Based upon the number of near-term challenges, we have lowered our recommendation for natural gas transporter TC PipeLines L.P. ( TCP - Analyst Report ) to Underperform from Neutral.

Calgary, Alberta-based TC PipeLines, L.P. is a master limited partnership (MLP) with interests in six pipeline systems: the Northern Border Pipeline Company, Great Lakes Gas Transmission, L.P, the Tuscarora Gas Transmission Company, the North Baja Pipeline, LLC, Bison Pipeline, LLC, and Gas Transmission Northwest, LLC.

The partnership – an indirect, wholly-owned subsidiary of TransCanada Corp. ( TRP - Snapshot Report ) – is facing headwinds on its contracting efforts for the Great Lakes pipeline system on the back of structural challenges. While almost 80% of its contracted capacity expired on November 1, 2012, we do not expect this to get replenished under long-term contracts anytime soon due to several structural challenges (indecision associated with the future tolling structure, competitive landscape etc.). This has led to heightened uncertainty regarding the pipeline system’s future.

The recent settlement with Northern Border – that is expected to lower TC PipeLines’ equity earnings and cash flows – has also been a negative. As per the agreement, Northern Border’s current transportation rates will be reduced by approximately 11%, thereby pulling down the partnership equity earnings and cash flows.

As usual, we remain concerned about weak natural gas fundamentals, which are likely to limit TC PipeLines’ ability to generate positive earnings surprises. The pipeline operator’s dependence on equity and debt markets for growth finance also remains an issue.

We also remain concerned about lower spending by consumers and businesses on transportation fuels, which adversely impacts TC PipeLines’ cash flows and distributions. Additionally, we remain wary of cost overruns on expansion projects (which lead to lower returns).

Considering these factors, we see TC PipeLines as a risky bet from which ordinary investors should exit.