enacted legislation, a distribution tax will be imposed on Enbridge Income Fund starting in 2011. This change resulted in the recognition of future income tax liabilities and expense of $1.9 million. Future income tax expense was not recorded for the temporary differences attributed to Alliance Canada because rate regulated accounting allows for the taxes payable method when future income taxes are expected to be included in the rates charged to customers in the future and fully recovered.
The Fund, with input from external legal and financial advisors, is carefully assessing the impact of the legislation on the business and financial outlook of the Fund and its broader effect on the income trust sector as a whole. The Fund’s objective in carrying out these activities is to adopt a strategy that will maximize value to unitholders going forward.
On December 20, 2007 the Minister of Finance announced proposed technical amendments to further clarify the Tax Fairness legislation contained in Bill C-52. The announcement provides clarity to the existing Tax Fairness legislation. If the proposed technical amendments are enacted as announced, Alliance Canada will continue to be a non-taxable entity for federal and provincial income tax purposes.
As enacted in its present form, the Tax Fairness Plan will result in a distribution tax of 29.5% starting in 2011 and, all other things being equal, likely result in a reduction of cash available for distribution by the Fund commencing in 2011. With respect to the limitations on equity unit issuances, the Manager believes the Fund should be able to fund its currently identified growth plans. However, with the current uncertainty in the capital markets resulting from Bill C-52, there can be no assurance that sufficient capital will be available to fund further acquisitions or expansion projects.
Regulation And Legislation
Earnings and expansion projects on the Alliance Canada and the Saskatchewan Systems are subject to the actions of various regulators, including the NEB. Actions of the regulators related to tariffs, tolls and facilities impact earnings and the success of the expansion projects. Delays in regulatory approvals could result in cost escalations and construction delays.
Changes in regulation, including decisions by regulators on the applicable tariff structure or changes in interpretations of existing regulations by courts or regulators, could adversely affect the results of operations of Alliance Canada and the Saskatchewan System. Further, the nature and degree of regulation and legislation affecting energy companies in Canada has changed significantly in past years and there is no assurance that further substantial changes will not occur. Such regulations and legislation may adversely affect the toll structure or other aspects of the Fund’s business or the operations and creditworthiness of shippers.
Financing Capacity & Liquidity
The Fund’s financing risk relates to the price volatility and availability of debt and equity in the market to finance expansion projects. This risk is directly influenced by the enactment of the Tax Fairness Plan which limits the amount of equity that can be issued by the Fund as well as market factors, financial performance and by the Fund’s current credit rating.
The Fund continuously monitors its capital requirement and debt levels in order to ensure sufficient liquidity and capital resources. Currently, the Fund estimates that its credit facility, combined with cash generated by operating activities, is sufficient to meet the forecast liquidity and capital resource requirements of the Fund.
Debt Covenants
Both the Fund’s credit facility and the Alliance Canada credit facility include provisions that prohibit distributions in the event of default. The Fund’s credit facility agreement includes a covenant that limits unconsolidated indebtedness to 4 times earnings before interest, taxes, depreciation and amortization (EBITDA.) In the event of default and in the absence of a waiver from the lenders, failure to remediate this covenant could result in a reduction of distributions to unitholders. Under the Alliance Canada credit facility, distributions cannot be made to owners if Alliance Canada’s debt service coverage ratio, calculated as of the applicable distribution date, falls below 1.25 to 1 for the four preceding fiscal quarters and the four succeeding fiscal quarters. The Fund and Alliance Canada actively monitor debt covenants to ensure compliance. As at December 31, 2007, both companies were in full compliance with the debt covenants and expect to continue to be in compliance for the foreseeable future. Additionally, the Fund’s obligations to pay the principal, interest and all other amounts payable by the Fund under its medium term notes outstanding rank in priority to distributions.
Interest Rate Risk
The Fund is exposed to interest rate fluctuations on variable rate debt and on future debt issuances. Increases in interest rates could reduce the Fund’s competitiveness and could have a material adverse effect on the Fund’s cash flow and distributable cash. The Fund may use derivative financial instruments in order to manage interest rate risk. There are no interest rate derivative financial instruments outstanding at year-end.
Supply And Demand
The operation of the Fund’s liquids and natural gas pipelines is dependent upon the supply of and demand for crude oil and natural gas from Western Canada and demand for crude oil from the refiners in the Mid-western United States. The demand for crude oil by refiners is dependent upon a number of factors including the price of crude oil, the cost of operating the refinery and market prices for the various refined products. Supply is dependent upon a number of variables, including:
- the level of exploration, drilling, reserves, and production of crude oil and natural gas;
- the accessibility of Western Canadian crude oil and natural gas;
- the price and quality of crude oil and natural gas available from alternative Canadian and United States sources; and
- the regulatory environments in Canada and the United States, including the continued willingness of the governments of both countries to permit the export of crude oil and natural gas from Canada to the United States on a commercially acceptable basis.
Operating Risk
The operation of Alliance Canada, the Saskatchewan System and Green Power involve many operating risks, including the failure of equipment, information systems or processes, poor performance of equipment (whether due to misuse, unexpected degradation or design, construction or manufacturing defects), lack of spare parts, operator error, labour disputes, disputes or issues with interconnected facilities and carriers and catastrophic events such as natural disasters, fires, explosions, fractures, acts of terrorists and saboteurs, and other similar events, many of which are beyond the control of the respective systems. The occurrence or continuance of any of these events could increase the cost of operating Alliance Canada, the Saskatchewan System and/or Green Power and reduce transportation capacity, thereby potentially impacting cash flow. The Fund employs various inspection and monitoring methods to manage pipeline, turbine and facility integrity as well as to minimize system disruptions.
Environmental Costs and Liabilities
The operation of the Saskatchewan System and Alliance Canada are subject to federal, provincial and local laws and regulations relating to environmental protection and operational safety. Risks of substantial environmental costs and liabilities, including those from leaks and explosions, are inherent in pipeline operations and there can be no assurance that significant costs and liabilities, including those relating to claims for damages to property and persons resulting from operations of Alliance Canada and/or the Saskatchewan System, will not be incurred. To mitigate this risk, Alliance Canada and the Saskatchewan System have established safety and environmental policies that are designed to ensure that all aspects of their operations comply with existing regulations relating to personal safety and protection of the environment. It is not possible to predict the effect that any future changes in environmental laws and regulations will have on future earnings and there can be no assurance that environmental costs incurred by Alliance Canada or the Saskatchewan System will be partially or fully recoverable under their tolls.
Easement Rights
Alliance Canada, Saskatchewan System and Green Power have acquired easement rights from landowners, tenants and service lease owners in order to construct, install and operate their pipeline and wind turbines. These easement rights were obtained through voluntary negotiation and, in certain cases, through statutory rights of entry. There can be no assurance that legal challenges will not be brought forward with respect to the form, content, or recording of such easements, or to business segments’ compliance with the terms of such easements during the construction and operation of the pipeline or wind turbine.
Material Debt
The Fund has debt instruments with maturities ranging from 2009 to 2014. If, on maturity, refinancing of the debt is not possible, or if the terms of the replacement debt are less favourable than the existing terms, cash available for distribution and earnings could decrease. In addition, Alliance Canada has debt instruments outstanding with maturities ranging from 2012 to 2025. Similarly, if such debt is refinanced on less favourable terms or cannot be refinanced, distributions from Alliance Canada will likely decrease.
Fluctuations In Distributions
Although the Fund’s policy is to distribute on average, 95% of cash available for distribution, cash distributions are not guaranteed and distributions will fluctuate. The actual amount of distributable cash will depend on numerous factors, including operating cash flow, demand for services, general and administrative costs, applicable taxes, debt service costs, capital expenditures, restrictions imposed by lenders, and disruptions in service and reserves established by the Fund, and ECT.