密歇根天然氣 (DTE) 2005 Q4 法說會逐字稿

Good day, everyone, welcome to DTE Energy's year-end 2005 earnings conference call. Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Mr. Dave Meador. Please go ahead, Sir.

Thank you. Good morning and welcome to our year-end conference call. As you all hear this morning, the team is pretty upbeat. We're coming off a good performance in 2005 and we just had a great showing of Detroit for the Super Bowl and we're looking forward to an even better 2006. Before we get started, though, I want to refer you to the Safe Harbor Statement on page two, including the language on forward-looking statements and the paragraph on proven reserves as it relates to unconventional gas, which is new language in that statement.

As you know, last year, Gerry Anderson was elevated to President and COO of DTE Energy. Given his new role, I've asked Gerry to join us on key conference calls such as today so he can present an overview on our performance and growth plans, and then help take questions at the end of the call. Also with us today is Nick Khouri, our Treasurer, [Peter Alexiair] who was recently promoted to the position of Corporate Controller, and [Mike McNally], our Director of Investor Relations as well as members of the leadership team. With that introduction, I'll turn it over to Gerry, will provide an overview.

Thanks, Dave, and good morning to all of you. I think as Dave said in moving on to slide five, we feel good about both the results that we showed in 2005 and the progress we made on a number of fronts. Our financial performance was strong. We had a nearly 30% increase in operating earnings versus 2004. We made good progress on the regulatory front. We finalized the MichCon rate case. We also had the restructuring case on the electric side move its way through and continued progress there. And we continued to make focus investments in our three nonutility business segments.

We expect this good progress to continue in 2006. You've seen our guidance, which is up 10 to 20% in terms of operating earnings per share. We also, in 2006, will be working on two big drivers of future performance. And one of those is our performance excellence process a broad cost reduction program, that I will talk a bit more about later in this presentation. And the second is the investment of the strong cash flows that we're getting out of our synfuel program into both our utilities and into our nonutility business segments.

When you look a little bit longer term, over the next two to five years, we think we're set up for continued steady growth on the utility side. And what we see between now and 2010 is 5% compound annual growth on the utility front. Nonutility businesses that we are pushing to bring to scale, and those will be combined with an attractive yield. And when you put that picture together, we think we've got a compelling value proposition.

Let me take some of the pieces of this and give you a little bit more color then. Moving from page five to page six, you see our operating earnings per share in recent years laid out. 27% increase in '05 versus '04. That was driven by the completion of the Detroit Edison rate case in late '04, the MichCon rate case in '05 itself, we did make progress on the choice front. And we continue to see nonutility growth. You see on the right-hand side of the slide that our guidance for this year is 360 to 390, up 10 to 20%. The drivers of that will be full year rate case at MichCon kicking in this year. The residential rate freeze at Detroit Edison, which was in place last year is not this year.

We continue to make progress on the choice front, our power costs are just more and more competitive in the structure, is much closer to a level playing field than it was a few years ago. We are going to be driving hard on the performance excellence plan that I will describe a bit later. And we continue to see growth on the nonutility side of the Company. We think we can continue this pattern beyond 2006. And that's due to dynamics that we have working on both the utility and nonutility side.

I want to use the next few minutes to go through each of those. Starting with the utility side of the Company. Now, really two pieces to the story on the utility side. And they are asset growth and broad cost reduction. And combination of those two that we think will enable the 5% growth that I mentioned a minute ago.

Let me start on slide seven with the asset investment and asset-based growth. You see laid out at the top left of the slide what we expect our investments and various segments of the business to be over the next five years. I would say that our degree of certainty over the scale of those investments has increased materially since we first presented them to you mid last year. The base utilities we see 650 to 750 million going into investments focused on reliability of our wires, our generation and our pipeline systems. 7 to 800 million on the environmental front for scrubbers and SCR's and gas system expansion safety of about a quarter of a billion. So in total we see a 1.6 to 1.8 billion expansion of our asset base and that's over and above depreciation.

The income impact of that is shown on the bottom left of slide seven. And you can see that the electric utility looks like it will be up over 70 million in earnings and the gas up 15 million for a total of 90 million increased utility earnings, assuming that we earn our allowed return on those investments. That's a roughly 20% increase in utility earnings over a 4 to 5 year period from what our 2006 guidance is.

We're pursuing a two-prong strategy to make sure that we do in fact earn our allowed returns on those asset investments. And one of those is laid out at the bottom right of this slide. That is, that we're going to very carefully lay out a rate case strategy to get timely return on the asset investments. It's possible that we will file a rate case for MichCon later this year. Not certain yet, but possible. And we will be filing a Detroit Edison rate case in mid 2007.

In addition to that rate case strategy, we are going to be working hard on cost reduction. And that discussion begins on slide eight. We are well aware that as we take undertake investments of the scale that I just described on, seek returns on those, and when we do that, in an environment where commodity prices have behaved the way that they have in recent months, that there is going to be an expectation from our customer base and from our regulators to do everything that we can to offset those pressures with cost reductions. And having thought our way through that about a year ago, we launched in the fourth quarter of last year, what we are now calling our performance excellence process. The description of that process is on page nine.

Performance excellence is a broad cost reduction effort in productivity and performance improvement program. It is touching every area of Detroit Edison, MichCon, and our Corporate Center. We are pushing our people wherever we are not currently first [inaudible] and performance to get there and to lay out the plans to do it. You can see the timeline on the plan for the program laid out at the top of the slide. We began in the fourth quarter of last year identifying cost reduction ideas and opportunities. We've got just an intense effort underway now to evaluate and risk rate and quantify those opportunities. That will wrap up within the first quarter of this year for most of the Company, at least. And we will then move on to implementation in the second quarter and beyond.

In terms of impact, we have not obviously completed the process so we don't know with certainty what the impact will be. But we estimate that at least 250 million in annual O&M and capital savings will result from the process. Those will not kick in immediately. Obviously these ideas take some time to implement and there will be restructuring that we'll need to do to realize that, I guess the point is that the savings that come out of this will be very material and I think our goal is to create the headroom in our rate structure, the room in our rate structure to recover the return on investment that we will need to as we make the asset investments I described a few minutes ago. That wraps up the discussion of the dynamics on the utility side of the Company.

I want to move now to the nonutility side of the Company, on slide ten. Our goal here is to continue to use the value focused approach, to focus on value creation as we have in the past. And I think that served us well. Use that approach to take the strong cash proceeds that we see coming out of both our synfuel business and our other nonutility business and reinvest that cash into three core segments and we're pushing those segments to have a minimum scale of 50 to 100 million in net income. And in the process of doing that, improve both the visibility of those segments and as a result of that, the valuation.

I think we're making good progress on this front, too. And let me take just a few minutes to describe that over the next few slides. On slide 11, we discuss the first of our three nonutility business segments, the power and industrial projects segment. This is the segment in which we go on to the sites of large energy users to provide them power, steam, chilled water or fuel under long-term contract arrangements. You can see at the bottom of this slide that in 2005 we invested 115 million in projects of this type and you see the expected returns there. We continue to do projects that our customers feel good about and we project will have strong returns on invested capital. That 115 million went into the projects that you see described on this slide. We bought a series of projects from DQE, it was a five-site transaction with them. We also had a second multi-site acquisition from another counter party and we added a multi-site landfill gas acquisition. Post that acquisition we're now the second-largest player in the nation in that segment.

We also continued our push into the pulp and paper segment. It's a very energy intensive segment, it's well suited to what we're doing and we undertook our second project there. Looking forward to this year, we continue to see a pipeline of these sorts of opportunities. In fact, I'd say that our opportunity list is fuller at this point than it has been any time in the last three years or so.

Second business line that we are investing against is described on page twelve, the fuel transportation and marketing segment. The real story here is described at the bottom of the page. We are playing into very strong storage and pipeline transportation fundamentals. If you follow these markets, the storage spreads are at all-time highs, just tremendous demand for new storage. And pipeline transportation storage, pipeline transportation demand, is very strong as well.

And as a result, we are investing in the things that are described on this slide. We are in process of wrapping up a 40 million investment to add nearly 15 Bcf of nonutility storage capacity here in Michigan, that's all fully contracted. We will be working to add an additional 15 to 35 Bcf. In fact we've got counter parties that we're in very active discussions with on those. We're also advancing a series of storage projects in the New York marketplace. And they're in discussions with off takers in the Northeast for those projects.

On the pipeline front, we are moving forward in expansion of Vector Pipeline, our equity into that will be about 15 million. Expect that to go in service next year. And we've made great progress on the millennium pipeline. I've got strong offtake interest and agreements lined up there. We expect equity for our partnership share to be 45 million. So when you look at the things that I've described and the gas pipeline and storage segment, about $100 million of investment that we are working on in high quality, fully contracted projects really feel good about what's happening there. In addition to the gas front, we had a extremely good year on the coal front in 2005, near record earnings in that segment and we continue to feel we'll have good results in the, on the coal marketing in the coal marketing arena as we have in the past.

The third segment that we're working in the nonutility front is unconventional gas. And that discussion begins on slide 13. I would begin this discussion by saying we pursue unconventional gas in two places, in Michigan and in Texas. They both are focused on gas production from shale. I want to make a simple point about our activities in Michigan. And that is, that this is, if you come to understand it, a very large business that is masked today. And I come at that two ways.

On the left-hand side of this slide 13, you see the Antrim net income hedged and unhedged. The green bars show that if our Antrim production were being sold at current market prices, this would be an 80 to $100 million net income business. In other words, a business at or larger than MichCon itself. But you also see that in the red, we have hedges that were put in place years ago at a little north of $3 that in 2005 had this business showing very modest income levels. And you see moving forward that we are stepping out of those hedges and we do a lot of that between now 2008 the step out of the hedges is completed by 2013.

So we will move from a business that's nearly fully masked in terms of its earnings power to one where the full earnings are in place by 2008. And a significant portion of those earnings come into play over the next three years. If you look at a PE valuation of the earnings that are currently visible in this business, you see that at the bottom of the left-hand box, we estimate that there's less than $0.50 a share coming into our stock price from this segment. But if you flip over to the right-hand side of the slide and take a more classic reserve valuation for our activities, in the Antrim, you can see that we have proved reserves of 338 Bcf and probable reserves of 35 BCF. And if you take the valuation comparables that are shown there, you come up with a gross value of these reserves in the 850 million to 1.050 billion.

And when we deduct the costs, the net present value costs of the hedges and the allocation of debt to this business, we come up with an equity valuation on it of 400 to 600 million. Which is in the $2.25 to $3.25 per share range in terms of valuation. So the simple point is this. That the hedges do mask the value of this business currently. But we think there's somewhere north of $2 a share that's being lost in translation. And we need to keep both making this point, as well as playing into the roll off of these hedges over the next few years.

Moving on from the Antrim in northern Michigan to the Barnett Shale in Texas. We're want to give you some update on key parameters in the Barnett and those are shown on slide fourteen. In the top left, we entered the year finished 2004 and entered 2005 with 49,000 acres in our position. We expanded that acreage position to 76,000 acres, by the end of 2005. You can see that only about 20% of our acreage position was developed by the end of the year. In terms of reserves, top right, we entered the year with 16 BCF of proven and probable reserves. And exited the year with almost 180 BCF of proven and probable reserves. So a very significant expansion of our reserve position, although I would make the point that we're still very early in actually proving up our overall Barnett holdings.

In terms of producing wells, we want from five wells entering last year to 65 wells exiting this year. And we expect to nearly double that level again this coming year. In terms of production, we entered the year in the Barnett with no production. And left the year with 4 million cubic feet a day or roughly 1.5 BCF per year in terms of a run rate. So our production grew materially across the year and, of course, is ramping quite quickly right now as we continue our drilling program down in the Barnett. [inaudible] so what of this slide is that the value of the Barnett and its potential to be a significant contributor to DTE's overall valuation is beginning to become visible and I think this will be another big year in that process.

If you combine the description that I just gave of the utility dynamics, the investment profile at the utilities, the cost reduction and the longer term growth that we think those will produce, with the dynamics on the nonutility side, you combine those two with the dividend shown on page 15, we think it creates an interesting value proposition. Our dividend yield currently is almost 5%. As you can see, that stacks up very well in the industry. And on top of that, it's been a very reliable dividend. We paid it for nearly 100 years. And in the pressure that came on in the industry over the past five years, we were one of a handful of companies that had no change in its dividend level. That dividend is backed by what are now stable credit ratings and a very long, very strong liquidity position.

So stepping back from all of this on slide 16, we feel we have some very good dynamics that play at DTE right now. The utilities with an opportunity for 5% annual earnings growth, through 2010. I think from the nonutility discussion, you can see that we feel like we have some very good opportunities there. And when we combine that with the dividend yield that I've just described, I think we have a value proposition that's a good one. And with that said, I'm going to hand things over to [Peter Alexiair], our Controller, to run through earnings results.

Thanks, Gerry. And good morning to everyone. Like to move us to slide 18 for summary of the progress made in 2005. As Gerry presented earlier, earnings were up 27% in 2005 with increases in both electric and gas utilities and overall nonutility income. Cash came in strong year-over-year as well. During the year, we've completed major regulatory filings with our electric and gas utilities, and successfully executed the first year of our synfuel cash redeployment strategy, with over 250 million reinvested for future growth.

The next page gives us a rundown of total year results. For the year, operating earnings per share for DTE $3.27, at the upper end of the earnings guidance we communicated in our third quarter call. Like to remind everyone that a reconciliation to GAAP reported earnings for the year and the quarter, is contained in the appendix. The fourth quarter results are also in the appendix of the presentation.

Primary contributions for the year with Detroit Edison at $1.54 and our nonutility power industrial project segment at $1.58. MichCon had operating income contribution of $0.42 a share. Corporal and other was at $0.30 loss for the year, largely due to financing costs held at the corporate level. As you mentioned in the third quarter call, certain energy trading contracts experienced innerperiod variability, with the commodity prices until the contracts are actually settled. Our fuel transportation marketing segment was impacted by this timing related accounting by $0.44 a share. We give an update on the forecast of accounting timing flow back later in the presentation.

Moving on to page 20, we can see each segment's performance year-over-year. Detroit Edison, our electric utility showed improved performance in 2005 with operating earnings improvement of 94 million. Key drivers for the year included a full-year of rate increase for our nonresidential customers and lower customer choice volumes. Temperature normal sales were relatively flat for the year, but as a 4% service area increased driven by weather related cooling demand. MichCon was up 49 million driven by the rate increase from the April, 2005 order, and the implementation of the approved [inaudible] expense tracker.

The power industrial segment was up 101 million with a full-year production at a synfuel facilities and the income capture of a recent spike in coke prices at our coke battery operations. The fuel transportation and marketing segment was down 68 million year-over-year as a result of the trading accounting timing impact discussed on the previous page. That wraps up the review of 2005 performance.

Now looking forward to 2006 starting on page 22. 2006 is a year where we will drive both utilities towards their targeted return. This will be done with a choice reacquisition for the electric business and the process excellence program for both utilities. For the nonutility business as our focus will be to manage the cash harvesting of our synfuel business and redeploying 450 million into the strategic opportunities Gerry highlighted at the beginning of the presentation.

Overall, we will deliver operating earnings growth at 10 to 20% in 2006. Operating earnings guidance shown on slide 23 remains at $3.60 to $3.90 a share. The level communicated in our press release last month. The components of 2006 will be addressed on the following pages.

I like to move us to slide 24 and go through the some of the details beginning with Detroit Edison. Key drivers for the year is the expiration of rate caps, assumption of normal weather and storm restoration expense. We're also forecasting another step down in choice buy-ins driven by the high commodity prices and the impacts of the December rate [inaudible] order. With the fight--with the flat territory growth, a key driver for performance will be the performance excellence cost improvement. 2006 earnings guidance for Detroit Edison is 320 to 335 million or 10.5 to 11% return.

Now, continuing on to MichCon in slide 25. With higher gas prices and local economic conditions, we are projecting increased customer conservation. 2006 will benefit from a full-year rate increase and the uncollectible tracker implemented with the final rate order. Similar to the electric utility, the performance excellence process will more than offset the impact of low volume growth and cost inflation. Earnings guidance for MichCon for the year is 70 to $80 million.

Moving on to nonutility earnings and 2006 key drivers on page 26. The power and industrial segment which contains our synfuel business line is impacted by increased hedging expense for the calendar year. The next two pages will cover synfuel in more detail. Within that segment, we do have projected growth for our on site business line. Earlier in the presentation, Gerry highlighted the Barnett and Antrim growth opportunities. For 2006, the segment's growth is driven by a step up in production at Barnett, and a portion of the legacy hedges rolling off our Antrim sales. The fuel transportation and marketing segment is up year-over-year as well, benefit by the trading accounting timing flow back in gas storage expansion.

Let's turn to page 27 and turn our focus to 2006 synfuel cash and net income. Our guidance assumes no tax credit phaseout or legislation. Under this scenario, cash flow will be 450 to 470 million, and income will be 210 to 220 million. As discussed earlier, the drop in income of 2006 is driven by the increased hedging expense. The uncertainty of oil prices, there's a range of potential cash and income outcomes for the calendar year. The range of cash and income under different oil prices can be seen on page 28. These scenarios assume an optimization of production with a level of phaseout. As to profile of cash to income indicates, we have more protection at the upper end of the phaseout range due to the hedging and production profiles.

Comparing cash to income, cash has more protection in a phaseout due mainly to the AMT carried forward utilization. Similar to 2005, we will likely defer the majority of synfuel revenue into the fourth quarter unless legislation passes and we have price certainty. The amount of accounting deferral this year will be greater than in 2005 due to the changes in agreements with our partners which makes more revenue contingent.

Now, turning to page 29, for an update on the forecast of energy trading timing related flow back. As we outlined in our third quarter call, the majority of the timing related impact was realized in the fourth quarter with gas storage withdrawals. The remainder will flow back this year and in 2007, but will remain subject to price shifts until the contracts are settled. So with that finish, we finish our look at 2006. I'd like to turn the discussion over to Nick Khouri and a look at cash flows and balance sheet help.

Thank you, Peter. As in the past, improved cash flows and balance sheet strength remains a key priority for Management and the Board of Directors. And as expected, cash flow is improving from the levels of the prior couple of years. Page 31 provides some history on adjusted cash from operations, including synfuel proceeds. DTE's internally generated cash is expected to climb nearly 50% from roughly $1 billion in 2003 to $1.5 billion this year. Driving this improvement has been the return to financial health of the two utilities, combined with synfuels turning from cash negative to cash positive. In addition to paying down parent company debt, the increased cash has been used to reinvest in our businesses.

Page 32 shows 2005 actual and 2006 projected capital spending by business. Capital investments are expected to rise from 1.1 billion in 2005 to between 1.3 and 1.7 billion this year. Year-over-year capital increases are split between base utility spending, environmental remediation at Detroit Edison on and nonutility growth. Of course, the actual level of growth capital will depend on finding projects, meeting our strict risk adjusted rate of return requirements, and the ability of our balance sheet in synfuel cash to support the discretionary investments.

Page 33 shows a full cash flow statement for 2005 and 2006. As we showed on the prior--the previous slide, 2006 adjusted cash from operations is expected to increase nearly 10% over last year. The major driver of 2006 cash is the improving cash position of the gas utility and additional synfuel cash net of hedges. These two things have partially offset by continuing working capital requirements to fund high commodity prices. In 2005, internal cash was sufficient to fund base capital spending and the dividend. Moreover parent company outstanding debt was reduced about $120 million. This year the required external financing may increase from the required levels of 2005, will ultimately depend on the level of capital investments.

Finally page 34 list the major balance sheet metrics followed by both [inaudible] rated agencies. We continue to target a strong triple B BAA2 credit rating. While leverage increases slightly from 2004 to 2006, reflecting a higher level of an environmental and operations spending at the utilities cash flow metrics continue to improve. FFO to debt rises from 19% in 2004 to 23% this year. About halfway toward our long run goal of 26 to 28%. Now, let me turn it over to Dave for some wrap-up comments

Thanks, Nick. Before I summarize, I want to note that we provided a significant number of schedules and reconciliations in the appendix to make your analysis easier, so you'll find in the appendix the quarter-over-quarter schedules and detail on the utilities including Detroit Edison's margin. Let me summarize on page 36 and 37. 2005 was a strong improvement over 2004 as we transitioned into full financial health at the utilities and continue to grow our nonutility businesses.

As Peter laid out our 2006 plans are to improve earnings another 10 to 20% over the 2005 levels. This will be achieved by returning two utilities to their full health, which is targeted 11% return on equity and continued growth in all three nonutility segments.

As Gerry laid out, the investment pipeline is full and we will continue to achieve scale and create value in all of our business lines. On the performance excellence process run, we are well under way as was reported out, as we drive towards consistent first quartile performance in both costs and customer satisfaction and there will be more details to come on that front in about 60 days. And as Nick reported out our balance sheets strong, and the cash metrics are improving. We're just on track and we're accomplishing the goals that we laid out for you several years ago. We'll be able to update you on our progress in all these fronts at our March 16th presentation at the Morgan Stanley Conference where Tony Earley will present, and also we will hold an analyst meeting in New York on April 6th. Thank you again for joining us. And we will now open it up for questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Paul Patterson of Glenrock Associates.

Good morning, guys. How are you?

Good morning, Paul.

I wanted to ask you about the Barnett Shale. What do you guys actually estimate your total -- I mean I see the 59 Bcf. But you've added some acreage and what have you. What are you guys expect that the total reserves to be? And how much would the additional acreage cost?

Paul, this is Gerry. You're asking what do we expect the total reserves to be for all 76,000 acres that we currently have in our holdings?

Yes, that's right.

Well, I would I guess I'd answer it this way. Paul, what we've shown here is concentrated in the core of the play and in our holdings in Jack County. We are beginning, but that's actually a fairly small percentage of the overall acreage that we hold. We are beginning to move from the core holdings up in the north and our holdings in the west and Jack County toward the south. But we're much earlier in the process of drilling and proving up the southern acreage holdings. So I think it would be speculative to say what we really believe all 76,000 acres will deliver ultimately.

Although it's certainly in our plan this year to make a lot of progress in the south where if you look at the Barnett this year, we really got two things going on. We are driving hard to produce in the areas where we hold these proven and probable reserves. In the core and in the west. And south, it's a program to be able to answer the questions you just asked a whole lot better as the year progresses. And we undertake our test drilling program down there.

Thank you.

I think that's probably the best we can do at this point.

Okay. How much would the additional acreage cost, I guess? What's the answer on that?

Well, I think I'd step back and talk about how much we have in total into the Barnett. And look at that relative to what we can see currently in terms of value. We have roughly 120 million in investment into the Barnett to date. And if you take those proven and probables and take current market valuations, you're probably 2 to 300 million in valuation. And as we turn those probables into provens, that valuation will continue to step up. So we feel like we've got good value produced from what we've invested to date already. That should continue to step up. And, of course, we've got a lot of acreage that we just don't know yet.

Okay. And then finally, what is the production that you guys expect for 2006 and 2007?

Dick--Dick Redmond is on. Dick why don't you answer for the 2006 production question?

Over the course of 2006, we expect to produce about 4 Bcf.

Okay. Thank you very much.

Thank you and in the interest of time if we could please limit ourselves to one question along with one follow-up. We'll take our next question from [Ben Sung] of Luminous Management.

Hi. Just I guess a little bit more clarity on the previous question. How many acres and do you currently have in Jackson county, the county where you sort of focused more of your efforts on proving?

I'm sorry, I missed the county name. We couldn't hear it on this end. Was that Jack county?

Yes.

We have about 20,000-acres in Jack county currently.

Okay. Thank you.

Thank you. We'll now move to Daniele Seitz of Dahlman Rose.

Good morning. Could you remind us or do you intend to recover your environmental expenditures? Is it going to be through the rate case that you plan on filing in May '07 and is there a deferral process going on or can you recover them pretty much on a timely basis? I don't recall that. Could you remind us?

Daniele, we've made about $550 million investments from 2000 to 2005. Those were all covered in our prior rate case. We will invest on the order of 200 million a year for the next couple of years. And we would expect that those will be recovered in the rate case proceeding that will be filed in 2007. And in the interim, we're going to try to use the performance excellence process and driving out of costs to cover the return requirements.

Okay. So there is no deferred process, you have to file, in order to recover the expenditures?

No, there is no process for recovery right now, other than the traditional rate case proceeding process. Although we are in discussions on various fronts to try to set a framework for investment in the state in both environmental on both the environmental front and the baseload generation front. But those discussions are ongoing and we don't have any results yet.

Okay. Great. Thank you.

Thank you, Daniele.

We'll take our next question from [David Groomhouse] of Copia Capital.

Good morning, guys.

Good morning.

Can you hear me?

Yes.

You had significant cost hedge to synfuel this year. As you indicated in your prior guidance when you gave the guidance. If the legislation goes through to revise, to have a look back on the phaseout year, what impact would that have on you all in terms of those costs?

Well, the, we've hedged, we spent about $50 million to hedge the 2006 calendar year. If the legislation goes through, those hedges would basically be done protecting the 2007 risks that you would have. So what we would do is, we would likely leave those hedges in place and we would take it out of operating earnings because we would want that cost matched up with the 2007 calendar year.

And then any hedging you've done for '07 you would sell out of --

We would take any hedging that we'd done for '07, any hedges from '06 we would flip over into '07. Any hedges that is we would done--done for '07 we would probably flip those out of that year and back into the '06 timeframe.

Okay. So is it most of those costs then flip out of '06 and into '07?

That's right. The costs flip out of '06 and into '07. And we could consolidate the position of the two years if you know what I mean.

Right, okay. Second question, follow up to Paul Patterson, in terms of proving up the acreage in the southern counties in the Barnett, you feel like you should have a good feel on that by the end of this year, about how valuable those reserves are?

I think as we go on through 2006, there are six distinct areas that we're in. And we're going to drill somewhere between five and 15 wells down there. Some of those areas are very close to proven. Others are going to take longer and probably won't know until the end of the year. So we'll have information on at least three of those six areas. And hopefully by the end of the year, some inclination as to the other three. So as Gerry said, this is going to be a year where we aggressively test this. Some of this we hope to get online actually this year.

Great. Thanks for the time today.

Thank you.

[OPERATOR INSTRUCTIONS] We'll take our next question from Zack Schreiber from Duquesne Capital.

Can you hear me?

Sure can, Zack.

Hi Gerry. Hi David. Just a question and-- I'm kind of in and out here, I apologize. On the section 29 issue, how hedged are you for '06 and given right now no legislation, where do we start to phaseout? If the legislation passes and the inflation gross up is removed, where would we start to phaseout then on the EIA basis and then looking at the EIA WT differentials, $6.00 or whatever, where we then start to phaseout? And then I guess I'll start, we'll start with that.

Zach, this is Dave. The synfuel schedules were on 27 and 28.

Yes, sir.

To answer your first question, if you look on at the cash generated projections for this year, it's 450 to 470 million. On a full phaseout basis, we are about 70% protected. If you look on page 28, what we did is, right now, as you know, that there's the possibility of legislation and we're also in a period where we've had high oil prices, even though recently they've been coming down.

So as we went through this, there's many permutations that you could develop, as you think through how the math might work, so what we did on page 28 is just to show the cash and net income impact of a phaseout in gradations of 10%. Now, this all assumes no legislation and if legislation happens, then 2006 is not exposed to oil prices. So it's not relevant, but as you point out, the one thing that the industry would give up is the inflation adjustment year-over-year.

Now, given your situation, where you're pretty highly ledged for '06, is this legislation actually a negative because you're not that hedged for 07? Such that it --

Zach it's a--

Or you just roll forward so that you actually get two years of protection?

You roll forward the hedges for this year into next year. And we actually have hedges on for next year that you, we would trade in the marketplace for '06 hedges. So we would end up through combining those two years more fully hedged.

So you guys want this legislation to pass?

Yes.

Okay. And just remind me, on the economics and you said it was better--if I recall it was at 50% phaseout, that's when it kind of got questionable, right? The economics of producing, right? Given the pretax operating loss of 13, $14 per ton relative to the $27 per ton tax credit, was that it?

Yes. It's around $66 that the economics are such that you would, it would be less economic to run. So if you look at the phaseout schedule on page 28, you know, it's 66 and below it's basically assuming that we had run full out at the right-hand side of the schedule. There's step down in production. More step down the higher the price of oil.

Got it. And I know the oil curve is now [contango], and it used to be [backerated], if we're looking at $57 right now on the front, where are we for '07? Is it 63, 64? And when you do the EIA adjustments and they're $5 a barrel, what kind of phaseout is implied by the market now, if any? I'm sorry, I should know all this.

Well, in recent days,[inaudible] obviously moves around with the market. But in recent days, the phaseout is ranged anywhere from possibly 20 to 40. It's in the range of 30. But that all, of course is contingent on what will play out in the House and the Senate over the next three weeks or so.

We have on page 54 is our estimate of the low and the high in the appendix on the phaseout. But we're hopeful even with, whether the prompt prices down on the averages at 63 we're still hopeful for the legislation, which as Gerry mentioned, takes the issue off the table for 2006 and allows us in essence to double up our hedges for the 2007, puts us in a very good position.

And last question, second to last question, demand response. What kind of demand response are you assuming in terms of sort of a percentage basis, and do you think that this demand response is going to be sort of interactive with fuel prices and actually going to lead to lower fuel prices and just sort of that sort of elasticity function?

Zach, are you asking for gas?

Yes, sir.

Demand response?

You mentioned demand response in your prepared comments.

For the MichCon utility.

I think so, yes.

Yes. It's something we're going to continue to monitor throughout the year. We're anticipating I think it's around like a $5 million net income at this point in time. But once again, we did have a step down with conservation for '05 calendar year. We're anticipating another step down but once again we'll continue to monitor that. We'll update you if conditions change.

And if we were to take 5 million off that income, what does that work out to in sort of percentage demand?

One of the reasons if you look at the page for MichCon, we have a target return of 11%. Actually our guidance is below that. So we've taken that into our guidance at this point in time.

I was less concerned about the financial backing we were more concerned about you're sort of what you're assuming in terms of macro, the macro dynamics in the gas market. You're assuming what reduction in percentage reduction in demand by your customers on a weather normalized basis?

Zach, we have those in the plan. I don't have them here at my fingertips. But I think they're in the range of 5% to 7% demands direction through conservation.

Got it.

Is what's in the plan. Got it. We can get you more precise number when we dig back into that.

Great. And then, last question, on the coke pricing, if I recall, we had a one-year contract on the coke battery and very, very high prices, that rolled off a couple of years ago. We then got that kind of blended and extended out at reasonably high prices for a couple of years. Where are we now on this new contract, how many years is it and how does of the economics of it compare to where we were in '04 and '05 and '03 just so I can monitor that coke battery business line?

Yes. It's a 10-year contract. And the price is stepped down to something that provides a good return on asset but not at the price spike levels that we saw last year. So, the return to step down, that really happened because when we did the contract, people's options were to contract with us or spend a couple years building a new facility.

Right.

We had to price these years with something competitive with a new facility. So we're now earning more normal returns. In terms of the specific earnings out of that individual asset, that would be something we'd have to get you offline, Zach.

Okay, great. Thanks so much for your time and for humoring my questions.

Thank you. This will conclude our question and answer session today. I would like to turn the call back over to Dave Meador for any additional or closing remarks.

I just wanted to thank everybody for joining us again and we look forward to seeing you at our next regularly scheduled event, which is the Morgan Stanley Conference on March 16th. And I hope that you'll join us there and we'll see you face to face. Thank you.

We'll conclude today's conference call, and we'd like to thank you all again for your participation and wish you a great day. [OPERATOR INSTRUCTIONS]