Fitch Assigns Initial 'BBB' Rating to Plains All American Pipeline

NEW YORK--()--Fitch Ratings has assigned Plains All American Pipeline, LP (PAA) a long-term Issuer Default Rating (IDR) and senior unsecured rating of 'BBB.' Fitch has also assigned PAA a short-term IDR and commercial paper rating of 'F2'.

The Rating Outlook is Negative. A full list of rating actions follows at the end of this release.

PAA's ratings reflect its beneficial size and scale, as well as, the cash flow and earnings stability provided by PAA's strong portfolio of assets which generate roughly 80% of EBITDA from fee based transportation and facilities businesses. These fee based businesses are expected to grow moderately in the near term even as commodity price weakness continues and oil & gas production in the U.S. and Canada declines near term. PAA has a strategically located asset base which spans all of the major oil production basins and most of the critical crude demand centers in the U.S. and Canada. PAA's fee-based EBITDA growth is supported by new projects and a robust near-term growth capital program with substantial minimum volume commitments from primarily investment grade counterparties. These projects are expected to provide revenue growth even with near-term commodity price volatility.

The Negative Outlook is reflective of Fitch's concerns around near-term high leverage, the impact of overcapacity and volume risk on profitability, and general uncertainty around capital market access for the MLP space.

KEY RATING DRIVERS

Beneficial Size & Scale: PAA's operations are located in all of the major U.S. and Canadian crude production areas and at substantially all of the inland and coastal crude oil terminals and interchanges. PAA's assets span the full crude oil midstream value chain for all regions in which they operate providing competitive advantages and an ability to capture incremental revenue for midstream services across their system. PAA has been a long-time operator in the crude midstream space, with long-term relationships with most of its customer base. The size and span of PAA's system should provide incremental growth opportunities when and as crude oil prices and production in the U.S. and Canada recover.

Removal of Incentive Distribution Rights: PAA is currently in the process of buying back its incentive distribution rights from its general partner (GP). Within the MLP structure the incentive distributions provide the GP and sponsor with an increasing amount of distributable cash flow from the operating partnership. As distributions paid by the MLP to common unit holders grow the amount of cash flowing up to the parent GP grows significantly, which typically drives equity cost of capital higher for mature MLPs in the higher levels of GP/Limited Partner (LP) distribution tiers (splits). Fitch views removal of incentive distributions and simplification of the organizational structure to be a credit positive. Associated with the simplification transaction PAA has reset its distribution, reducing it by 21% with a stated goal of maintaining a 1.15x minimum annual distribution coverage and retaining more cash at the partnership.

Overcapacity and Volume Risks: Overcapacity and volume exposure are key concerns for PAA. PAA's fee based business with minimum volume commitments will provide cash flow stability in the near term consistent with levels expected from a 'BBB' rated midstream issuers. However, declining exploration and production (E&P) budgets and North American basin production declines are expected to drive further delays or pullbacks in midstream volumes that have the potential to weigh on longer-term profitability and keep leverage elevated.

Capital Market Access: Capital market access, which is a concern for Fitch across its midstream coverage, has improved. However, higher equity yields and credit spreads have largely precluded midstream issuers in general, from accessing traditional debt and equity markets. Fitch recognizes that PAA's steps to simplify its structure have lowered its cost of capital, which is expected to provide PAA equity market access at reasonable yields. PAA has also successfully divested and intends to divest non-strategic assets to aid in deleveraging. Growth capital spending is expected to be elevated through 2017 and PAA will need to access equity markets at reasonable yields in order for leverage to improve. Fitch expects PAA's continuous offering program to provide PAA access to equity markets. However, there remains a significant amount of uncertainty in the willingness and ability of midstream issuers to access equity markets should sector sentiment and unit prices weaken. PAA management has publicly committed to maintaining investment grade credit ratings.

High Near-term Leverage: PAA's leverage is high relative to similarly rated midstream MLP issuers. For a 'BBB' midstream energy rating Fitch typically expects mid-cycle leverage in a 4.0x-4.5x range. Fitch expects PAA's leverage as defined as debt/Adj. EBITDA of 5.3x to 5.6x for 2016 improving to roughly 4.5x to 4.75x by 2018. With leverage expected to be over 5.0x in the near term Fitch is concerned that lower or range bound commodity prices and differentials at or near current levels could continue to weigh on operating results and lead to high sustained leverage. (Fitch's calculation of debt includes short term borrowings associated with working capital needs and 50% equity credit for PAA's preferred units. Fitch's calculation of Adj. EBITDA excludes equity in earnings from unconsolidated affiliates but includes cash distributions from those unconsolidated affiliates.)

Short-term borrowings associated with PAA's working capital needs primarily linked to its supply and logistics operations can distort PAA's leverage calculations. Fitch would be tolerant of leverage above its 4.5x mid-cycle target provided that the short-term working capital borrowings were not expected to be sustainable in nature. Distribution coverage currently remains below 1.0x as of the end of 2Q 2016 but is expected to improve given the recently announced structural simplification transaction. Going forward management is targeting robust distribution coverage of 1.15x at minimum with the retained cash available to help fund capital needs.

KEY ASSUMPTIONS

Fitch's key assumptions within its rating case for the issuer include:

--The proposed simplification transaction announced on July 12, 2016 is completed in the next several quarters;

--Growth capital spending of $2.1 billion in 2016 and 2017 consistent with management public guidance and funded with a 55%/45% equity/debt funding mix. Returns on projects assumed in the 6x to 8x multiple range;

--Base case commodity prices are consistent with Fitch's price deck. Fitch's price deck assumes modestly rising commodity prices, with WTI of $42/bbl for 2016, $45/bbl for 2017 and $55/bbl for 2018 and a long-term price of $65/bbl. Henry Hub natural gas of $2.25/mcf for 2016, $2.50/mcf for 2017, $2.75/mcf for 2018, and $3.25/mcf long term.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action including a stabilization of the Outlook include:

Fitch would likely revise the Rating Outlook to Stable if:

--PAA begins execution of its current operating plan; and

--Commodity prices remain consistent with or above base case expectations of WTI at $45/barrel in 2017, $55/barrel in 2018 and $65/barrel long term; and

--2017 leverage is expected to improve to below 5.0x (again inclusive of 50% equity credit and short-term borrowings) with distribution coverage above 1.0x.

Fitch would likely revise the Outlook in early 2017 following completion of the simplification transaction and with more visibility with regard to commodity prices, production volume expectations, and funding plan viability.

Leverage below 4.0x on a sustained basis with distribution coverage expected to remain above 1.0x could lead to a positive rating action.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--Leverage (defined as debt-to-adjusted EBITDA) in excess of 4.5x on a sustained basis. Fitch recognizes that recent adjusted leverage has been above this and attributes the increase to higher growth spending and short-term borrowings associated with PAA's working capital needs. While Fitch expects 2016 leverage to be high for the rating at above 5.0x, Fitch anticipates that leverage should decrease in 2017 to between 4.5x and 5.0x and improving to 4.5x to 4.75x in 2018 and beyond.

--Increased exposure to market-sensitive businesses and other more volatile operations without offsetting adjustments to leverage targets or distribution coverage targets.

--High leverage coupled with distribution coverage below 1.0x.

--Fitch expects volume growth on PAA's systems associated with new projects coming online in 2016 and 2017 with volumes on existing systems roughly flat for those years should volumes experience significant deterioration and weigh on profitability Fitch could take negative ratings action.

--Inability or unwillingness to fund capital needs with stated 55%/45% debt/equity balance.

--Inability to complete proposed restructuring resulting in the cancellation of incentive distribution payments.

LIQUIDITY

Liquidity Adequate: PAA's liquidity is adequate. PAA has a $3 billion commercial paper program which is backstopped by its $1.6 billion senior unsecured revolving credit facility and its $1.4 billion senior secured hedged inventory credit facility. In addition PAA has a $1 billion senior unsecured 364-day revolving credit facility which matures in August 2017. In total PAA has access to $4 billion in revolving credit facilities.

The senior unsecured revolving credit facility, senior secured hedged inventory facility and senior unsecured 364-day revolving credit facility treat a change of control as an event of default and also require PAA to maintain a debt-to-EBITDA coverage ratio that, on a trailing four-quarter basis, will not be greater than 5.0x (or 5.5x an acquisition period (generally, the period consisting of three fiscal quarters following an acquisition greater than $150 million)). From the date the simplification closes through December 2017, the covenant will not be greater than 5.5x. For covenant compliance purposes, consolidated EBITDA may include certain adjustments, including those for material projects and certain non-recurring expenses. Additionally, letters of credit and borrowings to fund hedged inventory and margin requirements are excluded when calculating the debt coverage ratio.

A default under PAA's credit facilities would permit the lenders to accelerate the maturity of the outstanding debt. As long as PAA is in compliance, its ability to make distributions of available cash is not restricted. As of June 30, 2016 PAA was in compliance with all of its covenants, and Fitch expects PAA to maintain compliance throughout Fitch's forecast period of 2016-2019.

FULL LIST OF RATING ACTIONS

Fitch has assigned the following ratings:

Plains All American Pipeline, LP

--Long-term IDR 'BBB';

--Senior unsecured rating 'BBB';

--Short-term IDR 'F2';

--Commercial Paper rating 'F2.'.

The Rating Outlook is Negative.

Summary of Financial Statement Adjustments - Fitch's calculation of debt includes short term borrowings associated with working capital needs and 50% equity credit for PAA's preferred units. Fitch's calculation of Adj. EBITDA excludes equity in earnings from unconsolidated affiliates but includes cash distributions from those unconsolidated affiliates

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

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Contacts

Fitch Ratings
Primary Analyst
Peter Molica
Senior Director
+1-212-908-0288
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kathleen Connelly
Director
+1-212-908-0290
or
Committee Chairperson
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Peter Molica
Senior Director
+1-212-908-0288
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kathleen Connelly
Director
+1-212-908-0290
or
Committee Chairperson
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com