Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) and senior unsecured rating of Portland Natural Gas Transmission System (Portland) at 'BBB+'.

The ratings are supported by Portland' long-term contracts with a diverse and creditworthy group of shippers, providing stable and highly visible cash flow.

The Rating Outlook has been revised to Positive from Stable due to a meaningful reduction in construction completion risk, along with leverage that is expected to be sustained below Fitch's positive sensitivity.

Portland is indirectly owned by TC Energy Corporation (TRP; A-/Negative) and Energir, L.P. (not rated). Though Portland benefits from the relationship with its owners, there are no explicit rating linkages between the company and its parents.

Key Rating Drivers

Final Phase of WXP Expansion: Portland completed phase II (of III) of Westbrook XPress (WXP) in November 2021, a brownfield compression project, which was a low risk project of building additional compression facilities inside its fence lines. The completion of phase II marked the in-servicing of more than 95% of Portland's total post-expansion capacity. The remaining volume is expected to be in-serviced when the third, and final, phase of the WXP expansion is completed, expected in November 2022. Portland has received final approvals for construction of this last phase, alleviating any regulatory hurdles that could slow down the final phase of construction.

Demand Pull Customers: Upon completion of all three phases of the WXP expansion, nearly all of Portland's capacity will be reserved under take-or-pay contracts with high-credit quality shippers. The weighted average remaining contract term at the time of completion, anticipated in November 2022, will be approximately 15.6 years. Nearly 85% of the long-term contracted shippers at that time will be with demand-pull natural gas utilities. Historically, utilities, which are close to (and sometimes at) the place where natural gas is consumed (both for the generation of electricity and the heating of homes) have been more consistent customers versus oil and gas exploration and production companies (supply push customers). This is mainly due to a steadier demand profile, versus more volatile supply/demand dynamics impacting production economics.

Demand pull customers tend to renew their contracts more often than supply push customers. This holds true at Portland insofar as the current largest customer under its foundational (1999) contracts has renewed its participation in the pipeline with Portland XPress (PXP) contracts. When the second expansion project is officially complete, Portland will have some concentration risk. After the completion of the WXP expansion, the top five shippers will account for approximately 85% of contacted volumes, while the largest customer will make up roughly 18% of expected total revenue.

Stabilizing Leverage: Historically, Portland has had very little debt and maintained leverage below 1.0x. Fitch expects the PXP and WXP expansion projects and the associated capital spending to continue to drive leverage above historical levels. In October 2021, Portland issued its second, and final, senior note used to finance its expansion projects. Growth capital expenditures will be completed once the WXP phase III project is completed and in-service, targeted for November 2022. Fitch expects the combination of no additional debt issuances and predictable contracted cash flows will result in leverage stabilized slightly below 3.0x throughout the rating horizon.

Pipeline Expansions Fulfil Important Goals: The Portland XPress and Westbrook XPress contracts are compelling opportunities for Portland's customers. Contract sign-ups were sufficient to sanction multiple expansions that will effectively double the company's capacity by late 2022, compared to 2017. Certain conditions exist in New York and New England such that it has been difficult to furnish sufficient pipeline capacity into the region to assure the protection of homeowners and businesses from losing heat during inevitable near-record cold snaps. Additionally, the expansion projects extend outside of the Portland system in order to increase the diversity of supply for Portland customers.

Parent Subsidiary Rating Linkage: There is parent subsidiary relationship between Portland and TC Energy Corporation (TRP; A-/Negative). Fitch determines Portland's ratings on the basis of its standalone credit profile (SCP). Fitch considers Portland as having a weaker SCP than that of TRP. As such, Fitch has followed the stronger parent path. Legal incentive is weak given the lack of guarantees or cross-default from the parent. Given that Portland does not constitute a meaningful portion of TRP's consolidated EBITDA and that the two entities have separate management teams, Fitch deems strategic and operations incentives as weak.

Due to these rating considerations, Fitch rates Portland on a standalone basis with no uplift from its parent. Despite the lack of explicit rating linkages, Fitch views the ownership dynamic as supportive of the company's credit quality. Fitch does not believe this relationship would change if TRP's rating, which has a Negative Outlook, were to change.

Derivation Summary

For most of the midstream sector, $500 million of annual EBITDA serves as a boundary line between investment-grade and below-investment-grade. The long-distance natural gas pipeline sector is an exception to this limitation, as the business has extremely low risk. Portland's closest peer, Sabal Trail Transmission, LLC (Sabal; BBB+/Stable), is another Fitch-rated small investment-grade pipeline company. At $88 million in future run-rate EBITDA pipeline, Portland is significantly smaller than most peer pipelines. However, its small size does not constrain the rating due to the strength of this particular sub-sector of Midstream companies.

Sabal and Portland both have long-term take-or-pay contracts with high-quality, demand-pull counterparties. Sabal's contracts have a weighted average remaining life of approximately 21 years, and once Portland's contracts for Westbrook XPress are all valid for their full amount (expected in late 2022), the weighted average life remaining will be 15.6 years. Fitch views Sabal's and Portland's contracts as equally supportive drivers of their respective ratings. Sabal's contract counterparties correspond to credit quality in the 'A' rating category. Fitch views Portland's contract counterparties, in aggregate, to have credit quality in the 'BBB' rating category. While both counterparties are Investment Grade, Sabal's shippers have a higher relative credit quality, compared to Portland's.

Throughout the rating horizon, Fitch expects Portland's leverage to be slightly less than 3.0x, which compares favorably to Sabal's forecasted low-to-mid 4x leverage. Portland has recently had greater construction risk than Sabal. Over the past two years, Portland has been progressing two expansion projects. The first project has been completed, and the second should be fully in-service in November 2022. As such, construction risk has been reduced.

Fitch considers the lowered construction risk as WXP nears completion a positive for the rating. Coupled with the long weighted average contract life remaining, strong counterparty credit ratings of mainly demand-pull customers and low relative leverage position, Portland is strongly positioned in the 'BBB+' rating category.

Key Assumptions

No new debt issued and no draws on revolving credit facility;

Capital spending for WXP III in line with management expectations;

Phases III of WXP completed on schedule;

Portland fulfils its obligations in its long-term contracts with shippers, and no shipper defaults on any payments;

Distributions to owners of all excess cash flow after maintenance capital expenditures and interest expense, provided that some cash is intended to be held back for working capital purposes.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch could consider a positive rating action following the successful completion and in-service of all phases of the Westbrook Xpress Project;

Total debt with equity credit/operating EBITDA expected to be below 3.0x for a sustained period of time;

A substantial shift in weighted average shipper credit quality towards the higher end of the rating scale.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Total debt with equity credit/operating EBITDA sustained above 4.0x;

Unexpected material construction-phase problems.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: In April of 2018, Portland entered into a revolving credit agreement for $125 million, which matures on April 5, 2023 and is extendible by two 12-month periods with the consent of the lender. As of March 31, 2022, the revolving credit facility is undrawn, and Fitch does not expect any draws on the facility throughout the rating horizon.

Portland issued 10-year $150 million Series B senior notes on Oct. 29, 2021. The proceeds were used to pay down nearly $93 million drawn on the revolving credit facility and fund the remaining portion of Portland's capital expansion. Portland's refinancing risk remains low as its Series A and B Notes mature in October of 2030 and 2031, respectively.

Issuer Profile

Portland Natural Gas Transmission System, a Maine general partnership, is a natural gas transmission pipeline operating in northern New England.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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