Competition

TransCanada faces competition at both the supply end and the market end of its systems. The competition is a result of other pipelines accessing the increasingly mature WCSB as well as markets served by TransCanada's pipelines. In addition, the continued expiration of long-term firm transportation (FT) contracts has resulted in significant reductions in long-term firm contracted capacity on the Canadian Mainline, the Alberta System, the BC System and the Gas Transmission Northwest System, and shifts to short-term firm contracts.

TransCanada's primary source of natural gas supply is the WCSB. As of December 2005, the WCSB had remaining discovered natural gas reserves of approximately 57 trillion cubic feet and a reserves-to-production ratio of approximately nine years at current levels of production. Historically, additional reserves have continually been discovered to maintain the reserves-to-production ratio at close to nine years. Natural gas prices in the future are expected to be higher than long-term historical averages due to a tighter supply/demand balance, which should stimulate exploration and production in the WCSB. However, the WCSB's natural gas supply is expected to remain essentially flat. With the expansion of capacity on TransCanada's wholly and partially owned pipelines over the past decade and the competition provided by other pipelines combined with significant growth in natural gas demand in Alberta, TransCanada anticipates there will be excess pipeline capacity out of the WCSB for the foreseeable future.

TransCanada's Alberta System is the major natural gas gathering and transportation system for the WCSB, connecting most of the natural gas processing plants in Alberta to domestic and export markets. The Alberta System has faced, and will continue to face, increasing competition from other pipelines. An emerging competitive issue for the Alberta System is the existence and access to natural gas liquids (NGLs) contained in the gas that is transported by the pipeline. The current extraction convention in Alberta allocates a heat content value to the receipt point shippers at the overall Alberta System average gas composition. This averaging is becoming a significant issue for northern gas producers whose gas is generally rich in NGL content as they seek to extract the full value of the NGLs. Alberta's petrochemical industry is also very interested in the issue as it relies on NGLs as their feedstock. The EUB is aware of the current extraction convention inequities and has indicated that they will commission a process to address these concerns.

The Canadian Mainline is TransCanada's cross-continental natural gas pipeline serving midwestern and eastern markets in Canada and the U.S. The demand for natural gas in TransCanada's key eastern markets is expected to continue to increase, particularly to meet the expected growth in natural gas-fired power generation. Although there are opportunities to increase market share in Canadian and U.S. export markets, TransCanada faces significant competition in these regions. Consumers in the northeastern U.S. generally have access to an array of pipeline and supply options. Eastern Canadian markets that historically received Canadian supplies only from TransCanada are now capable of receiving supplies from new pipelines into the region that can source western and Atlantic Canadian, and U.S. supplies.

Over the last few years, the Canadian Mainline has experienced reductions in long-haul FT contracts. This has been partially offset by increases in short-haul contracts. While decreases in throughput do not directly impact the Canadian Mainline earnings, such decreases will impact the competitiveness of its tolls. Over the course of 2005 and into early 2006, strong prices in eastern Canada and the northeastern U.S. resulted in higher than anticipated flows on the Canadian Mainline. Moderating prices in these markets in the latter part of 2006 have reduced flows toward expected levels. Looking forward, in the short to medium term, there is limited opportunity to further reduce per unit tolls by increasing long-haul volumes on the Canadian Mainline.

The Gas Transmission Northwest System must compete with other pipelines to access natural gas supplies as well as to access markets. Transportation service capacity on the Gas Transmission Northwest System provides customers with access to supplies of natural gas primarily from the WCSB and serves markets in the Pacific Northwest, California and Nevada. These three markets may also access supplies from other competing basins in addition to supplies from the WCSB. Historically, natural gas supplies from the WCSB have been competitively priced in relation to natural gas supplies from the other supply regions serving these markets. The Gas Transmission Northwest System experienced significant contract non-renewals in 2005 and 2006 as natural gas transported from the WCSB on the Gas Transmission Northwest System competes for the California and Nevada markets against supplies from the Rocky Mountain and southwestern U.S. supply basins. In the Pacific Northwest market, natural gas transported on the Gas Transmission Northwest System competes against the Rocky Mountain natural gas supply as well as additional western Canadian supply transported by other pipelines.

In October 2006, the Gas Transmission Northwest System's largest customer, Pacific Gas & Electric Company (PG&E), extended its contract to October 31, 2008. In 2006, PG&E accounted for approximately 22 per cent of the Gas Transmission Northwest System's revenue. By October 31, 2007, PG&E will inform TransCanada whether it elects to either extend the contract beyond November 2008, utilize the contract's right of first refusal process or terminate the contract.

Transportation service on North Baja provides access to natural gas supplies primarily from both the Permian Basin, located in western Texas and southeastern New Mexico, and the San Juan Basin, primarily located in northwestern New Mexico and Colorado. North Baja delivers gas to the Gasoducto Bajanorte Pipeline at the California/Mexico border, which transports the gas to markets in northern Baja California, Mexico. While there are currently no direct competitors to deliver natural gas to North Baja's downstream markets, the pipeline may compete with fuel oil, which is an alternative to natural gas in the operation of some electric generation plants in the North Baja region.

Counterparty Risk

The risk of counterparty default is always present. In December 2005, Calpine Corporation and certain of its subsidiaries (Calpine) filed for bankruptcy protection in both Canada and the U.S. Calpine repudiated its transportation contracts on certain of TransCanada's Canadian pipelines effective January 1, 2007 as allowed under a Companies' Creditors Arrangement Act Order. Given that TransCanada considers itself prudent in having obtained the maximum financial assurances allowable under the respective Canadian tariffs, TransCanada will make an application to the regulator for recovery under the current regulatory model for any lost revenue, net of assurances and any revenues from the defaulted capacity. Should Calpine be successful in rejecting its contracts on certain of TransCanada's U.S. pipelines, the unmitigated annual after-tax exposure of the contract obligations is estimated at $10 million for the Gas Transmission Northwest System. Mitigating factors exist which may reduce this exposure including recontracting the capacity where possible and recovery from bankruptcy proceedings. The potential impact of such mitigating factors and the resulting net exposure are unknown at this time.

Regulatory Financial Risk

Regulatory decisions continue to have a significant impact on the financial returns for existing and future investments in TransCanada's Canadian wholly owned pipelines. TransCanada remains concerned that the approved financial returns fail to be competitive with returns from assets of similar risk and will discourage additional investment in existing Canadian natural gas transmission systems. In recent years, TransCanada applied for an ROE of 11 per cent on 40 per cent deemed common equity for both the Canadian Mainline and the Alberta System to the NEB and the EUB, respectively. The outcome of these proceedings resulted in the Canadian Mainline's current 36 per cent deemed equity thickness and the Alberta System's 35 per cent deemed equity thickness. Additionally, the NEB reaffirmed its ROE formula, while the EUB set a generic ROE which largely aligns with the NEB's formula. In 2006, the NEB's ROE formula declined to 8.88 per cent from the 2005 ROE of 9.46 per cent and the EUB's generic ROE declined to 8.93 per cent from 9.50 per cent in 2005. In 2007, the Canadian Mainline and the Alberta System's ROEs continued to decline, dropping to 8.46 percent and 8.51 per cent, respectively.

Throughput Risk

As transportation contracts expire on TransCanada's U.S. pipeline investments, these pipelines will be more exposed to throughput risk and their revenues are more likely to experience increased variability. Throughput risk is created by supply and market competition, gas basin pricing, economic activity, weather variability, pipeline competition and pricing of alternative fuels.