Alliance Pipeline Limited Partnership. Management s Discussion and Analysis

Transcription

1 Alliance Pipeline Limited Partnership Management s Discussion and Analysis December 31, 2011

2 Table of Contents Our Business 4 Map of Alliance Pipeline System 5 Forward Looking Information and Non-GAAP Measures 6 Financial Highlights 8 Corporate Vision 8 Corporate Strategy 8 Key Goals 10 Business Growth 10 Operating Performance 10 Delivery Requirements 10 Systems and Processes 11 Strategic Relationships with Equipment Manufacturers 11 Health, Safety and Environmental Stewardship 12 Pipeline Safety 12 Environment 13 Outlook 14 New Meter Station Connections 14 Comprehensive Income 5 Year Comparatives 15 Financial Position 15 Partners Equity 16 Selected Quarterly Information 16 Regulatory Matters Toll Filing 18 Land Matters Consultation Initiative 18 Pipeline Right of Way Encroachment 19 Liquidity and Capital Resources 18 Distributions to Partners 19 Capital Management 19 Results Three Months Operations 20 Results Twelve Months Operations 22 Future Accounting Policy Changes 23 Adoption of US GAAP 24 Adoption Activities 24 P a g e 2 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

3 Risks and Uncertainties 24 Exposure to Shippers 24 Recovery of Capital 25 Dependence on Related Parties 25 Competition 25 Operating 26 Environmental Matters 26 Credit Risk 26 Liquidity Risk 27 Foreign Exchange and Interest Rate Risk 28 Work Force Development 28 Employees 28 Incentive Compensation Plans 29 Related Party Transactions 29 Critical Accounting Estimates 30 Accounting for Rate Regulation 31 Depreciation and Amortization 31 Asset Retirement Obligations 32 Financial Instruments 33 Master Asset Vehicle II Notes 33 Forward Foreign Exchange Contracts 33 Disclosure Controls 34 Internal Controls 34 P a g e 3 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

4 Our Business The Alliance Pipeline System (the System ) is comprised of two principal assets: the Alliance Canada pipeline ( Alliance Canada or the Partnership ) and the Alliance USA pipeline ( Alliance USA ). The System consists of 3,000 km of integrated, high-pressure, natural gas transmission pipeline, a series of gathering laterals located in Canada and related equipment such as compressor stations and communication and station control equipment. The Alliance Canada System consists of 1,560 km of natural gas mainline pipeline, 730 km of related lateral pipelines connected to 53 natural gas receipt locations, primarily at gas processing facilities in northwestern Alberta and northeastern British Columbia, and related infrastructure. The System delivers rich gas or natural gas with relatively high natural gas liquids ( NGL ) content, through a high-pressure transmission service primarily from the Western Canadian Sedimentary Basin ( WCSB ) to the Chicago area. The transportation of rich gas increases operating efficiency and delivers more energy to markets than a typical natural gas pipeline. The Alliance Canada mainline connects to the Alliance USA pipeline at the Canada/US border near Elmore, Saskatchewan. The Alliance USA pipeline connects near its terminus in the Chicago area with five interstate natural gas pipelines and two local natural gas distribution systems. These pipelines and local distribution systems serve major natural gas consuming areas in the mid-western United States and Ontario. Connection to these pipelines provides shippers with access to other major natural gas markets in northeastern United States and eastern Canada. The current downstream natural gas receipt capacity of these connected pipelines and local distribution systems in the Chicago area exceeds 6 bcf/d. Near the terminus of the System in the Chicago area, Alliance USA also connects with an NGL extraction plant, the Aux Sable Extraction Facility. The Aux Sable Extraction Facility is one of the largest, state-of-the-art extraction and fractionation plants in North America and provides access to multiple NGL markets and distribution channels. The Aux Sable Extraction Facility is owned by Aux Sable Liquid Products LP ( Aux Sable ), a related party of Alliance Canada. The System is also connected to three ethanol producing plants; two in North Dakota and one in Iowa. Launched in December 2011, the Alliance Chicago Exchange Hub ( ACE Hub ) offers a new suite of services that leverage the System s interconnections in the Chicago area to other pipelines and downstream markets. As a step forward in the development of new services, the ACE Hub enables market participants to access greater commercial liquidity and delivery flexibility in their transactions. Enhanced title transfers, wheeling, and park and loan services at the delivery head at Channahon, Illinois, are available to existing shippers and new customers. Alliance USA is moving forward with preparations to construct a 127 km lateral pipeline (the Tioga Lateral ) in North Dakota that would connect new natural gas supply from the Bakken area to the System mainline. The natural gas would then be shipped onward to the Chicago market hub. The Tioga Lateral would extend from an area near Tioga, ND to the System mainline near Sherwood, ND. In the second quarter of 2011, a precedent agreement was executed with Hess Corporation as an anchor shipper. The pipeline s initial design capacity is approximately 106,000 mcf/d, which could be increased, subject to further shipper demand. This new infrastructure will enable producers to economically move to market natural gas and natural gas liquids being produced in association with oil production in the Bakken area. This energy might otherwise be flared or vented to the atmosphere due to a current lack of infrastructure. On January 25, 2012, Alliance USA filed an application for regulatory approval to construct and operate the Tioga Lateral and pending approvals, the pipeline is expected to be put into service by mid P a g e 4 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

5 Alliance Canada has negotiated transportation service agreements with its 28 shippers for bcf/d, which is 100% of the firm transportation capacity on the Alliance Canada pipeline. The transportation service agreements have capacity and terms as follows: o 20 mmcf/d with a contract term ending October 31, 2012, o 1,199 mmcf/d with a contract term ending December 1, 2015, o 30 mmcf/d with a contract term ending December 1, 2016, and o 76 mmcf/d with a contract term extended to December 1, All of the transportation service agreements obligate shippers to pay all costs of providing service on a monthly basis regardless of whether or not they transport gas on the System. Alliance Canada is subject to federal regulation by the National Energy Board ( NEB ) and is jointly owned by Enbridge Income Partners Holdings Inc. and Fort Chicago Pipelines (Canada) Ltd. Alliance USA is subject to regulation by the Federal Energy Regulatory Commission ( FERC ). P a g e 5 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

6 Forward-looking Information and Non-GAAP Measures This Management s Discussion and Analysis ( MD&A ) dated January 25, 2012 provides a review of the significant events and transactions that impacted our performance during the three and twelve months ended December 31, 2011 relative to the same period in Certain information contained in this MD&A constitutes forward-looking information under applicable Canadian securities laws. All information, other than statements of historical fact, which addresses activities, events or developments that we expect or anticipate, may, or will occur in the future, is forward-looking information. Forward-looking information typically contains statements identified with words such as "may", "estimate", "anticipate", "believe", "expect", "plan", "intend", "target", "project", "forecast" or similar words suggesting future outcomes or outlook. Forward-looking information in this MD&A includes, but is not limited to, statements with respect to the sufficiency of our available committed credit facilities to fund distributions and planned capital expenditures; statements with respect to the proposed development of new services; and the estimation of impairment of a Master Asset Vehicle ll ( MAVll ) note investment. The risks and uncertainties that we are subject to may affect the operations, performance, development and results of our businesses and include, but are not limited to, our ability to successfully implement our strategic initiatives and achieve expected benefits; the continued existence of contracted shippers; the availability and price of capital; the availability of energy commodities; fluctuations in foreign exchange and interest rates; changes in regulatory, environmental, and other laws and regulations; competitive factors in the pipeline and NGL industries; operational breakdowns, failures, or other disruptions; and the prevailing economic conditions in North America. Additional information on these and other risks, uncertainties and factors that could affect our operations or financial results are included in our filings with the securities commissions or similar authorities in each of the provinces of Canada. Readers are also cautioned that the foregoing list of factors and risks is not exhaustive. The impact of any one risk, uncertainty or factor on a particular forward-looking statement is not determinable with certainty as these factors are independent and management's future course of action would depend on our assessment of all information at that time. Although we believe that the expectations conveyed by the forward-looking information are reasonable based on information available to us on the date of preparation, no assurances can be given as to future results or levels of activity and achievements. Undue reliance should not be placed on the information contained herein, as actual results achieved may vary from the information provided herein and the variations may be material. We make no representation that actual results achieved will be the same, in whole or in part, as those set out in the forward-looking information. Furthermore, the forward-looking statements contained herein are made as of the date hereof, and, except as required by law, we do not undertake any obligation to update publicly or to revise any forward-looking information, whether as a result of new information, future events or otherwise. Any forward-looking information contained herein is expressly qualified by this cautionary statement. This MD&A should be read in conjunction with our financial statements as at December 31, 2011 and our Annual Information Form dated April 29, Capitalized terms used herein and not otherwise defined have the same meanings attributed to them in our December 31, 2011 audited financial statements. Alliance Canada is a rate-regulated entity and as permitted by the Canadian Institute of Chartered Accountants ( CICA ) Accounting Standards Board ( AcSB ) has elected to defer the adoption of International Financial Reporting Standards ( IFRS ) for one year and continue to apply the standards in Part V Pre-changeover Accounting Standards of the CICA Handbook for our interim and annual financial statements for the year beginning January 1, Accordingly, all financial information contained within this MD&A has been prepared following the same accounting policies and methods of computation as the financial statements for the year ended December 31, P a g e 6 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

7 Certain financial information contained in this MD&A may not follow standard measures under General Accepted Accounting Principles ( GAAP ) in Canada and may not be comparable to similar measures presented by other entities. These measures are considered to be important measures used by investors and should be used to supplement other performance measures prepared in accordance with GAAP. Partnership distributions paid represent an objective of Alliance Canada, which is to provide a predictable flow of distributable cash to the limited partners. Partnership distributions include net income and 30% of negotiated depreciation expense included in transportation tolls. Partnership distributions can include other income, results of litigated settlements and/or the distribution of funds not required to ensure compliance with debt covenant requirements. Rate base does not have a standardized meaning prescribed by GAAP and is not considered a GAAP measure. Rate base is used, among other things; to calculate a debt to rate base test to ensure compliance with debt covenant requirements contained in the Partnership s financing agreements. Rate base may not be comparable to a similar measure presented by other companies. Additional information concerning our business is available on SEDAR or at P a g e 7 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

8 Financial Highlights Twelve months ended December 31, (millions of dollars, unless otherwise noted) Revenue Comprehensive income Comprehensive income per unit ($) (1) Total assets 1, , ,109.3 Long-term debt 1, , ,342.9 Partner distributions paid (2) Distributions paid per unit ($) (1) (1) (2) Per unit comparisons reflect amounts available to limited partners (99%). 629,765.1 units were outstanding for each of the reporting periods presented above. Distributions are paid net of the 30% equity share of maintenance capital expenditures ( Equity Holdback ). Corporate Vision and Strategy Corporate Vision Alliance Canada s vision is to challenge the competition and offer superior natural gas transportation services; set standards for the industry by implementing new technology to enhance pipeline optimization; and to expand in the critical business of safe, reliable, and efficient energy delivery in North America. Strategically, we will continue to redefine our role in developing the expanded infrastructure and gas transportation services necessary to deliver needed natural gas and natural gas liquids to supply major North American markets. Corporate Strategy Since initiating operations, we have concentrated on our core business by meeting our company objectives in all key areas of operational performance; availability, reliability, safe operations, throughput and efficiency. Alliance Canada, together with Alliance USA, operates state-of-the-art technology, to provide a high-pressure, liquids-rich service from western Canada to the Chicago market hub. We have developed strategic relationships with major equipment manufacturers enabling us to lower total maintenance costs, achieve higher equipment availability and to access operating equipment best practices. We have implemented a number of pipeline system optimization projects including installation of the Taylor Junction compressor station, which started commercial operations in 2009, in response to shipper demand for increased receipt capacity from northeastern British Columbia. We have further increased our receipt capacity from liquids-rich sources of natural gas including the Montney shale play connecting into Alliance Canada and the Bakken formation in North Dakota delivering into Alliance USA. Since 2010, Alliance Canada has added an additional 255 mmcf/d of new receipt capacity and with the expected completion of a new receipt meter station in the second half of 2012, an additional 120 mmcf/d of capacity will be added to the System. In the Bakken formation in North Dakota, we connected the Prairie Rose Pipeline in 2010 and have recently filed project plans with FERC to construct the Tioga Lateral. P a g e 8 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

9 Alliance Canada continues to engage shippers in discussions to develop new services aligned with our business model. Over the next several we expect to transition to a multi-service natural gas transportation business providing shippers a choice of competitively priced infrastructure and energy transportation services to deliver needed supply to major markets in North America. We believe that the Alliance System offers several advantages including: market connectivity Alliance Canada is in close proximity to significant natural gas production areas in northeastern British Columbia and northwestern Alberta. In this region, approximately 5.5 bcf/d of natural gas production is within a 40 km radius to the Alliance Canada pipeline. In 2010, the Septimus pipeline, owned by Aux Sable, and located in the Montney shale play in British Columbia was connected to the System and is flowing liquids-rich gas. Also in 2010, in the Bakken region of North Dakota, the Prairie Rose Pipeline was connected to Alliance USA and in 2011, contract capacity from this pipeline was doubled to 80 mmcf/d. In 2011, Alliance USA proposed a new Tioga Lateral pipeline that is supported by an executed precedent agreement with Hess Corporation and an application for FERC regulatory approval was submitted on January 25, Both the Prairie Rose Pipeline and the Tioga Lateral, when it is approved, provide new sources of rich natural gas supply from the Bakken region. New meter stations added to Alliance Canada since 2010, will provide an estimated 375 mmcf/d of new receipt capacity by the end of The liquidity of the Chicago market and the associated takeaway capacity and diversity of pipeline connections, have enabled Alliance USA to offer new market hub services at its delivery header near Channahon to existing System shippers and new customers. The delivery header has over six bcf/d of downstream natural gas receipt capability with major interstate pipelines and local gas distribution systems in the Midwestern US. competitiveness A high pressure pipeline service provides for the dense phase transmission of rich gas, which increases the efficiency of the System. Alliance Canada s tariff provisions provide for a volumetric tolling methodology that benefits shippers that deliver high energy natural gas. Competitive transportation tolls currently provide shippers with daily Authorized Overrun Service ( AOS ). AOS is available capacity offered to shippers in proportion to their contracted shipping capacity for no extra cost beyond fuel gas. AOS reduces shippers effective per unit transportation cost. Since the startup of operations on December 1, 2000, Alliance Canada has averaged 1.8% annual transportation toll increases and Alliance USA has had average transportation rate increases of 2.7%. design and operational efficiency The design of the System has the capability to accommodate higher energy natural gas either at current receipt stations or at new stations, with what is expected to be minor System modifications and routine regulatory approvals. This is an advantage in the current environment in which liquids-rich gas drilling is prevalent. The System design provides an alternative for liquids-rich gas shippers looking to avoid building costly field extraction plants. The System was designed to be able to increase the firm transportation capability by approximately 30% by adding compression facilities. While an expansion is not imminent, adding compressor stations may prove to be a more cost effective alternative to constructing new large diameter pipeline facilities, which require regulatory and environmental approvals and possibly additional right-of-way. P a g e 9 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

10 We continue to leverage our assets and competitive advantages for further optimization and growth opportunities, including expanded receipt capacity, the potential for new delivery markets and new service offerings that could result in Alliance Canada providing greater market energy economics to the emerging natural gas production areas that are adjacent to our pipeline. Key Goals Our key goals are focused on the following areas: o Leveraging existing assets and competitive advantages as a platform for growth. o Excellence and innovation in operations. o Health, safety and environmental stewardship. Leveraging Existing Assets and Competitive Advantages as a Platform for Growth Alliance Canada s strategy is to grow from a single-service, single-toll pipeline to a multi-service pipeline enhancing its competitive position by giving shippers greater commercial options, attracting a more diverse shipper community and creating new sources of revenue. New services will be designed to attract and retain customers and exploit existing infrastructure while coexisting with the current firm transportation contracts and tariffs. Alliance Canada will leverage a number of advantages to facilitate growth such as: o o The pipeline s unique ability to transport rich gas; a combination of natural gas (methane) and natural gas liquids (such as ethane, propane, and butane), which delivers more product (energy) to market than a typical natural gas pipeline system at competitive tolls. This transportation advantage positions Alliance Canada to be competitive in producing areas in British Columbia and Alberta in Canada and the Bakken region in the US. With fractionation spreads for NGL in today s market, the value of the delivered product and potential netbacks to shippers have the potential to be higher than on competitor pipelines. The System s efficiency in preserving liquids until the point of liquid extraction considerably increases the value of the rich gas. The NGL extraction and fractionation plant owned by Aux Sable connects to the pipeline near its terminus in the Chicago, Illinois area. One of the largest plants of its type in North America, this state-of-the-art facility provides access to multiple NGL markets, distribution channels, and storage. Excellence and Innovation in Operations Alliance Canada is focused on maximizing the reliability, availability and throughput of its transportation services in a safe and environmentally responsible manner. We continue to ensure effective and prudent management of our operating costs, as part of our management focus on Alliance Canada s long-term competitiveness. delivery requirements Alliance Canada provides firm take or pay transportation services under negotiated contracts and shippers are obligated to pay for contracted volumes regardless of whether they ship natural gas or not. Alliance Canada continues to meet its contracted daily firm service shipping requirements and shippers continue to substantially utilize all the AOS offered. P a g e 1 0 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

11 The average offered AOS for 2011 was 18.0%, compared to 20.7% offered in The decrease in offered AOS was primarily due to compressor equipment change outs, related modifications to the System and preventative maintenance activities. The annual AOS for 2012 is forecasted to be 16.0%, a reduction stemming primarily from an increase in planned maintenance work during 2012 including scheduled compressor control panel replacements. AOS is expected to be similarly impacted in systems and processes The main control centre for the System is located in Alberta, and has control, alarm and leak detection monitoring capability. Control centre operators have the ability to remotely shut down individual stations or facilities on the System. In addition, each remote station has local emergency shutdown capabilities. A back-up control centre has also been established in a different location in Alberta. We utilize a satellite communications system for data transmission to and from remote facilities and the main and back-up control centres. The satellite system is backed up by land lines to the remote facilities. Mainline block valves are linked to the control centre to monitor gas pressure and temperature and provide for rapid closure of block valves in the event of an emergency. All major compressor station equipment is monitored by on-site sensors for parameters such as temperature, pressure and vibration. Compressor station operational performance and throughput are monitored and automatically controlled. Each compressor station is designed to be unmanned but is monitored and operated on a continuous year-round basis from the manned system control centre. Our gas management system is a critical element of our business. It meets both business and regulatory requirements by providing functionality which includes contract management, customer account management, capacity release, nomination entry, scheduling, confirmation and allocation, imbalance management, invoicing and reporting. Alliance Canada s maintenance program includes semi-annual inspections of all compressor stations as well as internal corrosion inspections and annual pipe-to-soil surveys, atmospheric inspections, above ground indirect assessments and the repair and replacement of compressor parts. In-line inspection of the mainline pipeline is completed on a seven year recurring schedule. Maintenance expenditures may vary from year to year. Alliance Canada entered its second decade of operations in 2011 and as the System matures and technology changes, increased maintenance requirements are anticipated. strategic relationships with equipment manufacturers We have developed a strategic supply and equipment maintenance relationship with the manufacturers of major components on nine of Alliance Canada s compressor units. One contract, signed in March 2008, provides certain major maintenance services with respect to most of our compressor equipment through Additional services under this agreement include those of resident engineers and technicians that can provide expertise aimed at further enhancing Alliance Canada s efficient, reliable and economic operation of our equipment; achievements that might not otherwise be possible under a more standard maintenance and overhaul program. Key Performance Indicators ( KPIs ) are tracked to evaluate the effectiveness of the maintenance program. KPIs evaluated include equipment availability, mean time between failures, fired hour costs and the depot/workshop turnaround time for major overhauls. P a g e 1 1 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

12 A second contract, signed in August 2009, is for the replacement of existing control panels, which control the power turbine, gas generator and compressor unit functions at most of the mainline compressor facilities along the System. The current control panel software and equipment are becoming obsolete and vendor support for the existing hardware components will be discontinued in The first compressor control panel installation was completed in September, 2011 and all equipment performance measures were achieved. Further installations are planned at compressor sites throughout the System in 2012 and Health, Safety and Environmental Stewardship Alliance Canada is committed to attaining high standards of environmental protection when designing, building and operating its facilities. We are committed to maintaining public and employee health and safety throughout all operations and construction activities. We believe that health and safety are the responsibility of each employee and contractor and that accident prevention is an integral part of every job. At Alliance Canada, safety is never compromised and environmental stewardship is a core value. Both are considered in our daily decisions and actions with the goal of being incident free and environmentally responsible. That means protecting the environment around us and keeping our neighbours and employees safe. We comply with or exceed all applicable health, safety and environmental laws and regulations in all material respects. pipeline safety 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 ( CSA ). Alliance Canada is subject to the NEB s Onshore Pipeline Regulations concerning the design, construction, operation and abandonment of pipelines. Operationally we comply in all material respects with the NEB Act, the Onshore Pipeline Regulations, and the requirements of all applicable safety regulations, standards and codes. We have implemented practices and procedures common in the pipeline industry and necessary to meet applicable laws in all material respects. We conduct, and expect to continue conducting, required inspections and audits of items such as cathodic protection, relief valves, mainline valves, and patrols of rights of way. In addition to complying with normal operations and maintenance requirements, we have rigorous integrity management programs in which in-line inspection tools are run periodically to assess the condition of the System. The frequency of these assessments is based on a detailed evaluation of risk not to exceed maximum intervals established under current Canadian regulations. In 2011 the NEB conducted safety inspections at certain Alliance Canada locations with no material findings resulting. Alliance revised and filed with the NEB its consolidated security plan to conform to the CSA standard that was adopted by the NEB in April The NEB conducted security inspections of certain Alliance Canada locations and reviewed Alliance Canada s security plan, confirming that Alliance Canada was in compliance with NEB requirements. An update of Alliance Canada s Emergency Response Program ( ERP ) that commenced in 2010 was completed in Alliance conducted routine internal safety and security inspections at its compression facilities in 2011 with corrective actions being identified and addressed as appropriate. During a scheduled flyover in August of 2011, Alliance Canada s aerial patrol observed what was thought to be an exposed section of 1067 millimetre (42 inch) diameter mainline at the Smoky River crossing in western Alberta. Same-day inspection confirmed a section of exposed pipe under the water. The riverbank had experienced significant erosion, resulting in migration of the bank and the subsequent exposure of pipe. P a g e 1 2 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

13 After obtaining approval from necessary regulators, which included Alberta Environment and the Department of Fisheries and Oceans Canada, work began at the site on November 7, The exposed pipe was covered with layers of rock shield matting, gravel, articulated concrete revetment matts and boulder-size rock to protect the pipeline and prevent any damage to the pipe. A rock spur was constructed upstream of the exposure area to act as a shield and alter the flow of the river by creating a gentle eddy in the river, thus decreasing the erosion of the river bank. Construction and final site clean-up and demobilization were completed on December 7, Site restoration activities will be completed in the spring of environment In developing its design basis for the System, Alliance Canada made several decisions to take advantage of being able to design all our facilities at the same time and to exploit modern technology and materials. The most significant of these design features are: dry low emission turbines which utilize state-of-the-art technology to reduce NOx and CO2 emissions, and increase fuel efficiency when driving the mainline compressors; internally coated pipe to reduce friction, thereby reducing fuel consumption; and high pressure/rich gas technology which also improves efficiency. These features make the System more efficient than older, conventional designs of natural gas pipelines. However, greenhouse gas ("GHG") emissions are created during the combustion of the natural gas in turbines to drive compressors that move natural gas through the System. Although the GHG emissions have been reduced by using high efficiency gas turbines, the emissions intensity from the System 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 CO2 annually are required to reduce their emissions intensity by 12 percent of their baseline emissions. Further emission reductions at the source for already high efficiency turbines are difficult to achieve and our remaining compliance options to meet required Alberta emission reduction targets are to purchase credits from the Alberta Climate Change Fund for $15.00 per credit (1 credit = 1 tonne of CO2 emission reductions) or to purchase offsets from qualified projects. The anticipated cost to purchase the necessary credits for 2011 is $1.0 million with the final cost to be determined in the first quarter of The cost of purchasing these credits is included in the transportation tolls. The government of British Columbia implemented the Carbon Tax Act in 2008, which taxes the consumption of all fuel sources in the province. Alliance Canada s Taylor compressor station is subject to this tax and the cost related to 2011 is expected to be $0.4 million based on current operational patterns. In Saskatchewan, The Management and Reduction of Greenhouse Gases Act was introduced in the provincial legislature and received Royal Assent on May 20, The Bill, when enacted will set emission reduction targets for emitters and a carbon compliance payment if the target is not achieved. Our facility emissions are also expected to exceed the regulatory threshold for the anticipated federal regulatory framework in Canada, although the timing for enactment of this framework is uncertain. It is probable that we will be required to comply with a federal regulatory scheme in Canada since our pipeline crosses several provinces and is regulated by the NEB. Alliance Canada also conducts regular inspections of its facilities, allows pertinent agency inspections as requested, and follows defined practices to ensure that regulatory requirements and commitments are met during the construction, operation and maintenance of its facilities. P a g e 1 3 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

14 Outlook Natural gas prices are expected to continue to be under pressure throughout 2012 due to the continuing fundamentals of oversupply; however, NGL prices remain strong and should continue to benefit from higher oil prices. Current market dynamics and expanded liquids-rich gas supply from unconventional development are key growth drivers for Alliance Canada given that the System s strength is its liquids capability. The System is flexible enough to be able to transport natural gas containing higher heat content than the levels contained in the streams currently being delivered. This added flexibility can be achieved with what are expected to be minor modifications to the System. Alliance Canada intends to grow in the market place through the proper blend of new receipt and delivery points and is engaged with market participants in developing new receipt facilities and services that can exist alongside the current transportation service agreements. Developments to date have been incremental to the core business of the pipeline. Alliance Canada expects to be able to increase the number of receipt point connections on the System based on the close proximity to natural gas production areas including the liquids-rich gas plays in Canada. Additional receipt points on the System have provided new liquids-rich gas sources and on Alliance USA, there is the additional benefit of increasing contracted capacity for deliveries out of the Bakken area. Discussions with shippers continue to focus on incremental services prior to 2015 and new services beyond The ACE Hub service launched in 2011 saw immediate shipper interest, and represents a step forward in the progression to a multi-service business model. It is expected that the ACE Hub will give Alliance USA exposure to new customers and commercial prospects, and play a contributing role in our future business growth. New Receipt Meter Station Connections Two receipt meter stations; the Sunrise meter station, situated northwest of Dawson Creek on the Alliance Fort St. John lateral and the Snipe Mountain meter station, situated in northwestern Alberta on the Ante Creek lateral, were constructed during The Snipe Mountain site went into service in October 2011 and the in-service date for the Sunrise site is expected in the second quarter of These two meter stations, together with the Septimus receipt meter station, which went in-service in the third quarter of 2010, on the Fort St. John lateral near Taylor, B.C. provide an aggregate of 255 mmcf/d of new receipt capacity. In the fourth quarter of 2011, an interconnect development agreement was executed for the construction of a 120 mmcf/d receipt meter station connection adjacent to Alliance Canada s existing Smoky River station. This station, called Bear Creek, is expected to be placed into service in the second half of P a g e 1 4 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

15 Comprehensive income 5 Year Comparatives (1) (millions of dollars) A key benefit of Alliance Canada s consistent and stable operations is limited variability in financial results year over year. Accounting for rate-regulated operations requires that revenue is recognized relative to the incurred cost of providing transportation services to shippers, including operating, maintenance, and administrative costs, allowances for depreciation and income taxes and an allowed return on investment. As a result of this approach income from operations is not impacted by fluctuation in expenses or revenues. (1) Comprehensive income in 2008 includes $12.1 million as a one-time payment in settlement of a repudiated contract. Financial Position (millions of dollars) December 31, 2011 December 31, 2010 Cash and cash equivalents Total assets 1, ,016.2 Current liabilities Long-term liabilities 1, ,283.3 Partners equity Cash and cash equivalents have increased to $45.4 million as at December 31, 2011 from $31.4 million at December 31, The increase is mainly the result of lower actual cost of service expenses in comparison to costs included in the 2011 tolls and an increase in trade accounts payable and accrued liabilities at year end. Total assets decreased to $1,917.2 million during the twelve months ended December 31, The decrease in total assets is primarily due to lower net property, plant and equipment balances as a result of ongoing depreciation for the twelve months ended December 31, This decrease is partially offset by the increase in cash and cash equivalents. Current liabilities at December 31, 2011 were $116.7 million compared to the December 31, 2010 balance of $100.9 million, an increase of $15.8 million for the twelve month period. The increase is due to higher current portions of long-term debt; an increase in the current portion of the long-term liability, which represents the lower actual cost of service compared to 2011 transportation tolls; and an increase in trade payables and accrued liabilities. The increases in trade payables and accrued liabilities are the result of a number of compressor control panel replacement parts having been shipped in the latter half of December, Long-term liabilities decreased $80.2 million to $1,203.1 million for the twelve months ended December 31, The decrease is mainly due to the scheduled repayment of principal on the senior notes, which is payable semi-annually in June and December. The decrease is partially offset by an increase in the regulatory liabilities which represent differences between expenses included in the financial statements and expenses included in transportation tolls. P a g e 1 5 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

16 Partners equity decreased $34.5 million for the twelve months ended December 31, This decrease is a result of the 2011 distributions of $150.5 million made to Alliance Canada s partners which is partly offset by comprehensive income for the twelve months of $115.2 million. Partners Equity The Partnership is authorized to issue an unlimited number of Class A and B units. The Class A and B units are voting and participate equally in profits, losses and capital distributions of the Partnership. The Class A and B units are held equally by the Partnership s limited partners, Enbridge Income Partners Holdings Inc. and Fort Chicago Pipelines (Canada) Ltd. There were 556,207.2 Class A units and 73,557.9 Class B units outstanding during 2011 and At December 31, 2011, Class A units were valued at $490.0 million (December 31, $520.9 million) and Class B units were valued at $75.9 million (December 31, $80.0 million). The general partner does not hold any units. It manages the operations and has a 1% interest in the profits and capital of the Partnership. Any units issued by the Partnership must be first offered to the existing group of limited partners in proportion to their ownership interests. The Class A Units and the Class B Units are equal with respect to all rights, benefits, obligations and limitations provided under the limited partnership agreement. Selected Quarterly Financial Information (millions of dollars, except where noted) Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Revenue Comprehensive income Comprehensive income per unit ($) (1) Partner distributions paid (2) Distributions paid per unit ($) (1) (1) (2) Per unit comparisons reflect amounts available to limited partners (99%). 629,765.1 units were outstanding for each of the reporting periods presented above. Distributions are paid net of the 30% equity share of maintenance capital expenditures ( Equity Holdback ). A key benefit of Alliance Canada s consistent and stable operations is limited variability in quarterly results. Variations generally result from one-time events. Interim results may fluctuate due to seasonal spending patterns as revenue is recognized relative to cost of service expenses in the period in which the cost of service is incurred. Significant items that impacted the quarterly financial results include the following: o The fourth quarter 2011 revenue reflects an increase in the cost of service related to compressor control panel replacements at several compressor sites, a project to remediate river bank erosion and subsequent pipe exposure, a compressor overhaul not included in the monthly equipment maintenance agreement and an increase in monthly office rental expenses. P a g e 1 6 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

17 o o o o o o o The third quarter 2011 revenue reflects higher operating expenses due to some operating and project activities being deferred from the first and second quarters to the current quarter. The second quarter 2011 revenue reflects lower operating expenses due to some operating and project activities being deferred to the third and fourth quarters, along with reductions in government levies and Alberta property taxes. First quarter 2011 distributions reflect the receipt of a construction litigation settlement in the fourth quarter of 2010 and subsequently included in the first quarter 2011 distributions. The first quarter 2011 revenue reflects a decrease in the cost of service resulting from year over year differences between estimates and actual payouts for compensation plans, lower operations expenses due to some operating and project activities being deferred to the second quarter of 2011, and a reduction in government levies. The first quarter 2011 comprehensive income reflects a lower return on equity, which is due to a depreciating investment base. Fourth quarter 2010 revenue reflected an increase in the cost of service related to higher labour costs, increased pipeline integrity requirements, and head office renovation expenses. These increases were partly offset by lower contractor charges for the maintenance of Alliance Canada s compressor equipment. Fourth quarter distributions reflected the receipt of a construction litigation settlement in the third quarter of 2010 and subsequently included in the fourth quarter distributions. Third quarter 2010 comprehensive income reflected an unrealized gain in the fair value of foreign currency forward contracts designated as cash flow hedges. Third quarter 2010 revenue reflects a decrease in the cost of service related to lower contractor charges for the maintenance of Alliance Canada s compressor equipment. Second quarter 2010 distributions reflected increases in the allowance for income taxes and depreciation expense amounts that are recovered as part of the transportation tolls for Comprehensive income includes an unrealized loss in the fair value of foreign currency forward contracts designed as cash flow hedges. In the second quarter of 2010, Alliance Canada entered into foreign currency forward contracts to hedge Euro denominated payments related to a contractual service agreement and a compressor control panel replacement project. First quarter 2010 results were consistent with ongoing operations. Regulatory Matters 2012 Toll Filing On October 31, 2011, we filed amended tolls with the NEB following consultation with our shippers. Effective January 1, 2012, our 2012 firm service transportation tolls increased $0.01/mcf or 1.2 % from $0.914/mcf to $0.925/mcf. This increase is due primarily to an increase in the negotiated shipper depreciation rates, increased expenditures for pipeline maintenance and system optimization activities, pipeline integrity and compliance projects, renewal and replacement of aging software applications and infrastructure and higher labour costs. These increased expenditures are partially offset by a decrease in the return on equity due to an estimated lower investment base and a decrease in interest expense due to scheduled payments of principal balances on the senior notes. P a g e 1 7 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

18 Land Matters Consultation Initiative Alliance Canada is responsible for compliance with all laws and regulations concerning the abandonment of the pipeline and related facilities at the end of their respective lives. In the fall of 2007, the NEB established a Land Matters Consultation Initiative ( LMCI ) as part of its examination of key land issues. The LMCI is a result of a desire to improve understanding and dialogue between pipeline companies and landowners. On May 26, 2009, the NEB adopted a report on the financial issues of pipeline abandonment that will require companies to set aside funds to cover future abandonment costs. The issuance of this report followed a public hearing, held in January 2009, into the financial matters of pipeline abandonment. As a result of the mandated framework and action plan, Alliance Canada filed preliminary abandonment cost estimates, largely based on NEB assumptions, on November 30, As part of the NEB submission, included were refined versions of the preliminary physical plans for pipeline abandonment, originally filed on May 31, Subsequently, each large pipeline company will have to file by November 2012 a proposal for collection of funds and a proposed process and mechanism to set aside the funds. Under the NEB s current directive, Alliance Canada will have to start collecting such funds no later than the 2015 toll year. Pipeline Right of Way Encroachment Activities The development of a casino complex in the vicinity of the Alliance Canada mainline in northwestern Alberta, near Whitecourt, has resulted in a reclassification of the applicable pipeline design parameters for this specific mainline segment. Population growth adjacent to a pipeline s right-of-way is a common event that occurs throughout Canada. However, when industrial, commercial or residential development activities occur in close proximity to a pipeline right-of-way, the NEB requires pipeline companies to make an assessment of the changed circumstances and a determination of whether there is a need for remedial action. In addition to Alliance Canada s technical submissions and implemented safety measures, the NEB has directed that this localized pipeline segment be replaced with heavier-wall pipe by May 31, The NEB also indicated that alternate options may be considered such as re-routing the pipe within this same time frame. Alliance Canada is currently assessing piping change out and re-route options and will file the associated facilities application with the NEB in due course. Alliance Canada expects to recover all direct and indirect project costs of complying with the NEB s safety related order through its tolls. Liquidity and Capital Resources As of December 31, 2011, Alliance Canada had $45.4 million in cash and cash equivalents and $118.0 million of undrawn bank credit facilities. The total cash and cash equivalents and the bank credit facility are, in management s view, adequate to meet ongoing liquidity and capital resource requirements. Alliance Canada renewed its credit facility in December 2011, which extends the maturity date to October 30, Cash and cash equivalents totaling $44.3 million at December 31, 2011 are held in trust accounts, which include funds held to meet certain covenants contained in financing agreements. P a g e 1 8 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011

19 Alliance Canada has estimated capital expenditures of $13.6 million for Capital plans for the upcoming year include the development of a new gas management system and mainline pipe expenditures relating to a right-of-way encroachment reclassification. We continue to comply with all of our debt covenants and no events have occurred to suggest that we will not continue to meet these requirements. The measures monitored for debt covenants are the rate base test and the debt service coverage ratio described in more detail in the Capital Management and Distributions to Partners sections, respectively. Distributions to Partners (1) Distributions in 2008 included $12.1 million as a one-time payment in settlement of a repudiated contract. (2) Distributions in 2010 included a $5.6 million payment received in settlement of a litigation claim. (3) Distributions in 2011 included a $3.5 million payment received in settlement of a litigation claim. 90 Any decision by Alliance Canada to make a distribution is 80 made by the Board of Directors of Alliance Pipeline Ltd., the 70 general partner, on the basis of cash flow, financial (1) (2) 2011 (3) requirements and other conditions existing at the time of such decision. Distributions are estimated for the year using (millions of dollars) projected net income and 30% of negotiated depreciation expense included in the toll filings for that year. The balance of depreciation expense is used to fund scheduled payments of principal on senior notes. Distributions can include other income, results of litigated settlements and/or funds not required to ensure compliance with debt covenant requirements. Quarterly distributions are approximated at one-fourth of the annual estimate and upon Board and lender approval are paid in the following quarter. Distributions to partners may be made quarterly, subject to Alliance Canada satisfying certain financing conditions including the satisfaction of a debt service coverage ratio ( DSCR ). The DSCR is defined as the ratio of cash inflows minus operating costs as compared with the scheduled debt service payable for a twelve month period. The DSCR for the four preceding fiscal quarters and the projected DSCR for the four succeeding fiscal quarters, calculated as of the distribution date, are required to be at least 1.25 to 1. The DSCR for the four preceding fiscal quarters as at December 31, 2011 is 1.97, compared to 1.96 as at December 31, Subject to lender approval, a distribution of $37.2 million is planned to be paid by Alliance Canada to its partners on January 30, We intend to continue to make future partner distributions on a quarterly basis. Capital Management When managing capital, our objectives are to optimize our capital structure so we can ensure a healthy financial position to support our operations and growth opportunities and to do this in a manner which balances the interests of our shippers and owners. P a g e 1 9 Alliance Pipeline Limited Partnership Management s Discussion and Analysis 2011