(By Mani) TransCanada Corp.
) (TSX:TRP) shares suffer from the competitiveness of the Mainline due to declining natural gas throughput and the resulting increase in tolls under the regulatory framework.
Due to declining volumes, the toll on the Mainline from Empress, AB to the Dawn Hub in Ontario has risen over the past five years to $1.89/GJ from roughly $1.00/GJ.
But, a potential conversion of part of the Mainline to oil from gas could reduce gas tolls and deliver earnings growth.
"We believe that a conversion of a portion of the Mainline to oil service (from natural gas) could drive up to $8/share of additional value, consisting of $3/share of tangible financial benefits in addition to an estimated $5/share of upside from a re-rating of the multiple," RBC Capital Markets analyst Robert Kwan wrote in a note to clients.
Conversion of part of the gas system could result in the removal of $1 billion to $2 billion of rate base , and all things being equal, a 25 percent reduction in rate base could drive a material reduction in gas tolls. Combined with the proposed Mainline gas toll restructuring, this could drive the tariff from Empress to Dawn down toward $1.00/GJ.
The conversion would switch one of the existing gas lines to oil service, something that was already done as part of the original Keystone project. The existing infrastructure could be sized for up to 900,000 barrels per day (bpd) of capacity from Alberta to eastern Ontario. The new pipeline could extend the system through Quebec and possibly to the New Brunswick refinery and a tidewater port.
"Overall capacity could range from as low as 300,000 bpd to as high as 900,000 bpd with further expansion opportunities, and if it proceeds, we believe the project could be in service in the 2017/2018 time frame. Further details on the project including potential interest from shippers may be forthcoming at the end of 2012," Kwan noted.
From TransCanada's perspective, the allure of the project would be a new growth project in the attractive oil pipeline segment, provide a competitive toll for its customers and removing under-utilized gas pipeline would improve the Mainline's toll competitiveness by reducing rate base.
With rising Mainline tolls and declining volumes, a key investor concern has been the economic viability of the Mainline. With lower and more competitive tolls, the idea is that the lower transportation cost would improve the competitiveness of Canadian gas.
"While there will likely be opposition to this proposal on a number of fronts, the east coast option appears to offer greater benefits to a wider range of stakeholders, which may end up improving the odds of gaining approval," Kwan added.
First, much of the pipeline would operate in existing right-of-way with TransCanada having long-standing relationships with landowners along the existing gas pipeline route and even into Quebec on the existing Trans-Quebec and Maritimes gas pipeline system.
Furthermore, unlike B.C., which recently cited a lack of economic benefits to the province, displacing expensive foreign oil and improving the competitiveness of the refineries in Quebec and New Brunswick could also end up being factors that will help the project garner support.
Meanwhile, a conversion would benefit Transcanada's earnings growth by delivering earnings on capital and extend the reach east of Ontario. In addition, oil pipelines generally earn an return on equity of 11 percent to 12 percent versus the 8 percent returns from Mainline.
Calgary-based TransCanada's assets include natural gas pipelines, power generation, and natural gas storage. The company has more than 57,000 kilometers of wholly-owned pipelines in North America, owns or has interests in about 10,800 MW of power generation (hydro, gas, nuclear and coal) in operation or under development, and 380 billion cubic feet (Bcf) of natural gas storage.