north american diversified natural gas transmission and...

Rating Methodology

New YorkMihoko Manabe, CFA 1.212.553.1653Edward TanSteven WoodJohn DiazTorontoAllan McLean 1.416.214.1635

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March 2007

North American Diversified Natural GasTransmission And Distribution Companies

Summary

The purpose of this methodology is to provide investors and other interested parties with a clear understanding of howMoody's assigns ratings to North American diversified natural gas transmission and distribution companies ("diversi-fieds"). Our goal is to help the market understand the factors that we consider most important for this sector and howthey map to specific rating outcomes. Readers should be able to use this report to gauge a company's ratings withintwo notches.

The common characteristic of these companies is that their core business activity is the ownership of regulatednatural gas distribution and transmission assets. The companies also have diversified energy activities that areupstream or downstream of the core natural gas distribution and transmission business. These diversified activitiesinclude oil and gas exploration and production, gas gathering and processing, and marketing and trading of naturalgas. The rate-regulation of the core assets plays a critical role in lowering business risk and enabling the majority ofthese companies to obtain investment grade ratings despite leverage that is higher than average for investment gradecompanies in other sectors. Moody's analysis of the companies in this sector focuses on four main rating factors:

1. Scale 2. Quality of Diversification3. Management Strategy and Financial Policy4. Financial StrengthMoody's also analyzes other factors that are common across all industries, such as ownership, liquidity, legal struc-

ture, and position in the corporate organization.We note that from time to time a company's performance on a specific factor will fall outside the expected range

for a company of its rating level. These companies are categorized as "outliers" for that rating factor. A "positive out-lier" would be a company whose performance on a given factor is better than its final, assigned rating would indicate. A"negative outlier" would be one whose performance for a specific factor is worse than its assigned rating would other-wise indicate. We will discuss the reasons for significant outliers.

ABOUT THE RATED UNIVERSEAll of the rated companies in this sector are located in the U.S. and Canada. The methodology covers 21 companies,which have rated debt totaling $102 billion. The companies in this grouping are heterogeneous, engaging in variouscombinations of regulated natural gas transmission and/or distribution in addition to other diversified activities. Whatthe diversifieds all have in common is a regulated gas business that constitutes the core of the company.

Diversified activities often include unregulated segments (such as oil and gas production (E&P), gas gathering andprocessing (G&P), and energy marketing) that can integrate vertically with the regulated segments. In some casesthese activities might also include regulated activities that are not gas-related, such as crude oil and petroleum producttransportation.

Diversified companies also differ in their position in the corporate organization, which is a rating consideration.The majority are holding companies that conduct all operations through subsidiaries: Questar, Consolidated NaturalGas, Peoples, Enbridge, Keyspan, National Fuel, Spectra Energy, Vectren Utility Holdings, Energen, NiSource, Wil-liams, and El Paso. Most of the rest are utility parent companies: Equitable Resources, TransCanada PipeLines,MDU, Kinder Morgan, ONEOK, CenterPoint Energy Resources, Enogex, Atmos, and Southern Union. A few aresubsidiaries of other companies: Consolidated Natural Gas, CenterPoint Energy Resources, Vectren Utility Holdings,Peoples.

This methodology is one of three recently published rating methodologies for companies in the largely regulatednatural gas industry. Moody's published rating methodologies for the local gas distribution companies (LDCs) and gastransmission companies (pipelines) in 20061. Many of the rated LDCs and pipelines are subsidiaries of the diversifieds.Please refer to our rating methodologies on LDCs, pipelines, and independent E&P companies for more detail onthese businesses, which together comprise the diversifieds' major business lines.

1. Rating Methodology: North American Regulated Gas Distribution Industry (Local Distribution Companies), October 2006; Rating Methodology: North American Nat-ural Gas Pipelines, December 2006.

Rated CompaniesIssuer Rating (1) Outlook Country of Domicile

Equitable Resources, Inc. A2 Review↓ United StatesTransCanada PipeLines Ltd. A2 Stable CanadaQuestar Corp. P-2 (2) Stable United StatesEnbridge Inc. A3 Review↓ CanadaKeyspan Corporation A3 Review↓ United StatesMDU Resources Group, Inc. A3 (3) Stable United StatesSpectra Energy Capital Baa1 Stable United StatesConsolidated Natural Gas Co. Baa1 Stable United StatesVectren Utility Holdings, Inc. Baa1 Stable United StatesNational Fuel Gas Company Baa1 Stable United StatesEnergen Corporation Baa2 Stable United StatesKinder Morgan, Inc. Baa2 Review↓ United StatesONEOK, Inc. Baa2 Stable United StatesPeoples Energy Corporation Baa2 (4) Stable United StatesCenterPoint Energy Resources Corp. Baa3 Stable United StatesEnogex Inc. Baa3 Stable United StatesAtmos Energy Corporation Baa3 Stable United StatesNiSource Inc. Baa3 Stable United StatesSouthern Union Company Baa3 Negative United StatesThe Williams Companies, Inc. Ba2 (5) Stable United StatesEl Paso Corporation B2 (5)(6) Positive United States

(1) Senior Unsecured Rating unless indicated otherwise(2) Questar does not have a long-term debt rating. The company has a Prime-2 short-term rating for commercial paper. For illustrative purposes for the charts and tables in this rating methodology, we have shown Questar as A3, one notch below the ratings of its regulated subsidiaries.(3) Issuer Rating(4) Peoples' senior unsecured rating of A3 reflects the guarantee of Integrys Energy Group, Inc., which acquired it in 2/07. For illustrative purposes for the charts and tables in this rating methodology, we have shown Peoples as Baa2, its rating prior to the acquisition and reflecting its pre-merger standalone credit quality.(5) Parent-level Corporate Family Rating(6) El Paso' Corporate Family Rating was upgraded to Ba3 in 3/07. For illustrative purposes for the charts and tables in this rating methodology, we have shown El Paso as B2, its rating prior to the upgrade and reflecting its historical credit quality.

2 Moody’s Rating Methodology

The wide range of ratings for the sector reflects significant differences in the degree of business risk that resultfrom differences in asset mix. The companies are almost all investment grade with an average rating of Baa2, reflectingthe stable nature of their core regulated businesses. The two non-investment grade exceptions are Williams and ElPaso, which are recovering after a period of financial distress.

Includes P-2 rating of Questar, Issuer Rating of MDU, Baa2 rating for Peoples, parent-level Corporate FamilyRatings of Williams and El Paso

Industry Overview

Two key factors for the credit ratings of North American diversifieds are the nature of the regulatory environment inwhich they operate and the business risks of their unregulated businesses.

Regulated rates provide a high degree of margin certainty. This is the fundamental credit strength of the diversi-fieds as it results in cash flow stability for the diversifieds' regulated operations.

Low business risk - which is defined by a focus on the core utility business - can promote ratings stability. Among thepeer group companies, business mix and related business risk (which accounts for 20% of the rating) vary significantly.

We note that diversifieds are more leveraged than similarly-rated companies operating entirely in competitive indus-tries. This is offset, however, by the stability of their cash flows and the low business risk of their regulated operations.

Diversified Natural Gas Long Term Debt Ratings (21 Companies in Total)

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A1 A3 Baa2 Ba1 Ba3 B2 Caa1

Current Rating

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Natural Gas Value Chain Exploration & Production Gathering & Processing Transmission & Storage Distribution Marketing

Upstream Midstream Downstream

Moody’s Rating Methodology 3

INDUSTRY FRAMEWORKThe natural gas industry has built a well developed infrastructure to gather, process, and deliver natural gas. In NorthAmerica, this structure primarily developed around the domestic gas supply.

Exploration and production (E&P) is "upstream" in the natural gas value chain. The "midstream" segment com-prises small-diameter pipes that take the gas at the well head (the gathering and processing function or "G&P") andlarger pipelines that take the gas to market. LDCs that distribute the gas to the consumer are "downstream." Diversi-fied companies engage in some or all of these functions and in ancillary services that support them.

In the U.S., the infrastructure tends to be regional, so the entire nation does not rely heavily on any single portion.In Canada, two companies -- TransCanada and Enbridge -- own critical components of Canada's energy supply.

REGULATIONThe transportation and distribution of natural gas tends to be a regulated activity. North American LDCs and pipe-lines are defined by several features including: • A stable regulatory framework (with a patchwork of local regulation for the LDCs and federal regulation for pipelines)• A history of being unbundled (pipelines only)2 • A low likelihood of comprehensive change in the regulatory framework for the foreseeable future• Highly individualized, company-specific rate mechanisms• Limited use of formula-based rates• A legacy of private (versus government) ownership

Interstate gas pipelines are regulated federally. Federal regulation provides very limited support to the credit rat-ings of diversifieds' regulated pipeline subsidiaries. This regulation takes a broad, national perspective and is generallylight-handed. Although this light-handed approach makes pipelines less exposed to adverse regulatory action thanLDCs, it provides limited scrutiny that may serve to insulate the pipelines' credit quality. For this reason, pipeline sub-sidiaries tend to hold ratings that are closer to those of their diversified parent companies than do their sister LDCsubsidiaries.

Conversely, LDCs are usually governed at the state or provincial level. They are subject to closer regulatory scru-tiny and are subject to more restrictions that limit risk-taking. This helps to protect the integrity of LDCs' credit andcontribute to LDC ratings that, on average, are higher (A3) than those of the diversifieds (Baa2). As a result, the sup-portiveness of the regulatory framework and rate design weigh more heavily in our credit assessment of LDCs.

BUSINESS RISKThe stability of the diversifieds' core LDC and pipeline activities contributes to a lower business risk profile that allowsthem to sustain more leverage than unregulated industrial companies at the same rating level. Specifically, LDCs andpipelines earn regulated rates that lend predictability to their cash flows. In addition, these businesses employ relativelylow-tech, long-lived assets and are characterized by low rates of technical innovation. As a result, these activities tendto be relatively predictable, albeit these businesses require significant capital expenditures. Further, these businessestend to be less cyclical than that of non-regulated corporates.

As regulated monopolies, LDCs and pipelines generally face limited competition and their creditworthiness bene-fits from varying degrees of protection from regulatory oversight and restrictions. The LDCs' business is seasonal andsubject to weather variations, but these fluctuations are more muted than those in competitive industries.

Although the downside is limited for LDCs and pipelines, so is the upside. Returns are modest. The average ROEfor is 9% for LDCs and 11% for pipelines. The regulatory framework prevents a regulated company from earningmuch above its allowed returns for long.

Because these businesses are generally mature and offer limited growth, companies often diversify into other busi-nesses that promise a higher return, albeit at higher risk. Generally, diversification is into a business within the naturalgas value chain and related to the company's core regulated business. For example, E&P and G&P are the most com-mon areas of diversification.

About half of the companies in this peer group engage in E&P. Our credit assessment of the E&P business isshaped by the fact that the assets are finite, depleting resources that are subject to unpredictable commodity prices. Tobe successful and remain in business, an E&P company must reinvest substantial capital each year to find new oil and

2. Pipelines were removed from the gas sales function in the 1990's and now serve only a delivery function. Unbundling among LDCs is not industry-wide.


natural gas reserves and replace production3. Because of these risks, the average rating on pure independent E&Pcompanies is Ba2, significantly lower than those for LDCs and pipelines.

Most diversifieds, particularly those with E&P operations, also have G&P operations. These are usually small,ancillary services for larger E&P affiliates. Other G&P operations serve mainly third parties and are revenue centers intheir own right. These G&P operations tend to contribute more to earnings when natural gas liquids (NGL) prices arehigher, and in some cases, when natural gas prices are higher. G&P is a relatively volatile business that is commodityprice-sensitive. With much of its use for the petrochemical and refining industries, demand for processing productsreflects economic cycles. Profitability is also affected by fluctuations in the price for alternative feedstocks.

LEGAL STRUCTUREMost diversifieds are parent companies. A few are subsidiaries of other companies. Notching practices reflect the legalstructure and structural subordination. Notching between the holding company and its regulated subsidiary dependson the regulated subsidiary's proportionate value to the organization, the type of legal organization, the type of regula-tion and degree of ring-fencing, the significance and risk of the unregulated businesses, and inter-company cash man-agement practices.

Key Rating Issues Going into the Next Decade

NATURAL GAS PRICE VOLATILITYNatural gas prices are becoming more volatile. Gas prices present different opportunities and challenges for each ofthe diversifieds' business lines. High gas prices spur drilling activity and raise the diversifieds' E&P and G&P revenues.Cyclical, price-related effects on those businesses' financial results, however, should not affect ratings, as the ratingsalready incorporate an expected range of financial performance through the price cycle.

CHALLENGES IN E&P INVESTINGE&P companies face the prospect of declining production volumes in mature basins such as the Lower 48 in the U.S.and the Western Canadian Sedimentary Basin. In conjunction, finding and development (F&D) costs are rising as itbecomes increasingly difficult to replace hydrocarbon reserves. Companies are drilling in deeper, more complex wellsusing modern, expensive techniques to find and extract reserves. Acquisition valuations have gone up, and so haveoperating costs, the latter because of increased demand for oilfield supply and services. The net result: despite higherprices, the projected return on investment - as measured by the leveraged full-cycle ratio - has not increased meaning-fully for companies engaged in E&P4.

HEDGING ISSUESMoody's considers price hedging of E&P production to be a conservative business practice that protects against fallingprices. However, when prices rise, highly hedged companies may miss out on much of the upside, while their costs willrise as a result of strong market conditions.

MEDIUM-TERM GAS INFRASTRUCTURE CONSTRUCTION ACTIVITYA resurgence of drilling activity in mature basins and development activity in frontier areas are stimulating the con-struction of new gas pipeline and handling facilities. Big-ticket greenfield projects could pressure credit metrics duringconstruction. However, such projects are not likely to affect ratings if the new capacity is fully contracted under firmlong-term contracts with creditworthy shippers.

LDC ISSUES RELATED TO CONSERVATION AND RATE DESIGNHigh gas prices have a negative financial impact on LDCs by increasing bad debt expense and consumer conservation.Per-customer usage continues to show a secular decline as a result of energy efficient homes and appliances. MoreLDCs are applying for appropriate rate design changes, but it will take time to first build the necessary understandingand support at the grassroots level. Rate designs that compensate LDCs for margin losses attributable to variations ingas consumption (because of weather variations or customer conservation) help to stabilize credit metrics and creditratings.

3. Please refer to Moody's Rating Methodology: Global Independent Exploration and Production (E&P) Industry, October 2005.4. Moody's Rating Methodology: Global Independent Exploration and Production (E&P) Industry, October 2005, pages 5-6.


In This Methodology

Moody's rating methodology for the diversifieds includes the following steps:

IDENTIFICATION OF THE KEY RATING FACTORSThe four key rating factors used in Moody's approach to rating the diversifieds are as follows:

1. Scale 2. Quality of Diversification3. Management Strategy and Financial Policy4. Financial StrengthThese factors are critical to the analysis of the diversifieds and, in most cases, can be benchmarked across the

industry. The discussion begins with a review of each factor and an explanation of its importance to the rating. Addi-tional factors that apply more generally to most companies (as opposed to only this sector) are explained near the endof this report. These include ownership, liquidity, legal structure, and position in the corporate organization.

MEASUREMENT OF THE KEY RATING FACTORSWe next explain the metrics or sub-factors that we use to define each of the four rating factors. These measurementsare quantitative where we can define an appropriate metric. However, for some factors, qualitative judgment or empir-ical observation is necessary to determine the appropriate category.

The weighting for the factors and sub-factors are as follows:1. Scale: 10% of the overall methodology indicated rating

Total Assets: 5% of the overall rating Net Profit After-Tax Before Unusual Items (NPATBUI): 5% of the overall rating

2. Quality of Diversification: 20% of the overall methodology indicated ratingScale of Unregulated Exposure: 10% of the overall ratingDegree of Business Risk: 10% of the overall rating

3. Management Strategy & Financial Policy: 10% of the overall methodology indicated rating4. Financial Strength: 60% of the overall methodology indicated rating

EBIT/Interest Expense: 15% of the overall ratingDebt/Book Capitalization (Excluding Goodwill): 15% of the overall ratingRetained Cash Flow/Debt: 15% of the overall ratingReturn on Equity: 15% of the overall rating

MAPPING FACTORS TO THE RATING CATEGORIESEach company is mapped to an indicated rating based upon its performance on each sub-factor and each factor. Foreach of the nine sub-factors, we describe appropriate ranges for Moody's broad rating categories, i.e., A and above,Baa, Ba, B and Caa. For example, we specify what level of retained cash flow/debt is generally acceptable for an Acredit versus a Baa credit. We provide a range or description for each of the measurement criteria.

We next score each company by rating level on each of the factors. For instance, a company may score at the "A"level for "Quality of Diversification" and at the "B" level for "Financial Strength." If a simple average of just those twofactors was applied, the rating would be Baa.

OUTLIER DISCUSSIONWe recognize that any given company may perform higher or lower on a specific factor than its actual rating levelwould otherwise indicate. We highlight companies with sub-factor or factor mapping that is 2 or more rating catego-ries higher or lower than the rating and offer a discussion of the general reasons for outliers within a given factor.

Applying the sub-factor weightings and scoring the rating assignment for each sub-factor in this manner results inratings that track our assigned ratings within one or two notches for all of the companies in this methodology. Theresults of our mapping appear in Appendix B of this report, as well as in the results section under each factor.


DETERMINING THE METHODOLOGY INDICATED RATINGTo determine the overall rating, each of the 9 assigned sub-factor ratings is converted into a numeric value based onthe following scale:

Each sub-factor's numeric value is multiplied by an assigned weight and then summed. The total sum of the fac-tors is then mapped to the ranges specified in the table below, and the indicated alpha-numeric rating is determinedbased on where the total score falls within the ranges shown.

NOTES ON OUR MEASUREMENT APPROACHThis methodology report includes financial ratios derived from publicly and privately reported financial statementsusing Moody's standard analytical adjustments.5

Moody's ratings are forward looking and consider future expectations for company performance as well as histor-ical information. While the rating process also makes use of anticipated financial results, the presentation for illustra-tive purposes in this document relies primarily upon historic data for a three year period.

Key Rating Factors

FACTOR 1) SCALEScale generally correlates highly with ratings in this sector. Larger companies are generally more broadly diversified,which can reduce volatility and lower credit risk. Larger companies benefit from greater financial resources, liquidity,and economies of scale

Positive Rating Indicators• Total assets of over $5 billion• Annual NPATBUI of over $300 million

Ratings ScaleAaa Aa A Baa Ba B Caa

1 3 6 9 12 15 18

Factor NumericsComposite Rating Sub-Factor Rating

Indicated Rating Aggregate Weighted Factor Score Indicated Rating Factor ScoreAaa < 1.5 Aaa 1Aa1 1.5 <2.5

Aa 3Aa2 2.5 <3.5Aa3 3.5 <4.5A1 4.5 <5.5

A 6A2 5.5 <6.5A3 6.5 <7.5

Baa1 7.5 <8.5Baa 9Baa2 8.5 <9.5

Baa3 9.5 <10.5Ba1 10.5 <11.5

Ba 12Ba2 11.5 <12.5Ba3 12.5 <13.5B1 13.5 <14.5

B 15B2 14.5 <15.5B3 15.5 <16.5

Caa1 16.5 <17.5Caa 18Caa2 17.5 <18.5

Caa3 >18.5

5. Please see Moody's Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Corporations - Part I, February 2006


Measurement Criteria• Total assets at the most recent reporting date• Average of the last three years' annual NPATBUI

Notes on Measurement CriteriaThe most recent period-end total assets serve as the latest publicly-available gauge of a company's scale. In most cases,the average of the last three years' net income before unusual items is a reasonable indication of a company's earningspower. Averaging reduces reliance on any one period, which could be affected by unusual events or market conditions.

Criteria for Mapping Factor 1: Scale

Results of Mapping Factor 1: Scale

Observations and Outliers There are no negative outliers for the Net Income sub-factor and only one (Enogex) for the Total Assets sub-factor.The positive outliers for both the Net Income and Total Asset sub-factors are Spectra Energy Capital and TransCan-ada. Their strong performance overall on this factor is offset by a weaker performance on Factor 4 (Financial Strength)due to relatively weak financial metrics.

Sub-factor Weighting Aaa Aa A Baa Ba B Caa

Factor 1: Scale (10% weighting)Total Assets (US$B) 5.0% >$11 $8-$11 $5-$8 $3-$5 $2-$3 $1-$2 <$1NPATBUI (US$MM) 5.0% >$700 $500-$700 $300-$500 $100-$300 $50-$100 $0-$50 <$0

Factor 1: Scale

Issuer Current RatingsIndicated Ratings

for Factor 1 Total Assets NPATBUISub-Factor Weights 5% 5%

Equitable Resources, Inc. A2 Baa Baa BaaTransCanada PipeLines Ltd. A2 Aaa Aaa AaaQuestar Corp. P-2 Baa Baa BaaEnbridge Inc. A3 Aa Aaa AKeyspan Corporation A3 Aa Aaa AMDU Resources Group, Inc. A3* A A BaaSpectra Energy Capital Baa1 Aaa Aaa AaaConsolidated Natural Gas Co. Baa1 Aa Aaa AaVectren Utility Holdings, Inc. Baa1 Baa Baa BaNational Fuel Gas Company Baa1 Baa Baa BaaEnergen Corporation Baa2 Baa Ba BaaKinder Morgan, Inc. Baa2 Aa Aaa AONEOK, Inc. Baa2 A Aa BaaPeoples Energy Corporation Baa2 Baa Baa BaCenterPoint Energy Resources Corp. Baa3 A A BaaEnogex Inc. Baa3 Ba B BaAtmos Energy Corporation Baa3 A A BaaNiSource Inc. Baa3 Aa Aaa ASouthern Union Company Baa3 A A BaaThe Williams Companies, Inc. Ba2** A Aaa BaaEl Paso Corporation B2** Baa Aaa Caa

*Issuer Rating**Parent-level Corporate Family Rating

Positive OutlierNegative Outlier


This balance between a strong performance on the Total Assets sub-factor and a weaker performance on Factor 4also exists for most of the larger companies: Enbridge, Keyspan, Kinder Morgan, NiSource, Williams, and El Paso. Con-versely, Enogex, the sole negative outlier in terms of Total Assets, balances smaller size against stronger financial metrics.

We note that the use of three-year historical average figures is less meaningful for several companies that havechanged significantly during that period, and whose ratings more heavily reflect their current and near-term forecastedperformance. Most notable are Southern Union and Kinder Morgan, which made major acquisitions that altered theircredit profiles during the three-year period. Other exceptions are Williams and El Paso, whose credit profiles are recov-ering after a period of financial distress. In such cases, a rating committee might vary the range of years used for this fac-tor or rely more heavily upon our expectations for future performance to best reflect an evolving credit situation.

FACTOR 2) QUALITY OF DIVERSIFICATION

Why It MattersUnsuccessful diversification into businesses that are riskier than the stable and largely regulated core transmission anddistribution activity has been a factor in many downgrades in this sector.

The "Quality of Diversification" factor measures and ranks the degree of business risk. This factor is divided intotwo sub-factors: "Scale of Unregulated Exposure" and "Degree of Business Risk."

Scale of Unregulated Exposure This quantifies the degree of exposure to unregulated businesses.

For most diversifieds, unregulated businesses comprise a minor portion of assets and earnings. However, issuerswith greater exposure to unregulated businesses will have more volatile performance and greater credit risk in compar-ison to more stable regulated activities.

This methodology uses unregulated operating income as a percentage of total operating income, or alternatively,unregulated assets as a percentage of total assets, as a measure for the scale of unregulated exposure.

Degree of Business RiskDiversifieds typically diversify into unregulated businesses that are upstream or downstream of their core natural gasdistribution and transmissionbusiness: E&P, G&P, andenergy marketing. As shown inthe chart, these unregulatedbusinesses present varyingdegrees of business risk. Thus,we seek to determine the rela-tive risk level of unregulatedactivities as well as the scale ofthese activities.

Positive Rating Indicators• LDC and pipelines

account for the majority of consolidated operating income

• Relatively high allowed rates of return and supportive regulatory relationships• Minimal, if any, exposure to G&P or any other diversified business

Measurement Criteria• The higher of: unregulated assets/total assets or unregulated operating income/total operating income. For regu-

lated business segments, all assets and operating income are considered to be regulated for this calculation. Forunregulated business segments, all assets and operating income are considered to be unregulated for this calculation.

• Business risk indicated by the model rating according to the Moody's methodology for the company's majorunregulated businesses (LDC, pipeline, and/or E&P)

• Percentage of G&P volumes and margins from keep-whole processing contracts

Business Risk Spectrum

Distribution Transmission Gathering & Processing Exploration & Production Trading & Marketing

Least Risky Most Risky


Notes on Measurement CriteriaMoody's maps ratings on this factor in accordance with each company's business risk spectrum. Higher exposure toriskier businesses is correlated to lower ratings.

When a model-derived rating is available under a published rating methodology6, Moody's will use it to comparethe unregulated operations of the diversified against rated pure-play companies and will refer to the model outcomewhen ranking the company under this sub-factor. The mapping grid for the Quality of Diversification factor considersthat LDCs and gas pipelines are low risk businesses that improve the overall risk profile of a diversified company.When the benefits of diversification (limited performance correlation) are factored in, the improvement in businessrisk is greater than would be indicated by the score of these business segments on a stand-alone basis under the LDCand pipeline methodologies. For example, a score in the A category under the LDC methodology results in a mappingof Aa for the Degree of Business Risk sub-factor under factor 2 the Quality of Diversification.

• LDCs: Generally speaking, LDCs have the lowest business risk. This is attributable to their high degree ofregulation.

• Interstate gas pipelines: Interstate gas pipelines fall next on the spectrum because they are more lightlyregulated, less ring-fenced from their affiliates, and often face more competition. In the mapping grid, the above regulated businesses could range from Aaa to A depending on the level ofreturns, regulatory support, and attractiveness of the service territory (as defined in Moody's rating methodol-ogies for LDCs and pipelines). Such industry-specific factors as they map under the LDC and pipeline meth-odology will be used for the Degree of Business Risk sub-factor, if there are no unregulated businesses ofmeaningful size.

• Gathering & Processing: Exposures to G&P can range from A to Caa. Mapping here depends onMoody's assessment of the quality of the operations and financial performance. This includes a determina-tion of the level of gas processing activity, and if that is significant, exposure to keep-whole processing con-tracts. For example, we would view a G&P operation more favorably if it has established a competitive position ina long-lived or growing basin. We also view favorably a lack of keep-whole processing contracts or keep-whole processing contracts with terms that mitigate keep-whole risk. We view less favorably small G&Poperations in which production is declining, competition is high, and keep-whole exposure is significant.

• E&P operations: We assess the business risk of a diversified's E&P operations on the mapping grid fromMoody's E&P rating methodology. If a diversified engages in E&P, it is normally its riskiest business. Con-sequently, the rating outcome for this sub-factor is based upon the rating under the E&P methodology,even if the company also has other businesses.Compared to G&P which is also sensitive to price and volume, E&P in general has higher risk because of itsgreater capital reinvestment requirements. G&P businesses have greater flexibility to cut capital spending,which helps them weather adverse price environments. Oftentimes, diversifieds' unregulated businesses are smaller, compare less favorably against pure-play compa-nies, and would not likely be rated investment grade on a standalone basis. For example, Moody's indepen-dent E&P peer group has an average rating of Ba2. Because the E&P operations of diversifieds tend to besmall and concentrated (scale and diversity of reserves account for 36% of the weighting in Moody's E&P rat-ing methodology), many of these operations on a standalone basis would likely be of non-investment gradequality. To be rated investment grade under the E&P rating methodology, a company needs to have estab-lished E&P operations in a long-lived basin, a large acreage position that leads to economies of scale, a historyof organic reserve replacement, and low full-cycle costs.

Diversifieds may engage in other activities. When a Moody's rating methodology is available for that industry, we willuse the model-derived rating.

6. Moody's has published rating methodologies for numerous industries. The most pertinent ones for the diversifieds are those for LDCs, pipelines, and independent E&P.


Criteria for Mapping Factor 2: Quality of Diversification

Sub-factorWeighting

Aaa Aa A Baa Ba B Caa

Factor 2: Quality of Diversification (20% weighting)the higher% of

the higher% of

the higher% of

the higher% of

the higher% of

the higher% of

the higher% of

Scale of Unregulated Exposure

10.0% Operating income from unregulated operations <20% of consolidated operating income.

Operating income from unregulated operations between 20-30% of consolidated operating income.




Operating income from unregulated operations >60% of consolidated operating income. Portfolio may evidence some stress that could lead to write-downs.

Operating income from unregulated operations >60% of consolidated operating income. Significant losses evident in the portfolio.

or or or or or or orSegment assets from unregulated operations <20% of consolidated segment assets.

Segment assets from unregulated operations between 20-30% of consolidated segment assets.




Segment assets from unregulated operations >60% of consolidated segment assets.

Segment assets from unregulated operations >60% of consolidated segment assets.

Degree of Business Risk

10.0% Aaa-Aa in LDC and Pipe methodologies

A-Baa in LDC and Pipe methodologies

non-IG in LDC and Pipe methodologies gathering only

Aaa-Baa in E&P methodology; gathering and processing; minimal keepwhole processing risk; large competitive position in long-lived/growing basin; geographically diversified

Ba in E&P methodology; gathering and processing; moderate keepwhole processing risk; good competitive position in long-lived/growing basin; moderate geographic diversification

B in E&P methodology; gathering and processing; significant keepwhole processing risk; average competitive position in average-lived/mature basin; modest geographic diversification

Caa in E&P methodology; gathering and processing; significant keepwhole processing risk; small, weak competitive position in short-lived/declining basin; no geographic diversification


Results of Mapping Factor 2: Quality of Diversification

Observations and OutliersPositive outliers include NiSource, whose high proportion of regulated earnings and low business risk allows it to sup-port a fairly leveraged financial position. Vectren Utility Holdings is a positive outlier that is purely regulated, and the"Degree of Business Risk" (mapping to Aa) reflects the low risk of these regulated utility activities. Atmos andEnbridge are positive outliers for the "Scale of Unregulated Exposure," reflecting the high proportion of these compa-nies' business that is regulated. The high scores on this sub-factor are offset by scores on financial strength under Fac-tor 4 that are lower than the ratings.

National Fuel and Peoples are negative outliers under "Degree of Business Risk" because of the high business riskattributed historically to their E&P businesses. However, these lower scores are offset by a more favorable perfor-mance under the "Scale of Unregulated Exposure" sub-factor.

FACTOR 3) MANAGEMENT STRATEGY & FINANCIAL POLICY

Why It MattersManagement's strategy and track record are meaningful for credit risk. The typical regulated gas business model offersstable baseline earnings from the regulated businesses, modest growth - either organic, via acquisitions, or via diversi-fication -- and a steady dividend. In this sector, dividends tend to be a fixed cash requirement with pay-out levels thatare higher than average for corporate issuers, leaving less flexibility to deal with fluctuations in cash flow or capitalexpenditure needs.

In this sector, companies with a stated strategy to grow through acquisitions tend to be riskier than those thatgrow organically. Acquisition-related risk can also vary depending on whether a company is prone to making large andtransforming acquisitions, if it is a serial acquirer or if has a weak record in integrating past acquisitions.

Factor 2: Quality of Diversification

Issuer Current RatingsIndicated Ratings

for Factor 2

Scale of Unregulated

ExposureDegree of

Business RiskSub-Factor Weights 10% 10%

Equitable Resources, Inc. A2 Ba B BaaTransCanada PipeLines Ltd. A2 A Aa BaaQuestar Corp. P-2 Ba B BaaEnbridge Inc. A3 A Aaa BaaKeyspan Corporation A3 A A BaaMDU Resources Group, Inc. A3* Ba B BaaSpectra Energy Capital Baa1 A Aa BaaConsolidated Natural Gas Co. Baa1 Ba B BaaVectren Utility Holdings, Inc. Baa1 Aa Aaa AaNational Fuel Gas Company Baa1 Ba Baa BEnergen Corporation Baa2 Ba B BaaKinder Morgan, Inc. Baa2 A Aa BaaONEOK, Inc. Baa2 Baa Ba BaaPeoples Energy Corporation Baa2 Ba Baa BCenterPoint Energy Resources Corp. Baa3 A Aa AEnogex Inc. Baa3 Ba B BaAtmos Energy Corporation Baa3 Aa Aa ANiSource Inc. Baa3 Aa Aaa ASouthern Union Company Baa3 A Aa BaThe Williams Companies, Inc. Ba2** B Caa BaEl Paso Corporation B2** Ba Baa Ba




Measurement Criteria • Relationship of acquisitions to existing business and management expertise• Frequency and materiality of acquisitions (number of acquisitions made annually, the percentage change in earn-

ings and total assets, change in mix of segment operating income)• Proportion of capital expenditures for organic growth vs. acquisitions• Frequency and materiality of write-downs (number of write-downs over five years, write-downs as percentage of

earnings and equity)• Degree to which acquisitions are funded with a substantial equity component

Criteria for Mapping Factor 3: Management Strategy and Financial Policy

Sub-factorWeighting Aaa Aa A Baa Ba B Caa

Factor 3: Management Strategy & Financial Policy (10% weighting)Management Strategy & Financial Policy

10.0% Diversifies consistently in areas of in-house expertise. Growth substantially organic. Excellent management track record for many yrs. Demonstrated commitment to having one of the highest ratings in the sector.

Diversifies consistently in areas of in-house expertise. Minor acquisition event risk. Good management track record for many years. Demonstrated commitment to having one of highest ratings in the sector.

Strategic step-out possible occasionally, but w/proven ability to execute. Moderate acquisition event risk. Above-average management track record for many yrs. Demonstrated commitment to A rating.

Strategic step-out possible. Meaningful acquisition event risk. Transforming transaction possible. Average management track record over more than several years. Demonstrated commitment to minimal investment grade.

Strategic step-out possible. Meaningful acquisition event risk. Below-average/short management track record. Write-downs indicate inadequate risk controls. No stated commitment or demonstrated record of issuing equity.

Weak/very short management track record. Large write-downs raise potential for liquidity issues and restructuring. Questionable ability to issue equity.

Poor management track record. Substantial write-downs likely to result in liquidity problems and restructuring. Unlikely access to new equity.


Results of Mapping for Factor 3: Management Strategy and Financial Policy

Observations and OutliersThe "Management Strategy & Financial Policy" factor tracks actual ratings closely. Equitable and MDU are positiveoutliers. There are no negative outliers. The majority of the companies are assessed as "Baa" for this factor, whichcoincides with the Baa actual ratings for over half of the peer group. This is indicative of the tendency for companies inthis sector to manage their financial policies around Baa1-Baa2 target levels, which provides some flexibility to diver-sify and to make large capital investments.

FACTOR 4) FINANCIAL STRENGTH

Why It MattersCredit metrics of regulated businesses are largely determined by the levels of capitalization and returns that regulatorsallow. Consequently, their earnings, returns, and capitalization ratios are highly predictable and correlate highly withratings. Their financial leverage is higher and profitability more modest than similarly-rated industrial companies.Diversifieds also have unregulated businesses that result in less stable earnings and cash flow and which tend to be cap-italized with less leverage than the regulated operations.

Measurement Criteria• EBIT/Interest• Debt/Book Capitalization (excluding goodwill)• Retained Cash Flow/Debt• ROE

Factor 3: Management Strategy and Financial Policy

Issuer Current RatingsIndicated Rating for

Factor 3Sub-Factor Weight 10%

Equitable Resources, Inc. A2 AaaTransCanada PipeLines Ltd. A2 AQuestar Corp. P-2 AaEnbridge Inc. A3 AKeyspan Corporation A3 BaaMDU Resources Group, Inc. A3* AaaSpectra Energy Capital Baa1 BaaConsolidated Natural Gas Co. Baa1 BaaVectren Utility Holdings, Inc. Baa1 BaaNational Fuel Gas Company Baa1 BaaEnergen Corporation Baa2 BaaKinder Morgan, Inc. Baa2 BaaONEOK, Inc. Baa2 BaaPeoples Energy Corporation Baa2 BaaCenterPoint Energy Resources Corp. Baa3 BaEnogex Inc. Baa3 BaaAtmos Energy Corporation Baa3 ANiSource Inc. Baa3 BaaSouthern Union Company Baa3 BaThe Williams Companies, Inc. Ba2** Baa




Criteria for Mapping Factor 4: Financial Strength

Results for Mapping Factor 4: Financial Strength

Observations and OutliersThe single outlier under Factor 4 is Energen, which is a positive outlier for all but one of the sub-factor ratios. Ener-gen is one of a number of companies with significant E&P businesses that have benefited from rising commodityprices (other examples are Equitable and Questar). Their ratings consider the risks of their E&P operations, expectedfinancial performance at mid-cycle, and variance through the price cycle.

The Canadian companies, TransCanada and Enbridge, are negative outliers for several sub-factors because of thehigher levels of debt relative to comparably rated U.S. diversified companies. These higher debt levels are in largemeasure reflective of the deemed capital structures in the Canadian regulated utility subsidiaries of these companies.Other sub-factor negative outliers are companies whose relatively weak financial metrics are mitigated by the largescale and low business risk of their regulated operations (e.g., CenterPoint, NiSource).

Sub-factor Weighting Aaa Aa A Baa Ba B Caa

Factor 4: Financial Strength (60% weighting)EBIT/Interest Expense 15.0% > 6X 5 to 6X 4 to 5X 3 to 4X 2 to 3X 1 to 2X < 1XDebt/Book Capitalization (Excluding Goodwill) 15.0% < 25% 25 to 35% 35 to 45% 45 to 60% 60 to 70% 70 to 80% > 80%Retained Cash Flow/Debt 15.0% > 40% 30 to 40% 20 to 30% 10 to 20% 6 to 10% 3 to 6% <3%Return on Equity 15.0% > 19% 16 to 19% 13 to 16% 10 to 13% 7 to 10% 4 to 7% < 4%

Factor 4: Financial Strength

IssuerCurrent Ratings

Indicated Ratings for

Factor 4

EBIT / Interest Expense

Debt / Book Capitalizatio

n

Retained Cash Flow /

DebtReturn on

EquitySub-Factor Weights 15% 15% 15% 15%

Equitable Resources, Inc. A2 Aa Aaa A Baa AaaTransCanada PipeLines Ltd. A2 Baa Ba Ba Ba AQuestar Corp. P-2 Aa Aaa A Aaa AaEnbridge Inc. A3 Baa Ba Ba Ba AKeyspan Corporation A3 Baa Baa Ba Baa AMDU Resources Group, Inc. A3* A Aa Baa A ASpectra Energy Capital Baa1 Baa Baa Baa Ba AConsolidated Natural Gas Co. Baa1 A A A A BaaVectren Utility Holdings, Inc. Baa1 Baa Baa Baa Baa BaNational Fuel Gas Company Baa1 Baa Baa Baa A AEnergen Corporation Baa2 Aa Aa Baa Aa AaKinder Morgan, Inc. Baa2 Baa Baa B B AaONEOK, Inc. Baa2 A A Ba Baa AaPeoples Energy Corporation Baa2 Baa Baa A Baa BaCenterPoint Energy Resources Corp. Baa3 Ba Ba Ba Baa BEnogex Inc. Baa3 Baa Baa A Ba BaaAtmos Energy Corporation Baa3 Ba Ba Ba Baa BaNiSource Inc. Baa3 Ba Ba B Ba BaSouthern Union Company Baa3 Ba Ba Baa Ba BaThe Williams Companies, Inc. Ba2** Ba B Ba Baa BEl Paso Corporation B2** Caa Caa Caa B Caa




Other Considerations

This rating methodology explains the factors that are most important for rating diversified natural gas transmissionand distribution companies. In addition to the key factors that have been discussed, there can be other credit consider-ations that affect a company's rating, some of which are common to all corporate issuers.

OWNERSHIPA diversified's rating may be lifted by a notch or more if it is owned by a strong parent company that has demonstratedsupport and retains strong strategic interests in it. We would be less likely to incorporate benefit from the ownership ifthe parent if the company has no integration with or connection to the parent's other holdings, or if there is less confi-dence in the parent's intention to hold the subsidiary over the longer term.

CORPORATE GOVERNANCEWe would view positively board members with proven professional experience in the segments in which the diversifiedcompany operates. For regulated businesses, it is desirable for the board to have regulatory affairs experience.

Corporate governance has not been a primary rating driver for most diversified companies but it can be a creditconcern if there is a particularly low level of director independence, if succession is a concern, if senior executive com-pensation appear to be weighted toward the short term, if the company moves in and out of assets, or if the companyappears to be highly prone to event risk.

LIQUIDITYLiquidity of diversifieds can be affected by seasonality, commodity prices, inter-company cash management practices,and the quality of alternate liquidity sources. Seasonality drives the liquidity profile of LDCs, with working capitaldemands peaking during the winter heating season, but falling, predictably, during the spring. Trading and marketingoperations could require substantial working capital to buy and sell gas. Hedging E&P production could require sub-stantial liquidity resources for margining when volumes are heavily hedged at prices below market levels.

RING-FENCING AND INTERCOMPANY MOVEMENT OF CASHRing-fencing is a regulatory mandate that can insulate the creditworthiness of regulated utilities from their unregu-lated affiliates. Commonly, a public utility is subject to broad statutory restrictions to preserve its financial integrity tobe able to provide its services in an effective manner. Utilities are generally prohibited from lending their creditworthi-ness (e.g., providing guarantees) to support non-utility activities. Depending on the company, utilities may also be sub-ject to more explicit ring-fencing orders. For example, an LDC may be required to maintain an allowed equity ratiothat would, in effect, limit dividends it can make to the parent. It may be restricted from participating in corporatemoney pool arrangements and may be required to get regulatory approval prior to any significant financing activity.

The stronger the ring-fencing, the more the rating of a regulated entity will reflect its standalone credit quality(and the less it will reflect the credit quality of non-utility affiliates). Stronger ring-fencing could result in more than aone-notch rating difference between the regulated subsidiary and its unregulated parent company.

LEGAL STRUCTURE AND STRUCTURAL SUBORDINATIONDiversifieds are legally organized as either non-operating holding companies or utility parent companies with regu-lated and unregulated subsidiaries. Operating subsidiary debt is usually rated at least a notch higher than that at a non-operating holding company, whose debt is structurally subordinated. Notching between the holding company and theregulated subsidiary depends on the proportion of value that the regulated subsidiary represents to the organization;the type of legal organization; the degree of ring-fencing; the significance and risk of the unregulated businesses; andinter-company cash management practices.

It is possible for a utility parent and its subsidiary to be rated at the same level if the distinct credit quality of eachlegal entity puts it, on balance, on par with the other. Examples are TransCanada PipeLines, which is both a holdingcompany and a substantial operating company, and its regulated subsidiaries NOVA Gas Transmission and Gas Trans-mission Northwest, Southern Union and its regulated subsidiary Panhandle Eastern, and ONEOK and its MLP affil-iate ONEOK Partners.


Summary Considerations

We score a company on each of the factors by assigning a rating category. To derive the modeled rating for a company,each of the nine sub-factors is individually assessed using the mapping tables in this report. Those ratings are eachequivalent to a numerical rating score and each represents a percentage of the overall methodology implied rating.

In this methodology, we cover 21 diversifieds. After placing these companies in the rating factor grid, 14 compa-nies have actual ratings that match the rating indicated by the grid, four have actual ratings lower than the rating indi-cated by the grid, and three have ratings higher than that indicated by the grid. All companies' indicated ratings fallwithin two notches of their actual rating.


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al s

trat

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with

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ratin

g.

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c st

ep-o

ut

poss

ible

. M

eani

ngfu

l ac

quis

ition

eve

nt

risk

. Tra

nsfo

rmin

g tr

ansa

ctio

n po

ssib

le w

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aver

age

man

agem

ent t

rack

re

cord

ove

r m

ore

than

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eral

yea

rs.

Dem

onst

rate

d co

mm

itmen

t to

finan

cial

str

ateg

ies

cons

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nt w

ith

Baa

rat

ing.

Stra

tegi

c st

ep-o

ut

poss

ible

. M

eani

ngfu

l ac

quis

ition

eve

nt

risk

. Bel

ow-

aver

age

or s

hort

m

anag

emen

t tra

ck

reco

rd w

/a h

isto

ry

of w

rite

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ns

indi

catin

g in

adeq

uate

ris

k co

ntro

ls. N

o st

ated

co

mm

itmen

t or

dem

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rate

d re

cord

of i

ssui

ng

equi

ty.

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k or

ver

y sh

ort

man

agem

ent t

rack

re

cord

for

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d fin

anci

al

polic

y. L

arge

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Related Research

Industry Outlook:North American Natural Gas Transmission & Distribution, October 2006 (100315)Special Comment: Local Gas Distribution Companies: Update on Revenue Decoupling and Implications for Credit Ratings, June 2006(98022)Credit Rating Fundamentals of the Gas Gathering & Processing Sector, December 2002 (76817)Rating Methodology: North American Regulated Gas Distribution Industry (Local Distribution Companies), October 2006 (99282)North American Natural Gas Pipelines, December 2006 (101229)Global Independent Exploration and Production (E&P) Industry, October 2005 (94692)Moody's Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-FinancialCorporations - Part I, February 2006 (96760)

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this reportand that more recent reports may be available. All research may not be available to all clients.


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