Moody’s Investors Service downgraded the credit rating of gas pipeline operator Iroquois Gas Transmission System LP on Wednesday to Baa1 from A3 in reaction to cost overruns associated with the Eastchester Expansion project and liabilities related to power transmission damage that occurred during construction of the project.

Moody’s also cited the declining credit quality of the pipeline’s customers and ownership partners as factors in its decision to lower Iroquois’ rating. The rating outlook on the pipeline is stable.

The 36-mile Eastchester Expansion project across Long Island Sound originally was expected to be completed in May 2003. However, the project, which added about 230 MMcf/d of transportation capacity to the Iroquois mainline in New York City, did not begin commercial operation until Feb. 5, 2004.

Delays in obtaining construction authorizations and permits, and additional delays caused by damage to undersea electric cables during construction all contributed to an increase in the cost of the Eastchester project to $334 million from the $210 million that was initially expected.

The higher Eastchester construction costs were financed by withholding dividends to the Iroquois partners in both 2002 and 2003, a $20 million cash call made on the partners in late 2003, and the postponement of capital expenditures related to a smaller expansion of the pipeline to the Athens generating plant in upstate New York.

“The dividend retention and cash call has negatively affected the returns of the partners on their Iroquois investment, and Moody’s believes that this may result in higher upstream dividends from Iroquois in the future to recoup some of this shortfall,” the ratings agency said. Iroquois’ partners include TransCanada PipeLines, Dominion Resources, KeySpan, National Energy and Gas Transmission, CTG Resources and New Jersey Resources.

During construction of the expansion project, two separate incidents caused damage to undersea cables and resulted in litigation against Iroquois, as well as the construction contractor and subcontractors. The litigation was initiated by the owners of the power cables, including The Long Island Power Authority (LIPA), Connecticut Light and Power Company (CL&P), and the New York Power Authority (NYPA). LIPA and CL&P are claiming a total of $34.2 million in damages and NYPA has asserted a claim for $21 million.

“While Iroquois believes that it is adequately insured for both of these matters, the uncertainty related to contingent liabilities associated with this litigation was also a consideration in the downgrade of Iroquois’ rating,” Moody’s said.

Iroquois has also been sued by Horizon Offshore Contractors, the original contractor for Eastchester, for $40 million for alleged wrongful termination of its agreement following the cable accidents. Iroquois also has notified state and federal government agencies that it may have violated certain underwater archeological exclusionary zones during construction, with undetermined financial consequences, according to Moody’s.

Meanwhile, since the Eastchester Expansion project was started, the weighted average rating of Iroquois’ shippers has declined to Baa2 from A3, Moody’s said. “While Iroquois has mitigated some of the negative effect of this decline by requiring letters of credit and other types of credit enhancement from some counterparties, the fundamental credit quality of the overall shipper profile is marginally lower.” The average rating of the pipeline company’s partners has also slightly declined over this period, Moody’s noted.

The ratings agency has a stable outlook on the pipeline because of its strategic position in providing gas to the growing New York City market and because of the expectation that shipper credit quality will be more stable going forward. Moody’s also said it expects the company’s partners to continue providing strong support to its operations.

Iroquois Gas Transmission operates a 375-mile interstate natural gas transmission pipeline from the Canada-U.S. border to Long Island, New York.

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