Sea Limited (SE) Q2 2009 Earnings Report, Transcript and Summary

At this time, I would like to welcome everyone to the Spectra Energy second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer Session. [Operator Instructions]. I would now like to turn the conference over to Mr. John Arensdorf, Spectra Energy's Chief Communications Officer.

Welcome to Spectra Energy's second quarter 2009 earnings review. We're very pleased that you have been able to join us today. Leading our discussion today will be Greg Ebel, our President and Chief Executive Officer, and Pat Reddy, our Chief Financial Officer. Both Greg and Pat will discuss our quarterly results and provide more color around our strategic plans to enhance the value Spectra Energy delivers to its shareholders. We'll then open the lines for your questions. Before we begin, let me take a moment to remind you that some of the things we will discuss today concern future company performance and include forward-looking statements within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements. So, you should refer to the additional information contained in Spectra Energy's Form 10-K and in our other SEC filings concerning factors that could cause these results to be different from those contemplated in today's discussion. In addition, today's discussion includes certain non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of those measures to the most directly comparable GAAP measure is available on our Investor Relations website at spectraenergy.com. With that, I will turn the call over to Greg.

As you can see from our earnings release this morning Spectra Energy delivered solid ongoing second quarter results of $141 million or $0.22 per share, very much in line with our expectations. While earnings saw the impact of lower commodity prices and a weaker Canadian dollar this quarter, our fee-based businesses, storage, transmission, distribution, and Canadian gathering and processing performed very well serving customers, markets and shareholders. In fact, after removing from ongoing earnings, the effect of commodity price and exchange rate changes, we saw a quarter-over-quarter and year-to-date EPS growth of about 8%. That's solid growth from expansion projects at our fee-based businesses. As you know, the overwhelming majority of this year's EBIT will come from these fee-based businesses with less than 20% sensitive to commodity prices. Oil prices appear to have rebounded from their first quarter lows, and as the economy recovers I expect we'll start to see some improvement in NGL prices as the year advances. The Canadian dollar is currently less than $1.10 to the U.S. dollar compared with $1.20 we assumed in our forecast. This quarter we continued to execute well on the capital expansion plans and so far this year we brought four projects into service, on time and on budget, totaling over $300 million in CapEx. As we mentioned last quarter, we brought the West Doe II project into service in March which provides access to the developing Montney play in Western Canada. The third phase of West Doe is scheduled to come into service later this year. In April, we completed the Steckman Ridge storage facility in Pennsylvania, which brings 12 billion cubic feet of new storage into service and Steckman is strategically situated between new natural gas supplies from the East, Mid-Continent and Rocky Mountain areas and is really close to…

Well thank you Greg and good morning, everyone. As announced earlier today, Spectra Energy reported second quarter 2009 earnings of $140 million or $0.22 per share compared with $295 million or $0.47 per share in the second quarter of 2008. After removing the effect of the special items and discontinued operations, our ongoing earnings for the quarter were $141 million or $0.22 per share compared with $276 million or $0.44 per share last year. Let's take a look now at our performance by business segment beginning with US. transmission. U.S. transmission had a very good quarter, the segment reported second quarter EBIT of $234 million compared with $244 million in the second quarter of 2008. However, the 2008 quarter included a $31 million special item related to a customer bankruptcy settlement. So, on an ongoing earnings comparison, the 2009 second quarter was up $21 million. This 10% EBIT increase at U.S. Transmission was primarily a result of the strong earnings from expansion projects as well as lower project development costs during the quarter. The second quarter earnings were partially offset by lower gas processing revenues as a result of lower prices and volumes and lower equity earnings from our non-consolidated subsidiaries. The lower gas processing revenues are consistent with our 2009 plan. You will recall that in early 2006, Texas Eastern increased its processing volumes after Hurricane Katrina closed a third-party owned gas plant. That plant didn't come back online until the second half of 2008. As a result of these extra volumes and relatively high commodity prices last year, the 2008 quarter includes much higher than normal processing revenues. This quarter's strong earnings from expansion projects reflect the fact that we placed $1.5 billion of new projects into service last year, projects like Southeast Supply Header, Maritimes Phase IV…

Thanks, Pat. At the halfway point in the year, I feel very good about where we are. During a period of economic uncertainty, our core fee-based businesses are providing steady profitable growth, stable cash flow from those businesses will enable us to continue to create value and pay an attractive dollar per share dividend. We're well-positioned for future growth beyond '09, and thanks to our proximity to strong supply basins, emerging shale plays and the high growth demand markets. We have another advantage, the natural gas is clearly an important part of the solution to our energy security and climate change issues. It is clean, domestically abundant, reliable, and we're working hard to ensure that it gets the fair treatment it deserves in any climate change and energy legislation. We'll maintain our investment grade balance sheet and the financial flexibility to respond to opportunities. As you would expect, we're managing our costs and fully expect to meet our $50 million cost reduction target this year. Combined, these factors underscore our ability to execute on our plan and deliver the operational and physical return targets we have committed to you to achieve. With that, we would be happy to take your questions.

Carie, would you please give instructions to the participants on how to ask questions.

(Operator Instructions). Your first question comes from Anthony Crowdell with Jeffries.

I just wanted to follow up on interest expense. You provided 2009 key assumptions first quarter or end of fourth quarter '08. You're looking at 2009 interest expense about $680 million. Right now you're roughly shy of $300 million. I want to know, are you seeing capital spending levels significantly lower than expected or should we still look at the 680 as where you end up in the 2009?

Anthony, thank you. This is Pat. Our growth CapEx for the year is actually going to be more in the $600 million range, so a little bit higher than the $500 million that we talked about in our guidance, but nevertheless we feel like the fact that we're a little below 300 million six months into the year on interest expense and it wouldn't be unreasonable to double that or annualize it, and expect just to come in closer to 600 million for our savings on total interest expense this year of about $80 million.

Your next question comes from Lasan Johong with RBC Capital Markets.

A couple questions. Maybe I missed it, but, Greg, did you mention CapEx numbers for the rex projects, rex offset projects you were going to do and is the CapEx at Fort Nelson still about a billion dollars to 2012?

The TEMAX group of projects runs around $700 million. I think I mentioned that, but that's what that number would be. Some of that spent in terms of TIME II, but 700 is a good number. And yes indeed, we see about a billion dollars worth of opportunity in the Fort Nelson region. Obviously, I see that more backend loaded than front-end loaded, but that's the type of number I would use through 2012.

Then returns 12.3%, that's really juicy and nice. Are we going to expect to see that on these new projects that you mentioned?

I would expect the TEMAX region of the world is a very competitive one, but I feel good that we should be able to realize those types of returns. Frankly, in Western Canada, I would be disappointed if we didn't do a fair bit better than that 12% type upper end of the target.

You had mentioned fee-based revenues, but just as an example a lot of E&P companies are cutting back CapEx spending and they are curtailing drilling. That means in theory at least you are going to see a significant reduction in new wells coming online and wouldn't that therefore then impact your fee business in terms of not enough gas to gather and process or is there some sort of minimum threshold that it's kind of a minimum take or pay type number?

Two different pieces there. The fee-based side of our gathering processing, that's really in the Canadian business. So those folks sign up for long-term contracts, so again that gives us confidence about the billion dollars spend and more importantly the revenue associated with that capital. In the United States through DCP, our joint venture with Conoco, we'll have to look closely as to whether or not we'll need to spend as much capital there. They spend and it is done by their own cash flow. They spend $500 million a year, call it in terms of capital, and we'll have to see. There is no doubt volumes being processed there are down from what we had predicted, and you know well about the rig count issue, but we'll have to see. You're seeing a lot of wells laid down, but let's not forget that from a CapEx perspective, the buyers on infrastructure are often looking for long-term type scenarios for supply problems that they have or supply needs that they have, and that's what really drives the bigger infrastructure build or the fee-based business if you will.

Do you have a minimum fee or minimum revenue that you collect from the producers in the U.S. regardless of whether they actually produce and deliver the gas for processing or not?

No, it depends. There are thousands and thousands of contracts at DCP. There are some fee elements to that. There is a fee business that accounts for about 10% of the margin at DCP. For some contracts, there is a minimum threshold, but well as you have seen with the earnings, we're directly impacted by both volume and 60% of the margin is percent of proceeds. So you've got to process that gas and then take your residual gas and your proportion of the NGL fill.

When do you kind of see an economic recovery happening in your minds?

Well, from our perspective it looks like we'll see some growth next year, perhaps not as optimistic in the last half of this year as some other folks. Until we see job growth pick up as opposed to just slow and decline, I think it is pretty tough to see anything, but anemic growth. Our focus is really that, look, the markets that we serve from what we're seeing, it looks like over the next ten years you're going to see about 3% growth in natural gas demand versus about 1.6, 1.7 for the rest of the lower 48, and that's what I am really focused on in terms of the long-term growth opportunities. In the short-term, there's no doubt until you see good economic growth that still hurts DCP, but the growth side of the business is really focused on the long-term need for natural gas which I think continues to be very strong.

Your next question comes from Carl Kirst with Carl Kirst with BMO Capital.

A couple of just clarifications. Greg, on the billion dollars of spend in 2010, you're specifically referring to the billion dollars of growth spend, right, so we're kind of looking at total CapEx now more in the 1.5 range, kind of the way it had been in prior?

That would be fair. Yes, I was referring to expansion CapEx.

With respect to the 700 million of TEMAX and TIME III, is that all now fully committed?

Yes, in particular the big counterparty there is obviously ConocoPhillips.

The third question was really just more revisiting Union Gas, I think you guys gave good color on the settlement. My question is more on the storage. What currently is the market-based rate storage environment up there and trying to get a sense of that. I guess storage market has changed over the last twelve to eighteen months with lower gas prices, trying to look at what perhaps our incremental pick up is over the next couple of years as you guys get more and more of the revenue?

Carl, maybe the way to think about that is to think about the second quarter where we had about $25 million of revenue from storage and transportation, and of that about $6 million related to the storage decision that gave us some outside incentives. So that kind of gives you a little bit of scale, and I think that will continue to grow because the storage market continues to deregulate at 25%, and so over the next couple of years through 2010 that should grow somewhat.

We're currently retaining 25% this year, is that correct.

No, we are at 50%.

We are at 50%.

We are at 50. Okay.

Your next question comes from Faisel Khan with Citi.

With regard to your growth projects for 2009, all the capital dollars you guys have laid out in your appendix or in your slides, has there been any change to those numbers over the last six months on any of these projects, are they all pretty much coming in online on budget?

In totality, we are pretty much online on budget. You always have some that are a little over and some that are little under, but feel very good that's where we'll end up about 650. Remember, Faisel the project cycle runs anywhere from 12 to 24 months, right. So you lock in a lot of costs, so you don't take on that risk just like you do with the revenue. So, if I think perhaps your question might partially also be around improvement in costs for steel and things like that. We're seeing some of that, but that's really going to impact projects going forward. Whether that really has an impact on return, I am a little skeptical, neither negative nor positive, just it's a competitive marketplace out there. So whatever we pick up and still things can end up going through to rates ultimately, particularly in the competitive areas.

On your Northern Bridge project, kind of connecting going from Clarington to Oakford. Once that expansion is done, what kind of flexibility do shippers have to move beyond from Oakford into the Northeast market? Do things get stocked up at Oakford and Delmont?

No. In fact, I think you see with TIME III, you can go out of OakFord, pull it out of storage there if you will and then come down into Transco or Texas Eastern. So I think there's a fair number of interconnection, although it is not infinite. I think the key of those projects, you're building to the incremental demands of customers today as opposed to try to create some perhaps fictional demand that may not be there right now.

You believe that there's flexibility to move those molecules farther east?

Absolutely.

Then in terms of where you guys are on the storage side, both at the utility in Canada and also within the U.S., where are you guys right now in terms of storage capacity in terms of being full? Are you 80% full, 75% full or how does that compare to last year?

Well, it would be substantially higher than last year, but the number depending on whether it is Union or the U.S., it's pushing between 80% and 90% at this point in time, so storage is pretty full.

And that's definitely a change from last year for you guys?

Yes, definitely a lot more gas and storage.

On the NGL side, did you talk about a mark-to-market loss in the quarter?

That's just fuzzy. No, that's really just the consolidation of DPM, the MLP at DCP. They do some hedging because they pay out all their cash in distribution like other MLPs, so they put hedges in place, and that's a proportional share of mark-to-market flows through each quarter. So we just back that out since it is not particularly relevant to the underlying earnings at DCP.

So, that's actually excluded from your earnings at DCP?

No, it's not excluded. It's just to give you better vision on what DCP is actually do. So you had $34million before the mark-to-market, you actually had a mark-to-market pickup. So you take that back out which gives you the $24 million for mark-to-market loss.

Faisel, the loss was about $54 million at the 100% partner level, and that compared to losses in 2008 of $170 million. So, it's a $116 million improvement year-over-year.

On the NGL realization, I think you said about 44% realization to crude prices, is that right?

That's correct.

It seems like that would be a little bit lower than some of the market indicators, which were pointing towards 50%. Just remind us what you're seeing with the different components of NGL demand.

Here's the real issue. Ethane, we're now back at about the peaks we saw in 2008, so that's around 840, 825 in terms of million barrels, and the utilization of the steam crackers is 82, 83%. So we have seen a steady increase in that during the year, but the issue is propane inventories are well above the five-year average. And since the propane is an alternative to ethane which is now below the five-year average in terms of inventories, that puts a cap on ethane pricing. So, we have got to see some more economic growth to actually bring propane supplies so that you can see a bigger move in ethane. Our barrel maybe a little bit different than other folks, but I don't think it's material. So it's moved all over the price. Earlier in the year, I think we were seeing some 70% correlation, and it has been as low as just a little bit under 40%. So with the massive move in oil which as you knew was moving for more than just economic reasons, moving dollar wise, et cetera, I think you see a big change. The NGL market, 90% of it is made up of the chemical industry, the refining industry, and then residential and commercial. Those are all domestic businesses that need to get moving to really see an improvement in NGL pricing. With economic growth, you should see that that start to happen in the last half of the year.

Faisel, we average 48% correlation for the first six months, so as Greg indicated the fact that it was 44% in the second quarter really just is a measure of how quickly oil prices have risen relative to natural gas liquids.

With the massive volatility that we have seen in currency and especially the Canadian dollar, what kind of impact does that have on your decision making process for projects or financing and just managing our general business?

Well, obviously it focuses on borrowing money when we invest in Canada and unfortunately we have two equivalent to Fortune 500 companies in Canada, both Union and Westcoast have long histories and are public debt companies in Canada. So obviously it focuses on borrowing there. I think the other thing is we are partially hedged, substantially hedged thanks to the fact that we do borrow up there. So what you may win or lose from an earnings perspective above the interest line the inverse is true, and the interest line. So I think Pat remind me, but I think for the quarter it was $0.01 impact in terms of FX even though you saw pretty substantial moves.

I think we also have to put in perspective. It's probably true with commodity prices overall that what we have seen going on in the last twelve months is not the norm. I wouldn't expect it to be the norm and while there's no doubt you're always going to see fluctuations in commodity prices. If you believe that the economic downturn of the last year or two has been at least as bad as anything we have seen since World War II, if not since the 30s, then I guess it kind of underlines the type of volatility you would see, but you would not expect it on an ongoing basis. I think that gets lost given it's all happened in twelve months.

Your next question is from Ross Payne with Wells Fargo.

First question is for Canada for the gathering business up there. Is that POP or keep hole or what is that?

That's all fee. There is no commodity. The Canadian processing business developed quite differently than the U.S. one. That is a fee business up there. The only commodity exposure we have there, Ros is that the fractionation plant which is Empress. So that's the movements you see up there in that business, and we thought we would earn about $55 million on the Empress side of the business this year, and frankly we have earned about 35 of that already. So the processing business, and what I am referring to when I say we could spend a billion dollars between 2012, that is a fee-based business.

What are you seeing in terms of laying down rigs similar to what we have seen in the States and will that impact the volumes and therefore I guess the fee-based?

A little bit like in the states. It's all location is everything, right, so we actually see an increase in activity up in the Horn River and the Montney region. And again since their fee-based commitment contracts, it's not dependent just on volumes. They are really for lack of a better word take or pay type contracts up there.

Regardless of volumes?

Yes, correct.

On DCP mid, any idea what volumes did year-over-year?

I believe volumes quarter-to-quarter were down about 8% on actuals, probably 5% year-to-date, but much less impact on margin. Margin was only down about 2%. That's because where we saw volumes come off, it was in our low margin areas as opposed to where we saw volumes doing pretty well in the high margin areas. Again, it's a regional game; places like the Rockies were up 6% or 7%, Mid-Continent and Permian kind of flat. We have a lot of activity down here in the Gulf Coast and South Central, those areas were down. Geography is very important as you know in this business, so no single answer really tells the whole story.

Pat, you've got a lot of availability here. You do have a bond issue coming at the end of the year. What are your thoughts there?

Ross, we're going to watch the market conditions. This is a good time to be in the capital markets with over $2.5 billion of liquidity we don't have to. We have got a little over $600 million of maturities between now and the third and fourth quarters. So we're just going to kind of wait and watch and we can access the market if we want to on kind of an expedient basis.

Your next question comes from Matthew Akman with Macquarie.

Are there any implications for the Maritime and Northeast expansion of the fact that counterpart LG is not really delivering volumes right now?

Matt, we have a long-term 25-year contract there that is reservation charges. So we make a return on enough capital on those reserve charges. So those revenues come in and started in March or April of this year and they will continue for 25 years. The transportation cost is relatively modest versus what they trying to arbitrage on the value of gas at any one point in time, but they're doing some commissioning out there. They are flowing some volumes through there now, Matt. So I think that it bodes well that the pipe is in good shape and expansion has gone well. Also they're obviously looking for the opportunities where they can actually make dollars on the commodity which is not our game, but it is theirs.

The pipeline is going to earn its return regardless?

Yes, sir.

Second question on the storage expansion at [Don] to 5 Bcf that came into service at the end of the quarter, can you confirm that that's going to be sold all at market rates under the OEB decision.

Yes, just to be clear, that's actually MHP, so not to confuse the matter too much, but that unregulated subsidiary actually flows through U.S. Transmission, so that is a market based project, and it's actually being completed or put in service by U.S. Transmission.

Is there any more expansion there because that's obviously very low cost expansion relative to other storage around the country and if you do it at market-based rates, it is probably very nice returns.

Yes, we think so. As you know we put some stuff a little bit further up the Bruce Peninsula as well. So we see opportunities there. It's not like 10 Bcf and 20 Bcf. It's probably more like 4 Bcf and 5 Bcf here an there, but we're always looking for those opportunities and as you well know our infrastructure there is so well connected to virtually all those opportunities, we can probably make those assets hum better than some other folks. So we're always looking for opportunities to develop it or if it is attractive to actually go out and acquire some assets. You can do that relatively small discrete acquisitions and bring it into the overall Don system.

On the detailed question, the T-South open season the West Coast system, is that just filling up existing capacity or is there any potential at some point to expand that? Is that on the horizon at all?

That's existing capacity. There is no capital associated with that. I think as you know how the overall volumes flow, whether they go north or whether they first go East and down, I don't see any big expansion of T-South at this point in time.

The TransCanada has announced that it's partnering with Exxon on the Alaska highway gas pipeline and once upon a time Spectra or its predecessors were involved in that project. I am wondering whether you guys have your eye on any involvement in that project at all under some of the new structure that may come out from TransCanada and Exxon?

We're always interested in opportunities. I think the first and pretty substantial capital opportunity is the Horn River, and you know how much capital we're putting toward there, and obviously I think the economics of gas there are better than they are at the further north you go. That being said, look, if that project gets built over time, and that will be a decision obviously of Exxon at some point in time down the road and other producers, that's going to be the largest infrastructure project in the world as I understand it. I don't think any one player may want to take on all of that risk and there will be opportunity perhaps for some others to participate, but I think it is a little early to look at that and that's still well into the next decade before that project really gets humming.

You do have a follow-up question from Carl Kirst with BMO Capital.

Greg, you just touched on the follow-up I had with Don and market hub partners. It wasn't too long ago that you could throw a rock in Houston and hit private equity developing salt dome storage, and since then the markets changed a little bit. The question is are there any sort of half developed projects that either look attractive or are floating around or present acquisition opportunities for you guys

Storage is finicky. You got to make sure you got the right geology and you are in the right location. I know there are a lot of folks that thought it was pretty easy as you suggested to throw a little private equity around and get projects developed. I don't think all of those storage projects are created equal. We're pretty picky about what we look at. That being said, I can't really comment on where we are on acquisitions, but definitely storage opportunities would be something we would look at. If they were supportive of both our current supply region storage that exists and obviously the market-based region and we thought we could do better with pulling those assets than some others. Steckman's a good example of that. We picked up Steckman Ridge I guess probably two years ago or so. That project has been a couple of hundred million dollars, great partner in New Jersey Resources, very well connected into Texas Eastern and other pipes, and that seems to fit the right type of storage project that we would be interested in if we could find one at a decent price.

It's kind of challenging when you only own 50% of it, but do we have any gross margin breakout for DCP yet? Is any of that data available?

Not yet. It will be on their website in the next few days after DP, because, Carl, it has pretty clear insight into what DPM did for the quarter. We don't put it out until they do their call. I think that's probably a little bit later this week. Operator (Operator Instructions). You do have a follow-up question from Anthony Crowdell with Jefferies.

Just two quick follow-ups. One is on the U.S. Transmission business. Could you provide any color to the lower equity earnings, any segment that's from? The second question follows my interest question earlier. Looking at roughly like a $0.07 per share savings from interest expense. Is it wrong for me to assume that the original $1.15 you put out did not include that?

That's correct. There is no $1.15 that we put out, it's just $680 million of interest expense and a lower number of shares. We actually have $646 million weighted average shares outstanding that you could use, but that sounds about right. With respect to U.S. Transmission, we had a couple of things going on there. One, the reduction was about $16 million in total of lower equity earnings from our joint ventures. In one case, about $7 million of debt relates to Southeast Supply Header Project where for technical reasons, we discontinued regulatory accounting under FAS 71 effective I think about August of last year. So, we had a retroactive adjustment that we made. The second piece of that, about $9 million relates to lower interruptible transportation revenues on our Gulfstream project, which by the way is fully contracted, but we sell interruptible service on top of our firm service.

Anthony, the other thing I would add with the interest expense question, I don't think your math is wrong. Take the interest expense, add the tax and then divide by the number of shares, you can get that number, but just thinking ahead of ourselves. That's actually offsetting some of the commodity impacts that we have seen as well. So you take all that into account.

It should caveat that it is also dependent on FX rates with the Canadian dollar staying about where they are for the balance of the year.

At this time there are no further questions. Sir, are there any closing remarks?

Yes. I will just thank everyone for joining us today. Appreciate you being on the call and I do want to remind you that on Thursday, August 13, we're going to be in Boston for breakfast, and then in New York for lunch. You should have received an invitation to join Greg and Pat at both of those locations, and join us for one of those discussions If you haven't already done so, we would appreciate knowing whether or not you're going to be able to attend. We'll look forward to seeing you in Boston or New York, and as always, if you have any additional questions, please feel free to call either me or Patti Fitzpatrick. Thank you.

This concludes today's conference. You may now disconnect.