The Alliance System. Alliance Pipeline Limited Partnership Management s Discussion and Analysis For the year ended December 31, 2016

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1 Management s Discussion and Analysis The Alliance System The Alliance System (System) consists of a 3,849 kilometre (km) (2,392 mile) integrated Canadian and U.S. natural gas transmission pipeline, delivering rich natural gas from the Western Canadian Sedimentary Basin (WCSB) and the Williston Basin in North Dakota to the natural gas market in Chicago. The System has been in commercial service since December 2000 and currently delivers an average of 1.7 billion cubic feet per day (bcf/d) of rich gas to the Aux Sable natural gas liquids (NGLs) extraction facility, owned by Aux Sable Liquid Products LP (Aux Sable), an affiliate of Alliance Pipeline Limited Partnership (Alliance Canada). Rich gas is natural gas with relatively high NGLs content; mainly ethane, propane, butane and condensates. The System connects with the Aux Sable NGLs extraction facility in Channahon, Illinois, which extracts NGLs from the natural gas transported before delivery to downstream pipelines. The pipeline connects in the Chicago area, through its downstream header, with five interstate natural gas pipelines and two local natural gas distribution systems, which provide shippers with access to natural gas markets in the Midwestern and Northeastern U.S., and Eastern Canada. All shippers have signed extraction agreements that give Aux Sable the exclusive right to extract the NGLs from the rich gas transported. The System also has three connections, two in North Dakota and one in Iowa, to provide for deliveries of small amounts of natural gas to ethanol production plants. Facilities include 14 mainline compressor stations that operate between approximately 31,000 horsepower (hp) and 46,000 hp each, spaced at approximately 193 km intervals; mainline block valves, spaced, on average, at 32 km intervals; operating and maintenance facilities; and an associated SCADA system. Construction of the System began in May 1999 and commercial operations commenced on December 1, Shippers executed transportation contracts with each of Alliance Canada and Alliance Pipeline L.P. (Alliance U.S.) that had a primary term ending November 30, Those contracts provided for tolls based on a cost-of-service tolling mechanism and the transportation of 100% of Alliance Canada s available firm capacity. Page 1

2 Management s Discussion and Analysis On May 22, 2014, Alliance Canada filed an application with the National Energy Board (NEB) for regulatory approval of the New Services Offering (Services Offering) tolls and tariff provisions, to be effective December 1, On July 9, 2015, the NEB approved Alliance Canada's Services Offering tolls and tariff, subject to certain Board directions and conditions. The conditions included restrictions on Alliance Canada's discretion to set bid floors for seasonal and interruptible transportation (IT) service to no more than 125% of the corresponding firm service toll, and on our ability to discount seasonal service below the corresponding firm service toll. In 2016, Alliance Canada sought a review and variance of the NEB s decision regarding Prior Period Adjustment fees, however that issue has been commercially resolved and once the resolution is implemented Alliance Canada will abandon its review and variance application. Similarly, Alliance U.S. applied to the Federal Energy Regulatory Commission (FERC) on May 29, 2015 for regulatory approval of amendments to its FERC Gas Tariff, to be effective December 1, On June 30, 2015, the FERC approved Alliance U.S. s amendments to its FERC Gas Tariff. Although long-term firm shippers on Alliance U.S. have negotiated rates, Alliance U.S. recourse rates were the subject of a proceeding during On December 15, 2016 the FERC conditionally approved Alliance U.S. s recourse rate settlement with minor modifications and severed and remanded for hearing certain gas processing issues. That hearing has been temporarily suspended to permit further settlement discussions. On December 1, 2015, Alliance Canada commenced the implementation of its Services Offering providing shippers with competitive long-term fixed firm tolls and biddable tolls for seasonal firm, short-term firm and IT services. The Services Offering includes both full-path and segmented receipt and delivery services. A new Canadian trading pool and a revised hydrocarbon dewpoint specification will also facilitate the transportation of rich gas. The new services were developed in a manner that is cognizant of "cost based" parameters, but deviates from the costof-service tolling model and reflects a more dynamic and flexible market-focused approach under which Alliance Canada will assume a higher degree of business risk and provide flexibility to effectively respond to evolving market conditions. Alliance Canada has re-contracted all of its available year-round firm receipt capacity through 2018, and approximately 90% of available year-round firm receipt capacity in 2019 and 2020, with average contract durations of 5.3 years. Following this successful marketing of Alliance Canada's initial firm contracts effective December 1, 2015, demand for Alliance Canada's seasonal firm services has been in excess of available seasonal firm capacity. Alliance has also effectively marketed short-term firm and IT services. ALLIANCE CANADA The Alliance Canada portion of the System consists of approximately 1,561 kms (970 miles) of natural gas mainline pipeline and 732 kms (455 miles) of related lateral pipelines connected to natural gas receipt locations, primarily at gas processing facilities in northwestern Alberta and northeastern British Columbia, and related infrastructure. Alliance Canada owns the Canadian portion of the System. Alliance Canada is jointly owned by Enbridge Income Partners Holdings Inc. and Veresen Energy Infrastructure Inc. (Partners) and is subject to federal regulation by the NEB. ALLIANCE U.S. The Alliance U.S. portion of the System consists of approximately 1,556 kms (967 miles) of infrastructure including the 129 km (80 mile) Tioga Lateral in North Dakota. Alliance U.S., an affiliate of Alliance Canada, owns the U.S. portion of the System. Alliance U.S. is jointly owned by Enbridge Income Partners US Holdings Inc. and Fort Chicago Pipeline II U.S. L.P. (a Veresen affiliate) and is subject to federal regulation by the FERC. Page 2

3 Management s Discussion and Analysis Financial and Operating Highlights Years ended December 31 ($millions, except where noted) Operating Highlights Average daily long-term firm (mmcf/d) (1) 1, , ,325.0 Average daily seasonal/short-term (2) firm (mmcf/d) (1) Average daily interruptible (2) (mmcf/d) (1) Total average daily contracted volume (mmcf/d) (1) 1, , ,325.0 Financial Highlights Total revenues Operating expenses (excluding depreciation) Depreciation expense Net interest expense and other income Extraordinary gain Net income Earnings before interest, taxes, depreciation and amortization (EBITDA) (3) Partner distributions paid Cash provided by operating activities Capital additions Financial Position Working capital (14.2) Total long-term assets 1, , ,278.4 Senior debt ,037.0 Debt service coverage ratio (DSCR) (1) mmcf/d - Million cubic feet per day (2) Seasonal firm, short-term firm and interruptible transportation service commenced on December 1, In December 2015 average daily seasonal and short-term firm was 57.6 mmcf/d and average daily interruptible was 64.8 mmcf/d. (3) Refer to Non-GAAP Financial Measures. All financial information in this Management s Discussion and Analysis (MD&A) has been prepared in accordance with United States Generally Accepted Accounting Principles (U.S. GAAP). This MD&A reviews the significant events and transactions that impacted our performance during the three and twelve months ended December 31, The following MD&A is as of February 2, 2017 and should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2016 and our 2015 Annual Information Form. All amounts in this MD&A are in millions of Canadian dollars except per unit amounts. Throughout this MD&A, the terms, we, us, our, and Alliance Canada mean. The term Alliance U.S. refers to Alliance Pipeline L.P., the owner of the U.S portion of the pipeline. Collectively, Alliance Pipeline Limited Partnership and Alliance Pipeline L.P. are referred to as the System. The cost of service model refers to the originally contracted services, that Alliance Canada provided to customers, that concluded on November 30, The Services Offering refers to the multi service, at risk transportation service model that was approved by National Energy Board (NEB) on July 9, 2015 for service to commence December 1, Page 3

4 Management s Discussion and Analysis Health and Safety Stewardship At Alliance Canada, safety and environmental stewardship are our top core values. We consider both in our daily decisions and actions with the goal of being incident free. That means protecting the environment around us and keeping our neighbors, employees and contractors safe. We comply with or exceed all applicable health, safety and environmental laws and regulations in all material respects. Natural gas pipelines in Canada are required to meet construction, operating and maintenance standards established by the NEB, other federal regulators and the Canadian Standards Association. Alliance Canada is subject to the NEB s Onshore Pipeline Regulations for designing, constructing, operating and abandoning pipelines. Operationally, we comply in all material respects with the NEB Act, the Onshore Pipeline Regulations and all applicable safety regulations, standards and codes. We conduct patrols of rights of way and required inspections and audits of pipeline condition through investigative excavations and assessments of the levels of protection related to our cathodic protection system, relief valves and mainline valves. Our maintenance program includes monthly, quarterly, semi-annual and annual inspections of all compressor station and meter station facilities. Maintenance expenditures vary from year to year. We are now in our second decade of operations and as the System matures and technology changes, we anticipate increased maintenance requirements for some facilities and optimization for other facilities that have undergone improvements or upgrades. As part of our maintenance inspection program, routine internal safety and security audits are performed at compressor station facilities with corrective actions as required. We have developed a structured Health and Safety Management System based on Occupational Health and Safety Management Guidelines. This system is part of Alliance s Integrated Management System that has been developed for integration of key operational programs to manage hazards and risks associated with operation of the System. We allow inspections and audits when agencies that regulate our industry request them, and follow defined practices to meet regulatory requirements during the construction, operation and maintenance of our facilities. In addition to complying with general operating and maintenance requirements, we have rigorous integrity management programs that regularly assess the condition of the System. Our robust pipeline integrity lifecycle efforts have resulted in three cycles of inline inspections completed in 16 years of operations. Page 4

5 Management s Discussion and Analysis Environmental Stewardship Even with the design features of the System making it more efficient than older, conventional natural gas pipelines, Greenhouse Gas (GHG) emissions are created during the combustion of natural gas in turbines that drive compressors to move natural gas through the System. Although GHG emissions have been reduced by using high efficiency gas turbines, the emissions intensity from the Alliance Canada pipeline still exceeds the net emissions intensity limit calculated under Alberta's Specified Gas Emitters Regulation (SGER). Under the SGER, facilities that emit more than 100,000 tonnes of CO 2 annually, which includes the Alliance Canada pipeline, are required to reduce their emissions intensity commencing in 2009 by 12% of their baseline emissions. Given that the Alliance Canada portion of the System is a relatively recently constructed facility, further emission reductions at the source are difficult and Alliance Canada's remaining compliance options to meet its required emission reduction target are to purchase credits from the Alberta Climate Change Fund for $20.00 per credit in 2016 (1 credit = 1 tonne of CO 2 emission reductions) or to purchase offsets from qualified projects. The Alberta Government announced changes to the SGER program in June The reduction target remained at 12% in 2015, but increased to 15% in 2016 and will increase to 20% in The cost of credits remained at $15 per tonne for 2015, increased to $20 per tonne in 2016 and will be $30 per tonne in Beginning January 1, 2017, the new carbon levy will apply to all fossil fuels at a rate of $20 per tonne of CO 2 emissions and increasing to $30 per tonne starting January 1, For the 2017 year, Bill 20 allows carbon levy exemption for facilities subject to SGER. All of Alliance Canada s facilities in Alberta are eligible for the SGER exemption. British Columbia implemented the Carbon Tax Act in 2008, which taxes the consumption of all fuel sources in the province. Alliance Canada's British Columbia operations are subject to this tax. The cost associated with the credits purchased from the Alberta Climate Change Fund and/or qualified projects, and the British Columbia carbon tax are included in the transportation tolls and recovered from shippers. In October 2016, the Federal Government passed a motion in the House of Commons to introduce a carbon pricing mechanism in accordance with the Paris Climate Agreement. The motion included a requirement for minimum carbon pricing in all jurisdictions in Canada by The minimum price on carbon emissions was set at $10 per tonne in 2018, rising by $10 a year for the next four years, reaching $50 per tonne in Provinces are free to implement their own carbon plan, however, the provincial plans must meet the federal minimum price or the federal government will impose a levy that makes up the difference. In November 2015, the Government of Alberta announced Alberta's Climate Leadership Plan, a framework which includes an economy-wide tax on carbon emissions starting in Subsequently, in June 2016, the Government of Alberta passed Bill 20, the Climate Leadership Implementation Act. The new legislation implements key elements of the Climate Leadership Plan, including enacting the Climate Leadership Act, which establishes Alberta's carbon levy. Page 5

6 Management s Discussion and Analysis Overview of Services Offering Alliance Canada introduced a market based Services Offering effective December 1, 2015, replacing the original firm service contracts that had a primary term ending on November 30, Our Services Offering combines service flexibility and firm toll predictability, together with enhanced natural gas transportation services that create economic value for customers. We offer firm and IT services to shippers. Natural Gas Transmission Services Effective December 1, 2015, Alliance Canada s Services Offering includes the following key elements: Firm Receipt Service includes two zones with fixed volumetric tolls, allowing shippers to move gas from their contract receipt point(s) to the Alliance Trading Pool (ATP). Shippers have the option to lock in their receipt tolls for three to ten year terms. Firm receipt shippers will also have access to a Priority Interruptible Transportation Service (PITS) that can provide additional transportation access as production volumes grow. PITS is available to Firm Receipt Service shippers with terms of three years or more and allows them to flow up to 25% more volume at their contracted receipt points. The two receipt zones are: Firm Delivery Service allows shippers to deliver gas from the ATP to the Canada U.S. border. Fixed tolls are offered on one to ten year terms. Firm Full Path Service is a volumetrically tolled service from Canadian receipt points in both Zone 1 and Zone 2 to the Canada U.S. border, with fixed toll terms between three and ten years. This service requires a corresponding firm transportation service contract with Alliance U.S. ATP a new Canadian trading pool allowing receipt and delivery shippers to trade gas. The ATP is a notional point connecting the receipt zones to the delivery zone. The introduction of the ATP facilitates the segmentation of services on the pipeline into receipt and delivery services, providing a platform for receipt and delivery shippers to transfer title and allowing shippers to access Term Park and Loan services. The Services Offering also includes biddable tolls for seasonal, short-term firm and IT services, rich gas services, and the ability to stage contract commitments. o Zone 1 includes all receipt points downstream of the Blueberry Hill Compressor Station near Gordondale, Alberta. o Zone 2 includes the Blueberry Hill Compressor Station and all receipts points upstream of that station. Page 6

7 Management s Discussion and Analysis To further establish Alliance Canada as the rich gas transporter of choice, we received NEB approval to change the Hydrocarbon Dewpoint (HCDP) gas quality tariff specification from -10 degrees Celsius to -5 degrees Celsius, effective December 1, Similarly, effective December 1, 2015, Alliance U.S. received approval from the FERC in 2015 to change the HCDP gas quality tariff specification from 14 degrees Fahrenheit to 23 degrees Fahrenheit. By delivering NGLs within the natural gas stream, Alliance Canada producers may gain a competitive advantage by delivering value added products to alternative markets for NGLs while only paying a transportation charge based on volume. This competitive advantage provided by the System has resulted in increasing levels of NGLs transported by Alliance Canada, a 58% increase since The HCDP specification change will enhance shipper access to rich gas transportation and facilitate an increase in the NGLs content of the gas Alliance Canada transports. In addition to this HCDP change, we offer services that can further enable shippers to optimize the heat content of the natural gas delivered to us. Curtailment mechanisms are included in the tariffs to ensure that pipeline operations and safety are not compromised. Competitiveness Alliance Canada's Services Offering is uniquely designed to enable rich gas producers to maximize the value of their product. Alliance Canada has the ability to transport a significant volume of NGLs (such as ethane, propane, butane and condensates) within the natural gas stream. This provides significant competitive advantages which can include: Saving producers processing and infrastructure costs, and providing an opportunity to reduce the time to market for their rich gas production; Providing access to the Aux Sable NGLs extraction facility allowing for considerable economies of scale; and Potentially providing a higher net back for rich natural gas. Page 7

8 Management s Discussion and Analysis Operational Performance The total throughput of all firm (including short-term and seasonal) transportation contracted to the Canadian border for 2016 averaged 1.5 bcf/d. In addition, Alliance Canada sells IT service, which averaged 0.1 bcf/day in Pipeline Activities The Saskatchewan Ministry of Highways and Infrastructure is constructing a major highway bypass project (Regina Bypass Project) near Regina, Saskatchewan. To accommodate the development of this project, Alliance Canada installed a new section of pipe at each of two locations where the new highway crossed our mainline. Alliance Canada has made arrangements to be reimbursed for project costs and foregone revenue from this planned outage. The System was shut down for a period of approximately seven days in October 2016 to facilitate the re-routing and replacement of our existing pipe and installation of a new block valve near Regina, Saskatchewan. During the shutdown, Alliance Canada also carried out a variety of maintenance and other activities along the pipeline to make the most efficient use of the outage. This is expected to minimize the need for future outages required to maintain and enhance system integrity. These activities included installing a NGLs scrubber at our Blueberry compressor station. Consistent with industry practice, other connected facilities undertook maintenance activities during this outage and as a result the outage required an extra day due to a delay in maintenance activities at the Aux Sable NGLs extraction facility in Illinois, U.S. Page 8

9 Management s Discussion and Analysis 2016 Operating Income Highlights For the twelve months ended December 31, 2016 operating income increased by $58.4 million to $250.5 million, compared to $192.1 million for the same period in TRANSPORTATION VOLUMES For the first full year of operation under the Services Offering, transportation volumes were strong throughout the year. The 2016 average daily firm contracted capacity, including short-term and seasonal, was 1,464.9 mmcf/d compared to the previous year s firm contracted amount of 1,340.1 mmcf/d. For the first 11 months of 2015, the contracted firm volumes were based on a costof-service model that limited firm transportation capacity to 1,325.0 mmcf/d, with transportation above this level categorized as Authorized Overrun Service (AOS). AOS was available capacity offered to shippers at no extra cost beyond fuel gas. Total average daily contracted volumes for the year ended 2016, for both firm and IT, amounted to 1,534.2 mmcf/d an increase of mmcf/d as compared to the prior year s amount of 1,345.6 mmcf/d (excluding AOS). This was due to the strong demand for the Services Offering, which resulted in a high utilization of pipeline capacity. Under the new service model, there was strong initial demand for more firm capacity, in particular firm seasonal service. Increased shipper demand during 2016 resulted in Alliance Canada offering additional short-term firm services as well as still allowing shippers to take advantage of IT availability throughout the year. Page 9

10 Management s Discussion and Analysis Canadian Contracted Transportation Volumes to the U.S. Border Years Ended December Average daily long-term firm (mmcf/d) 1, , ,325.0 Average daily seasonal/ short-term firm (mmcf/d) Average daily interruptible (mmcf/d) Total average daily contracted volume (mmcf/d) 1, , ,325.0 TRANSPORTATION REVENUE, transportation revenue decreased $2.8 million to $460.8 million compared to $463.6 million in the same period in Excluding the transportation fuel revenue, transportation revenue decreased by $39.8 million for the year ended December 31, This reduction is a result of lower firm transportation toll receipts based on a lower cost structure compared to the same period in This was partially offset by an increase in contracted transportation volumes. Seasonal and short-term firm, and IT revenues were $73.3 million for the year ended December 31, Seasonal, short-term firm and IT services were introduced on December 1, Ancillary services revenue of $9.7 million includes rich gas service fees, park and loan services and other related revenue. Years Ended December Revenue Long-term firm transportation revenue Seasonal/short-term firm transportation services IT services Ancillary services Transportation revenue Service revenue from related parties Other revenue Other related party revenue Total revenue Starting in 2016, transportation revenue includes recognition of revenue for the fuel gas that is consumed in the transportation of natural gas. For the year ended December 31, 2016, transportation fuel revenue was $37.0 million, with an equal amount recorded as cost of fuel gas consumed in operating expenses. Page 10

11 Management s Discussion and Analysis EXPENSES, total expenses decreased $67.7 million to $321.6 million compared to $389.3 million for the same period in Years Ended December Operating expenses Operations and maintenance General and administration Property taxes Administrative service agreement fee Operating expenses Depreciation and amortization Net interest expense and other income Total expenses , operating expenses decreased $7.0 million compared to The overall decrease was primarily a result of the reductions in operations and maintenance, and general and administrative expenses, partially offset by the cost of fuel consumed in the transportation of natural gas in operations and maintenance expenses. Operations and Maintenance Expense, operations and maintenance increased $8.7 million as compared to the same period in Starting in 2016, the operations and maintenance expense includes the cost of fuel consumed in the transportation of natural gas. For the year ended December 31, 2016, the cost of fuel consumed in the transportation of natural gas totaled $37.0 million, with an equal amount recorded as transportation fuel revenue. General and Administration Expense, general and administrative expenses decreased $17.8 million compared to The decrease is a result of lower contractor, consulting and salary expense due to cost reduction efforts in Property Tax Expense, property tax expense decreased $1.0 million compared to 2015 due to a reduced assessment value in Alberta. Administrative Service Agreement Fee, the administrative service agreement fee was $3.0 million. This fee is a result of the Executive, Managerial, and Administrative service agreement (EMA) with Alliance U.S., effective January 1, Depreciation Expense, depreciation and amortization expense decreased $46.5 million compared to The reduction is a result of depreciation rates being lowered from 4.0% to a composite rate of 2.4% effective January 1, The change in rates is the result of a depreciation study that reviewed the service life estimates of the pipeline in service assets. Net Interest Expense and Other Income, interest expense decreased $6.9 million compared to The reduction is due to declining long term debt balances as a result of scheduled principal payments on the senior notes., interest income and other increased $7.3 million compared to The increase includes reimbursements of $8.0 million for foregone revenues as a result of the Regina Bypass Project. Excluding the costs of fuel consumed, total operations and maintenance expenses decreased by $28.3 million for the year ended December 31, 2016 compared to This is primarily a result of reductions in salary expenses, consulting and contractor fees, repair and maintenance expenses, and general operating expenses. Page 11

12 Management s Discussion and Analysis Results of Operations for the Three Months ended December 31, Change ($) Change (%) Transportation revenue Total revenues Operating expenses (excluding depreciation) Depreciation expense (11.9) (39.8) Net interest expense and other income (8.3) (54.2) Net income EBITDA (1) Partner distributions paid Cash provided by operating activities (18.7) (38.3) Capital additions (1) Refer to Non-GAAP Financial Measures. TRANSPORTATION REVENUE Transportation revenue increased $0.7 million to $115.6 million for the three months ended December 31, 2016, compared to $114.9 million for the three months ended December 31, Starting in 2016, transportation revenue includes transportation fuel revenue related to the fuel gas that is consumed in the transportation of natural gas. For the three months ended December 31, 2016, this transportation fuel revenue was $13.0 million. Excluding the transportation fuel revenue, total transportation revenue decreased by $12.3 million for the three months ended December 31, 2016 compared to the same period in The reduction in transportation revenue is due to commencement of the Services Offering that became effective December 1, While the Services Offering had strong shipper interest and was fully subscribed, the revenue generated was lower compared to the cost-ofservice tolls that expired on November 30, 2015 and were based on different tolling principles. OPERATING EXPENSES Total operating expenses increased $8.1 million to $58.8 million for the three months ended December 31, 2016, compared to $50.7 million for the three months ended December 31, In the fourth quarter of 2016, operating expenses include $13.0 million for the cost of fuel consumed in the transportation of natural gas. Excluding the costs of fuel consumed, operating expenses decreased by $4.9 million for the three months ended December 31, 2016 compared to the same period in This is primarily as a result of reductions in salary expenses and general operating expenses due to the lower cost structure of the Services Offering. DEPRECIATION EXPENSE Depreciation expense decreased $11.9 million to $17.9 million for the three months ended December 31, 2016, compared to $29.8 million for the same three months ended December 31, The reduction is a result of depreciation rates being lowered from 4.0% to a composite rate of 2.4% effective January 1, TOTAL REVENUES Total revenues increased $4.3 million to $132.7 million for the three months ended December 31, 2016, compared to $128.4 million for the three months ended December 31, Total revenues increased due to $4.2 million of operational linepack activities. Page 12

13 Management s Discussion and Analysis NET INTEREST EXPENSE AND OTHER INCOME Interest expense decreased $1.5 million to $14.5 million for three months ended December 31, 2016, compared to $16.0 million for the three months ended December 31, The interest expense is lower due to declining long-term debt balances as a result of scheduled principal payments on the senior notes. Interest income and other increased $6.8 million for the three months ended December 31, 2016 compared to The increase includes reimbursements of $8.0 million for foregone revenues as a result of the Regina Bypass Project. NET INCOME Net income is $48.9 million for the three months ended December 31, 2016, an increase of $16.3 million when compared to the same three months ended December 31, The increase in net income can largely be attributed to lower depreciation due to a change in rates. EBITDA EBITDA increased by $2.1 million to $80.3 million for the three months ended December 31, 2016, compared to $78.2 million for the same three months ended December 31, 2015 The increase in EBITDA is due to higher total revenues and reimbursement for foregone revenues for the Regina Bypass Project, included in interest and other income, partially offset by an increase in operating expenses. PARTNER DISTRIBUTIONS PAID Distributions paid to Partners are $58.0 million for the three months ended December 31, 2016, compared to $33.8 million for the same quarter in Cash available for distribution increased from the prior year due to Alliance Canada s transition from a cost-ofservice toll setting model to a new suite of transportation services and contract arrangements that were well received by Alliance Canada s shippers. The new services have contributed to higher cash balances as a result of the strong utilization of available transportation capacity along with a reduction in cash requirements associated with Alliance Canada s debt covenant obligations. Reductions in operating expenses throughout 2016 compared to 2015 also contributed to the increase in cash available for distribution. CASH PROVIDED BY OPERATING ACTIVITIES Cash provided by operating activities was $30.1 million for the three months ended December 31, 2016, a decrease of $18.7 million compared to $48.8 million for the three months ended December 31, The decrease in cash provided by operating activities for the three months ended December 31, 2016 can be attributed to lower transportation tolls and higher accounts receivable for expense reimbursements. This was partially offset by lower expenses and higher accounts payable at year end due to increased maintenance activity compared to the three months ended December 31, CAPITAL ADDITIONS Capital additions increased to $3.1 million for the three months ended December 31, 2016, compared to the $0.5 million for the three months ended December 31, While capital activities increased in 2016 compared to 2015, the Regina Bypass Project costs incurred were reimbursed. Page 13

14 Management s Discussion and Analysis Results of Operations for Twelve Months ended December 31, Change ($) Change (%) Transportation revenue (2.8) (0.6) Total revenues Operating expenses (excluding depreciation) (7.0) (3.4) Depreciation expense (46.5) (39.7) Net interest expense and other income (14.2) (21.4) Extraordinary gain (3.2) (100.0) Net income EBITDA (1) Partner distributions paid Cash provided by operating activities (1.6) (0.6) Capital additions (2.1) (27.6) (1) Refer to Non-GAAP Financial Measures. TRANSPORTATION REVENUE Transportation revenue decreased $2.8 million to $460.8 million for the year ended December 31, 2016, compared to $463.6 million in Starting in 2016, transportation revenue includes transportation fuel revenue related to the fuel gas that is consumed in the transportation of natural gas. For the year ended December 31, 2016 this transportation fuel revenue was $37.0 million, with an equal amount recorded as cost of fuel gas consumed. Excluding the transportation fuel revenue, total transportation revenue decreased by $39.8 million for the year ended December 31, The reduction in transportation revenue is due to commencement of the Services Offering that became effective December 1, While the Services Offering had strong shipper interest and was fully subscribed, the revenue generated was lower compared to the cost-ofservice tolls that expired on November 30, 2015 and were based on different tolling principles. TOTAL REVENUES Total revenues increased $4.9 million to $519.8 million for the year ended December 31, 2016, compared to $514.9 million in Total revenues increased due to $10.7 million of operational linepack activities partially offset by decreases in transportation revenue of $2.8 million and service revenue of $2.6 million. OPERATING EXPENSES Operating expenses decreased $7.0 million to $198.5 million for the year ended December 31, 2016, compared to $205.5 million in In 2016, operating expenses include $37.0 million for the cost of fuel consumed in the transportation of natural gas. Excluding the costs of fuel consumed, operating expenses decreased by $44.0 million for the year ended December 31, 2016 compared to This is primarily as a result of decreased salary expenses, a reduction in consulting and contractor fees, lower repairs and maintenance expense and a reduction in general operating expenses compared to the same period in Operating expense decreased due to lower cost structure of the Services Offering when compared to the 2015 cost-of-service model. DEPRECIATION EXPENSE Depreciation expense decreased $46.5 million to $70.7 million for the year ended December 31, 2016, compared to $117.2 million in The reduction is a result of depreciation rates being lowered from 4.0% to a composite rate of 2.4% effective January 1, The change in rates is the result of a depreciation study that reviewed the service life estimates of the pipeline in service assets. Page 14

15 Management s Discussion and Analysis NET INTEREST EXPENSE AND OTHER INCOME, interest expense decreased $6.9 million compared to The reduction is due to declining long term debt balances as a result of scheduled principal payments on the senior notes., interest income and other increased $7.3 million compared to The increase includes reimbursements of $8.0 million for foregone revenues as a result of the Regina Bypass Project. NET INCOME Net income increased $69.4 million to $198.2 million for the year ended December 31, 2016, compared to $128.8 million in The overall increase is due to lower depreciation expense as a result of the rate decrease, lower operating expenses and lower interest expense as a result of reduced debt outstanding. This was offset by a decrease in toll receipts for the year ended December 31, 2016 compared to the 2015 cost-of-service tolls that expired on November 30, CASH PROVIDED BY OPERATING ACTIVITIES Cash provided by operating activities is $252.1 million for the year ended December 31, 2016, compared to $253.7 million in The decrease in cash provided by operating activities can be attributed to lower transportation tolls and higher accounts receivable which resulted in lower cash receipts. This was partially offset by lower operating expenses. CAPITAL ADDITIONS Capital additions are $5.5 million for the year ended December 31, 2016, which is a net decrease of $2.1 million compared to capital additions of $7.6 million in While capital activities increased in 2016 compared to 2015, the Regina Bypass Project costs incurred were reimbursed. EBITDA EBITDA increased $18.8 million to $329.7 million for the year ended December 31, 2016 compared to $310.9 million in The increase in EBITDA is primarily due to lower operating expenses, higher total revenues and other income. PARTNER DISTRIBUTIONS PAID Distributions paid to Partners increased by $37.7 million to $175.0 million for the year ended December 31, 2016, compared to $137.3 million in Cash available for distribution increased from the prior year due to Alliance Canada s transition from a cost-ofservice toll setting model to a new suite of transportation services and contract arrangements that were well received by Alliance Canada s shippers. The Services Offering has contributed to higher cash balances as a result of the strong utilization of available transportation capacity along with a reduction in cash requirements associated with Alliance Canada s debt covenant obligations. Reductions in operating expenses throughout 2016 compared to 2015 also contributed to the increase in cash available for distributions. Page 15

16 Managements Discussion and Analysis Selected Quarterly Financial Information (1) Q Q Q Q Q Q Q Q Total revenues Net income Net income per unit (2) EBITDA (3) Partner distributions paid Distributions paid per unit (2) (1) Prior to December 1, 2015, Alliance Canada operated under a cost of service business model that produced results that did not vary significantly quarter over quarter. (2) Per unit comparisons reflect amounts available to limited partners (99%). The number of units outstanding for each of the above reporting periods was 629, (3) Refer to Non-GAAP Financial Measures. Significant items that impacted the quarterly financial results include the following: Q Partner distributions increased compared to the third quarter of 2016 due to an increase in cash available for distribution. Total revenues increased due to operational linepack activities. Q The third quarter net income increased due to higher revenues compared to the second quarter of Partner distributions increased compared to the second quarter of 2016 due to the increase in cash available for distribution. Q The second quarter increase in net income reflects a decrease from prior year in repair and maintenance costs, contractor and consulting costs and reduced salary expenses. The second quarter of 2016 transportation revenue also included a decrease in firm and IT revenue as compared to the first quarter of Q The first quarter of 2016 reflects the first full quarter of operations under the Services Offering, in which Alliance Canada began offering a market based suite of services. The increase in net income and EBITDA is a result of the lower fixed-cost structure and higher revenues in the first quarter of Q In the fourth quarter of 2015, Alliance Canada commenced operations under the Services Offering which resulted in a decrease in transportation tolls collected in December The toll reduction is primarily due to the lower fixed cost structure included in the Services Offering tolls. Fourth quarter net income also reflects lower operating expenses as a result of a reduction in contractor, consulting costs, and salary expenses due to reduced staffing requirements. Q The third quarter 2015 transportation revenue reflects the impact of Demand Charge Credits resulting from the transportation service outage that occurred in August Q The second quarter 2015 net income reflects the discontinuation of rate regulated accounting for a portion of operations. We recognized an extraordinary gain of $3.2 million mainly due to the de-recognition of regulatory assets and liabilities. Q The first quarter 2015 revenue reflects higher negotiated depreciation rates in the transportation service contracts for 2015 as compared to the negotiated depreciation rates in effect in Page 16

17 Managements Discussion and Analysis Related Party Transactions Alliance Canada provides transportation services to a number of shippers that are related entities of the Partners of Alliance Canada. The terms of these contracts are the same as those agreed to with independent third parties. For the year ended December 31, 2016, transportation revenue from related party services amounted to $118.1 million (December 31, 2015 $52.5 million). The EMA allows Alliance Canada to provide services to and receive services from Alliance U.S. in exchange for reimbursement of incurred costs, plus an applicable mark-up, and are invoiced on a monthly basis. All amounts exchanged under this agreement are presented as service revenue from related parties or general and administrative expenses. Alliance Canada also provides management, administrative, operational and workforce related services to entities related by virtue of a common ownership group. Amounts exchanged under these services are presented as service revenue from related parties. Occasionally, Alliance Canada leases equipment to a related entity. As of December 31, 2016, no leases exist. All amounts earned as a result of these transactions are presented as other income. The total income earned for the year ended December 31, 2016 is $nil (December 31, 2015 $0.5 million). Pipeline Ltd. (the General Partner) under the terms of the Limited Partnership Agreement. Alliance Canada reimburses the General Partner for service costs incurred under the terms of the Limited Partnership Agreement on a monthly basis. The General Partner does not record any profit or margin for the services charged to Alliance Canada. All amounts exchanged under the Limited Partnership Agreement are presented as general and administrative and operating and maintenance costs. From time to time, Alliance Canada sells operational linepack to Alliance U.S. to supplement operational linepack or as fuel gas to support the efficient operation of the pipeline. The terms of these purchase transactions are the same as those that would be associated with purchases made from independent third parties. Amounts Due From Related Parties (excluding transportation revenue) Years ended December Alliance Pipeline entities NRGreen Power Limited Partnership Aux Sable entities Alliance Canada does not directly employ any of the individuals responsible for managing or operating the business, nor does Alliance Canada have any directors. Alliance Canada obtains management, administrative, operational and workforce related services from Alliance Page 17

18 Managements Discussion and Analysis Liquidity and Capital Resources LIQUIDITY Liquidity risk is managed by ensuring access to sufficient funds required to meet obligations. Alliance Canada forecasts cash requirements to ensure funds are available to settle liabilities as they become due. The primary sources of funds are transportation toll receipts, undrawn credit facilities and funding from the Partners. Working capital deficiencies may occur from time to time as a result of seasonal activity fluctuations, but any such deficiencies have no material effect on our liquidity because of regular monthly cash flow due to a high level of firm contracts and available committed credit facilities. We hold in our debt service reserve account an amount equal to at least six months scheduled interest and principal payments, which is funded by letters of credit as part of the bank credit facility. The bank credit facility which was amended in the fourth quarter of 2016 to mature June 29, Undrawn bank credit facilities are $122.0 million at December 31, The total of cash, trust deposits and the bank credit facility is, in management s view, adequate to meet on-going liquidity and capital resource requirements. We have no planned capital expenditures for DISTRIBUTIONS TO PARTNERS Distribution decisions are approved by the Board of Directors of the General Partner, on the basis of cash flow, financial requirements and other conditions existing at the time. Distributions may be made quarterly, subject to Alliance Canada satisfying certain financing conditions, which include a DSCR. Subject to lender approval, a distribution of $40.0 million will be paid to our Partners on February 2, We intend to continue making Partner distributions on a quarterly basis. The debt service reserve is in addition to funds transferred monthly to the debt service account held for the semi-annual interest and principal payments on the senior notes outstanding and the monthly debt service amounts due on the credit facility. Funds available under the revolving credit facility may also be accessed from time to time should cash receipts prove insufficient to fund the month s operating and investing activities. We may need to refinance our indebtedness or may require additional financing depending on future developments, enhancement opportunities or acquisition plans. As of December 31, 2016, we have $82.3 million in cash and trust deposit accounts. Cash totaling $72.6 million is held in trust accounts to meet certain covenants contained in financing agreements. It also includes restricted deposits provided by the shippers as well as restricted deposits related to the Alliance Pipeline Abandonment Trust (the Trust). Page 18

19 Managements Discussion and Analysis CAPITAL MANAGEMENT Alliance Canada s objective in managing capital is to optimize our capital structure so we can ensure a healthy financial position to support our operations and growth opportunities. Capital is managed by funding our rate base using a maximum ratio of 70% debt to 30% equity. Senior debt consists of senior notes, including the current portion, and credit facility drawings. Rate base does not have a standardized meaning under U.S. GAAP. See Non- GAAP Financial Measures section. We monitor our capital structure by periodically calculating the ratio of senior debt to rate base to ensure compliance with debt covenant requirements contained in financing agreements, which set a maximum borrowing amount for senior debt that will not exceed 70% of rate base by more than U.S.$10.0 million. We are in compliance with all the terms and conditions of the covenants associated with our senior debt for the years ended December 31, 2015 and December 31, 2016 and expect to remain in compliance throughout PIPELINE ABANDONMENT COSTS The NEB s Land Matters Consultation Initiative is an initiative that requires NEB regulated pipelines to set aside funds to cover future pipeline abandonment costs. The NEB provided several key guiding principles under this initiative, including the position that abandonment costs are legitimate costs of providing transportation services and are recoverable, upon NEB approval, from shippers. Alliance Canada collects abandonment funds through a pipeline abandonment transportation surcharge as defined in the Tariff. These funds are set aside in the Trust until such time that the funds are required to settle abandonment-related expenditures. The Trust is consolidated and presented on the financial statements as investments held in trust. As per the Trust agreement, Alliance Canada is the primary beneficiary of the Trust. The pipeline abandonment costs fall within the scope of ASC 980 which results in the revenue being adjusted to reflect differences between the period in which the abandonment funding is collected through toll receipts and the period the abandonment costs are incurred. These differences are presented as a long-term regulatory liability on the financial statements. Page 19