• 
• 

Business Risks

Supply, Markets and Competition

TransCanada faces competition at both the supply and market ends of its systems. This competition comes from other natural gas pipelines accessing the increasingly mature WCSB and markets served by TransCanada's pipelines. In addition, the continued expiration of long-term firm contracts has resulted in significant reductions in long-term firm contracted capacity and shifts to short-term firm and interruptible contracts on the Canadian Mainline, the Alberta System, Foothills and the GTN System.

In 2008, the gas supply environment changed. Production out of the WCSB declined while supply in the U.S. grew. Previously it had been expected that U.S. supply would decline. Furthermore, with lower natural gas prices, lower cost U.S. gas developments may hinder the further development of WCSB gas supplies.

TransCanada's primary source of natural gas supply is the WCSB. The WCSB has 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, sufficient additional reserves have been discovered on an ongoing basis to maintain the reserves-to-production ratio at close to nine years, however, supply from the WCSB has declined in recent years due to a continued reduction in levels of drilling activity in the basin. The reduced drilling activity is a result of lower prices, higher supply costs, which include higher royalties in Alberta, and competition for capital from other North American basins that have lower exploration costs. Drilling levels in the WCSB are expected to reach a low point in 2009 and then should begin to recover in the ensuing years assuming that gas prices stabilize at $6 to $7 per gigajoule (GJ) and that finding and development costs become more economical. TransCanada anticipates there will be excess natural gas pipeline capacity out of the WCSB in the foreseeable future as a result of capacity expansions on its wholly owned and partially owned natural gas pipelines over the past decade, competition from other pipelines, and significant growth in natural gas demand within Alberta driven by oil sands and electricity generation requirements.

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. Despite reduced overall drilling levels, activity remains robust in certain areas of the WCSB, which has resulted in the need for new transmission infrastructure. The primary areas of high activity have been deeper conventional drilling in western Alberta and in the foothills region of B.C., and coalbed methane development in central Alberta. Recently, shale gas production in B.C. has emerged as a potentially significant natural gas supply source.

Historically, TransCanada's eastern natural gas pipeline system has been supplied by long-haul flows from the WCSB and by short-haul volumes received from storage fields and interconnecting pipelines in southwestern Ontario. Over the last few years, the Canadian Mainline has experienced reductions in long-haul flows, which have been partially offset by increases in short-haul volumes, resulting in an increase in Canadian Mainline tolls.

Demand for natural gas in TransCanada's key eastern markets, which are served by the Canadian Mainline, is expected to continue to increase, particularly to meet the expected growth in natural gas-fired power generation. However, the Company believes the current environment could reverse this trend in the short term given sufficient levels of erosion of market demand. Although there are opportunities to increase market share in Canadian domestic 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 natural gas pipeline and supply options. Eastern markets that historically received Canadian supplies only from TransCanada are now capable of receiving supplies from new natural gas pipelines that source U.S. and Atlantic Canadian supplies.

The source of oil supply for Keystone is located primarily in Alberta, which produces approximately 79 per cent of the oil in the WCSB. In 2008, the WCSB produced a total of approximately 2.4 million Bbl/d, comprised of 1.2 million Bbl/d of conventional crude oil and condensate, and 1.2 million Bbl/d of oil from the oil sands area of Alberta. The production of conventional oil has been declining but has been offset by increases in production of oil from the Alberta oil sands. The Alberta Energy Resources Conservation Board has estimated that there are 173 billion barrels of remaining established reserves in the Alberta oil sands.

A decline in oil prices in late 2008 has resulted in announcements of delays in oil sands projects and upgraders, however, in December 2008, the Canadian Association of Petroleum Producers forecast WCSB oil supply would increase from 2.4 million Bbl/d in 2008 to 3.5 million Bbl/d by 2015 and 4.1 million Bbl/d by 2020.

Keystone has 910,000 Bbl/d of contracts for capacity, on a ship or pay basis, with an average contract life of 18 years, which the Company believes will provide incentive for contract shippers to ship on Keystone. However, Keystone must compete for spot throughput with other oil pipelines from Alberta.

Keystone's markets for crude oil are refiners in the U.S. Midwest and Gulf Coast regions. A competing pipeline can also deliver WCSB crude oil to the Midwest markets supplied by Keystone. Currently, competing pipelines can deliver oil to the U.S. Gulf Coast, through interconnections with other pipelines. Keystone must also compete with U.S. domestically produced oil and imported oil for markets in the Midwest and Gulf Coast regions.

ANR's natural gas supply is primarily sourced from the Gulf of Mexico and mid-continent U.S. regions, which are also served by competing natural gas pipelines. ANR also has competition from other natural gas pipelines and storage operations in its primary markets in the U.S. Midwest. The Gulf of Mexico region is extremely competitive given its extensive natural gas pipeline network. ANR is one of many interstate and intrastate pipelines in the region competing for new and existing production as well as for new supplies from shale production in the mid-continent, from the Rockies Express natural gas pipeline originating in the Rocky Mountain region, and from LNG. Several new natural gas pipelines are proposed or under construction to connect new supplies to the numerous pipelines in the Gulf of Mexico region. ANR competes with other natural gas pipelines in the region to attract supply to its pipeline for alternative markets and storage. In addition to pipeline competition for market and supply, current difficult economic conditions are expected to reduce energy demand and may put future ANR capacity renewals at risk as the North American economy slows or potentially contracts in key markets in the upper U.S. Midwest. As lower natural gas prices reduce drilling activity, the supply growth that has been fuelling the growth in pipeline infrastructure in the mid-continent could slow down but is still expected to exceed demand requirements in the near term. These factors could negatively affect pipeline capacity value as transportation capacity becomes more abundant.

The GTN System must compete with other pipelines to access natural gas supplies and markets. Transportation service capacity on the GTN System provides customers in the U.S. Pacific Northwest, California and Nevada with access to supplies of natural gas primarily from the WCSB. These three markets may also access supplies from other basins. In the Pacific Northwest market, natural gas transported on the GTN System competes with the Rocky Mountain natural gas supply and with additional western Canadian supply transported by other pipelines. Historically, natural gas supplies from the WCSB have been competitively priced in relation to supplies from the other regions serving these markets. The GTN System has experienced significant contract non-renewals since 2005 as the natural gas it transports from the WCSB competes for the California and Nevada markets against supplies from the Rocky Mountain and southwestern U.S. basins. Recently, Pacific Gas and Electric Company, the GTN System's largest customer, received California Public Utilities Commission approval to commit to capacity on a proposed competing project out of the Rocky Mountain basin to the California border.

Regulatory Financial Risk

Regulatory decisions continue to have a significant impact on the financial returns from existing investments in TransCanada's Canadian wholly owned pipelines and are expected to have a similarly significant impact on financial returns from future investments. TransCanada remains concerned that current financial returns approved by regulators are not as competitive as returns from other assets with similar risk profiles. In recent years, TransCanada applied to the NEB and the AUC for an ROE of 11 per cent on 40 per cent deemed common equity for both the Canadian Mainline and the Alberta System. The NEB has reaffirmed its ROE formula and the AUC has established a generic ROE that is largely aligned with the NEB formula. Through rate applications and negotiated settlements, TransCanada has been able to improve the common equity components of its Canadian wholly owned pipeline capital structures, but there is no assurance that this success can be repeated.

Most recently, TransCanada has continued to address concerns about financial returns on the Alberta System in the AUC's 2009 Generic Cost of Capital Proceeding. In November 2008, TransCanada filed an application requesting an ROE of 11 per cent on 40 per cent deemed common equity for the Alberta System. TQM filed an application with the NEB in December 2007 requesting a fair return on capital, consisting of an ROE of 11 per cent on 40 per cent deemed common equity. The outcome of these proceedings may influence the regulators' view of fair financial returns on equity associated with TransCanada's other Canadian wholly owned pipelines.

Throughput Risk

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

Execution and Capital Cost Risk

Capital costs related to the construction of Keystone are subject to a capital cost risk- and reward-sharing mechanism with its customers. This mechanism allows Keystone to adjust its tolls by a factor based on the percentage change in the capital cost of the project. Tolls for the portion of Keystone to Wood River, Patoka and Cushing will be adjusted by a factor equal to 50 per cent of the percentage change in capital cost. Tolls on the expansion to the U.S. Gulf Coast will be adjusted by a factor equal to 75 per cent of the percentage change in capital cost.

Refer to the "Risk Management and Financial Instruments" section of this MD&A for information on managing risks in the Pipelines business.