OGE Energy Corp (OGE) 2010 Q3 法說會逐字稿

Good many, my name is Alicia, and I will be your conference operator today. At this time, I would like to welcome everyone to the OGE Energy Corp third 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). Thank you. Mr. Todd Tidwell, you may begin your conference.

Thank you. Good morning, everyone, and welcome to the OGE Energy Corp's third quarter 2010 earnings call. I'm Todd Tidwell, Director of Investor Relations, and with me today, I have Pete Delaney, Chairman, President and CEO, Sean Trauschke, Vice President and CFO of OGE Energy Corp, and several other members of the management team to address any questions that you may have. In terms of the call today we will first hear from Pete, followed by an explanation of third quarter results by Sean, and finally as always we will answer your questions. I would like to remind you that this conference is being webcast, and you may follow along on our website at www.oge.com. In addition to the conference call and accompanying slides will be archived following the call on that same website. Before we begin the presentation, I would like to direct your attention to the safe harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate to date. In addition there is Regulation G reconciliation, for ongoing earnings guidance with projected capital expenditures. I will now turn the call over to Pete Delaney for his opening comments. Pete?

Thank you, Todd. Good morning, everyone. Welcome to our third quarter earnings call. This morning, 'I'll update you on some of the more important initiatives. The outlook on our business, and Sean will review our financial results in more detail. Our third quarter consolidated operating results were $1.65 per share, up from $1.40 compared to the third quarter of last year, with increased earnings at both the utility and midstream businesses. Utility increased primarily to hot summer weather, and regulatory riders associate with various investments at the utility.

Cooling degree days were 19% above normal, and 30% above the cool summer of last year. These gains were tempered by higher operating maintenance expenses. The extreme summer temperatures, strained our electrical system. Particularly generation, and my many thanks to our members who did a great job of managing through those tough conditions. We remained focused on controlling our operating costs, and we have several initiatives focused on controlling costs. One of those as you know is our 20/20 underway now for several years that defers the need for any additional fossil-fuelled capacity for another ten years. Part of that is demand response and distribution automation. As I will discuss later, we have committed to cost savings associated with that deployment.

This leads in to a very topical discussion, in the dpas of ever tightening regulation. Our generation has a low-embedded cost of about $180 per KW. Excluding wind, reflecting the age of our fleet, and the cost of the recent purchases in the last 5 years of about 1000 megawatt for the combined cycle capacity of about $575 dollars per kw, and as a consequence with the older units, our operation of maintenance will tend to be higher. The net associated with a more modern -- especially during periods of extreme conditions. However, we do find great value for our customers and operating and maintaining the reliability of our low-cost fleet. As you know generation planning is a complex issue under normal circumstances, and more so given the environment at regulations scheduled for release by the EPA late next year, and this would only be compounded by CO 2 legislation, which seems to be less of a concern.

In regard to potential retrofits with pollution control equipment, we are looking at all of our operations prior to committing the large capital outlays. In the meantime we will continue to invest in our plants to extend reliable service with an eye on these future outcomes. As always our primary focus will be on our approach that results to lowest risk to our customers. Which should deliver over the long run the lowest cost of power. Several weeks ago we announced a transaction with ArcLIght selling just under 10% of interject around $184 million, and we are excited about the financial flexibility this ongoing funding commitment provides us. We have already begun working with ArcLIght to pursue additional opportunities together, bottom line we look for that partnership to accelerate our growth at Enogex.

Enogex had another solid quarter increasing 33%. As we experienced record processed volumes. Natural gas liquids prices were also higher compared to the third quarter of last year, with the year to date commodity spreads remaining fairly consistent, around $5.24 per btu. Gathering volumes increased 6%, and processing volumes grew 16%, compared to the third quarter of last year. In our updated guidance, we lowered our year-over-year gathering volume to 6%, due to line outage and capacity constraints, not a change in our fundamental outlook for the potential in our region. Concerns of the economy, continue to dominate the needs in the market, and from our perspective here in Oklahoma, the economy does remain stronger than most of the countries. The Oklahoma state and unemployment are 6.3% and 7% respectively as we know, well below the national average. However, like much of the country, state and local governments are under spending pressure as tax revenues have declined. And any state as a sizable structural deficit, going into the next budget cycle.

We do closely track our customer growth which has added around 6,300 customers to the system, and analyze growth rate about 0.8% per year, which isslightly below our historical average of around 1%. Our industrial load increase for the fifth consecutive quarter, industrial sales were up 8% since September of last year. As we have for the last two years, however, we remained cautious regarding the economic outlook, recognizing this state often lags the national economy. In terms of next week's elections in Oklahoma, we do not believe the outcome of the governor's race in which the republican is currently heavy favored will have any impact on the Company. The only Oklahoma corporation up for reelection is Dana Murphy, and she is running unopposed.

Since our last call, we have continued to make progress on our Smart Grid transmission offed with farm initiatives. We have 144,000 smart meters functioning at this time, and still early into our early fair of $57 million system wide roll out. We are on schedule and the technology is functioning in line with expectations. As part of our rate rider, we are committed to re usesing our OEM by $12 million. We expect the program to be fully implemented by the engineer of 2012. The cross road wind firm continues to move forward, and once all of the wind projects are complete, our portfolio will be near 780 megawatts or about 10% of our generation mix. Our transmission program continues to advance with four high voltage projects, either in the rounding or design phase. We did notify the Southwest Power Pool in September. OG&E will construct portions of two priority projects in accordance with their notice to construct.

Turning to regulatory activities we filed for the OU Spirit Wind Farm in August, and hope to secure a rider if approved. In September we fought a general rate case in Arkansas related to infrastructure investment and requested a rate increase of $17.7 million with new rates in effect by the third quarter of 2011. Earlier this month, as well, we filed with FERC for recovery of CWIP for a high voltage transmission project, and have requested an effective date of January 1, 2011.

At Enogex we continue to see opportunities to -- Enogex has begun the construction of a new processing facility, and related gathering lines due to projected volume growth on the system. This new $120 million a day processing facility in Texas is expected to cost about $109 million. This project is expected or plant is expected to be in service by January of 2012. So this project, which the Board just approved this last quarter, combined with our previously announced south Canadian plant will add about $320 million a day of processing capacity to our system, which represents an increase of Inland capacity of 33%. Enogex continues to see ample growth opportunities in the system, and our agreement with ArcLIght will help us take advantage of these opportunities. The Enogex management team is reviewing with ArcLIght investment opportunities to develop a capital expenditure plan to develop the business. We are very pleased with our new equity partner, and excited about the future of the Enogex business.

Today we're increasing our 2010 ongoing earnings guidance from $2.95 to $3.05per share. The increase of guidance is primarily driven by higher earnings expectations at Enogex as we realize higher than projected commodity pricing. We continue to hit our milestones on key business initiatives in both positions which will position us to sustain our earnings growth. Much work remains as our management team -- compliance and cost-management, but due to new challenges and opportunities associated with the Smart Grid deployment. There are ample opportunities in both of our businesses. And now Sean, is here to discuss our results. Sean?

Thank you, Pete. For the third quarter, our net income was $163.1 million, or $1.65 per average diluted share, as compared to net income of $136.8 million, or $1.40 per average diluted share in 2009, or an 18% increase in quarterly earnings. The contribution by business on the compare to basis is listed on the slide.

At OG&E net income for the quarter was $142.1 million, or $1.43 per share, as compared to net income of $123.2 million, or $1.26 per share in 2009. Some of the primary factors are as follows. Gross margin increased nearly $70 million or 20% and I'll touch on gross margin on the next slide. Operation and maintenance expense increased. Of that $7.8 million of the variance was from new riders. There are two primary drivers for the increased OEM in 2010. First the hot summer put a great illed stress on generation system, and in particular as we began work on some of our units, we found more repair work needed to be done than expected. We're taking this information and incorporating this in to our outage plans for the remainder of the year. Second, our post-retirement medical costs continued to escalate, and they expected to run about $8 million higher than our previous estimates.

We are working on various solutions and regulatory options regarding these issues, which I'll discuss later. Depreciation and amortization expense increase $5.8 million, primarily due to additional assets being placed in to service, including the OU Spirit Wind Farm and Wind state transmission line. Net income was lower by $9.1 million primarily due to lower margin associated with the guaranteed flat bill program of $4.8 million as a result of our warm summer weather, and lower amounts of equity of $4.8 million.

Finally, interest expense increased $4.6 million, in part due to the issuance of $250 million of long-term debt at the utility in June of 2010. Now turning to gross margin. You can see the drivers on this slide for the $69.6 million increase in gross margin at the utility for the third quarter compared to 2009. The biggest driver for the increase was weather. Cooling degree days were 30% higher than last year, and 19% above normal. Quarter-over-quarter, favorable weather added $33.3 million of gross margin. However, the net weather impact was $28.5 million, because revenue from the guarantee flat bill program was $4.8 million lower. Compared to normal weather, gross margin was positively impacted by approximately $22 million. Year to date, favorable weather has increased gross margin by approximately $32.3 million compared to normal, and $46.7 million compared to 2009.

Various riders including the wind speed rider, and the OU spirit rider, increased by $25.1 million, and the Oklahoma rate increase implemented in August of 2009 added $5.2 million of gross margin. Higher demand fees for non residential residents grew by $4.5 million, and new customer growth added $2.9 million. System megawatt sales were up 12.4% for the quarter, industrial sales were up 8.1%, and our overall customer growth rate year to date was 0.8% with the majority occurring this the residence shall sector. For the year weather normalized megawatt hour sales are up 0.7% compared to 2009.

I did want to briefly discuss our current regulatory activities. In Arkansas we have two filings under review. First is the application to recover the Arkansas portion of the OU Spirit Wind Farm and the 280 megawatts of -- the OUspirit recovery regulates to roughly $2.6 million of margin in 2011, and the PPAs would recover our cost. No procedural schedule has been established in this manner to date. The second item in Arkansas is the general rate case we filed in September to recover infrastructure investments made since 2008. We are requesting $17.7 million on 53% equity with an ROE of 11.25% on a rate base of 444 million.

Also as part of the Arkansas rate filing, We are asking two other items. First, an SPP cost tracker. This would recover the actual costs allocated to OG&E by the SPP for transmission by others. Second in Arkansas we do not have a tracker for pension costs nor forced retirement expenses, and we're addressing both of these in the current filing. The tracker would defer costs to the extent actual expenses vary from what is in base rates. The intent is to reduce volatility in rates to our customers. A hearing has been scheduled for May of 2011, and we would anticipate new rates in effect by the third quarter of 2011.

Moving on to Oklahoma, we have several rating requesting a tracker for post requirement medical costs, similar to the existing pension rider we have. We have filed for an SPP cost tracker to recover the Oklahoma allocation of SPP costs, and we're asking for a regulatory asset effective January 1st until the tracker is established. Moving on to FERC, we are asking 100% CWIP recovery for certain 345 KV projects. These are primarily the SPP projects we have discussed at length before. In addition, we're are requesting if a project is canceled or abandoned, we can receive 100% recovery for prudently incurred costs, and we are requesting new tariffs in place by January 1st, 2011, we view as this as prudent thing to do for both our customers and our shareholders. We'll keep you posted on timeliness, and outcomes as they become known.

Now turning to Enogex, net income for the quarter was $24.2 million or$0.24 per share, as compared to net income of $18.1 million or $0.18 per share in 2009. The largest variance was gross margin which increased by $10 million or 11%, which I'll discuss in a moment. The other primary drivers were operation of maintenance expenses which increased $4.2 million, in part due to the pipeline integrity work we mentioned last quarter. Interest expense was $5 million lower, primarily due to the Enogex refinancing we did in 2009. Looking at gross margin, the vast majority of the increase in gross margin came from the gathering and processing businesses. Volumes increased 6% and 16% respectively. And realized commodity spreads increased from $3.73 per MMbtu in 2009 to $5.28 per MMBtu in 2010. Natural gas liquids prices also saw a significant increase from $0.74 cents in 2009 to $0.92 per gallon in 2010. We established many new records in the quarter.

For the second consecutive quarter Enogex had record-gathering volumes, which were 123 million MMBtu the processing business had record volumes for the third consecutive quarter which was 79 million Debut's. In addition we established a third quarter record for common stake sales of 4.4 million gallons as well as natural gas liquids production of 58.7 million gallons in September. We continue to make progress on increasing our fixed-fee contracts, and at the of the third quarter, 28% of inlet volumes were under fixed-fee arrangements. This compares with 20% at the end of the third quarter in 2009. So not only are volumes increasing. But we are also increasing our fixed-fee percentage.

Finally, transportation gross margins were slightly lower, associated with the MSP and gulf crossing pipeline was out for maintenance. For a more detailed explanation for these financial results, I would refer you to the Company's third quarter 10-Q filed with the SEC this morning. Before turning to your questions, I would like to address some of the changes we have made to our 2010 guidance. We're now projecting ongoing earnings for 2010 will be between $2.95 and $3.05 per share, an increase from our previous guidance at the upper end of $2.70 to $2.95 range. At the utility we are maintaining our guidance of $2.10 to $2.20 per share, but now are projecting earnings at the upper end of the range. We benefited from favorable weather thus far in 2010, but expect an increase in operating expenses primarily resulting from the higher maintenance at some of our power plants and higher post-requirement benefits as well as the increase in our effective tax rate mentioned last quarter, so offset most of the weather benefit.

As a result of the announced transaction with ArcLIght, the marketing business will be contributed to Enogex. At year end the marketing business will be part of Enogex's results, so we need to adjust the geography of our guidance. At Enogex, we are now projecting ongoing earnings for 2010 will be between $0.85 and $0.95 per share, an increase from our previous guidance at the upper end of the 64 to $0.86range. This is largely by higher margins for the processing business which is primarily the result of projector commodity prices and NGL recoveries outpacing our previous expectations, also included is the projected loss for the marketing business which remains unchanged at $0.07 to $0.09 per share.

The revised guidance for Enogex also includes $2.5 million of pre-tax income for our equity partner. In addition, we have revised downward our volume growth to 6% from the previous midpoint of 9%, due to system constraints as a result of line maintenance. The projected loss at the holding company is $0.04 per share, down from $0.11 to $0.13 per share as a result of moving the marketing business to Enogex. This concludes our prepared remarks, and we'll be glad to open it up for your questions.

(Operator instructions). We'll pause for just a moment to compile the Q&A roster. And our first question comes from the line of Anthony Craddal. Your line is open.

Good morning. Thank you. Good morning. Just a question I think you mentioned the south Canadian processing facility that goes on line, I guess in mid-2012, and another increase in processing facility, are those fully contracted, or, like, how long does a contract last? Or it is immersion facility, and you are out there looking for volumes?

Yeah this is Keith Mitchell. We have dedications from producers in their drilling, and we see the volume growth increasing, and we're going to need that capacity at that time that those come on.

Is dedication the same as a contract that somebody takes -- say, a PPA or something out of an electric power plant? It is similar or dedication is something different?

No, it's a situation where they have certain acreage that they have contracted, they have leased up, and so they have plans to drill that, and what it is is in our agreements, when they drill that, that volume will come to us. We have the contract where that volume will come to us upon drilling.

Okay. Thank you.

Our next question comes from the line of Garland Buchanan. Your line is open.

Thank you for taking the call. Regarding ArcLIght can you talk about where this relationship ends up? Like, what is the game plan there? And also the growth opportunities that you see in and then lastly, on south Canadian to follow-up on the last question, is it possible that the producers could not drill out that acreage?

Let me -- this is Pete Delaney. Let me reverse order. Keith you want to talk about the producers and the risks associated with the south Canadian.

Sure. You know, first of all these are -- these areas that the volumes are coming from is The Granite Wash areas, as well as the Canadian Woodford area. They are very economic to drill even at low-commodity prices, so we really looked at what the different drilling plans are, the various producers, and there are multiple producers. We see an opportunity for volumes, exceeding the capacity that we will building, and so we feel like this is the appropriate amount of capacity to build given what we see activity in the area.

Just to be clear then, there is potential risk there on this CapEx, if for some reason the drilling doesn't take place?

The drilling would have to drop off fairly significantly for us to really have too much CapEx here.

Okay.

I think we have looked at that, assessed that risk, and we think it would really have to drop off quite significantly.

Okay.

The other parts to your question. ArcLIght, we are expecting close on Monday, so we're very excited about that, and, you know, the transaction structure really focussed on continuing growth on Enogex. You know, off -- you know, in the mid-continent. We'll talk about that for a minute. We see a lot of potential opportunities for continued expansion. Keith just talked about the additional -- well, I mentioned and talked about south Canadian, but the Fort Elliott plant that we added on the far Western part of our system, again, when looking at the economics, and using consultant numbers, not our numbers, but -- and what the producers tell us that this is probably their best return plays that they have in their portfolio. We have seen analysis of natural gas prices below $3 and still being able to provide a return to the producers that keep them actively engaged because of the wet nature of this gas, and the -- you know, correlation with oil prices, and getting very good returns. So we see other basins, of course, of growth not being as long, and again, we believe that fundamentally, that the demand for natural gas going forward is pretty good, it's particularly looking at the power generation side, so our -- we see a lot of opportunities. You know, we -- our policy has been that we put in our capital expenditure plans known and committed projects, but -- at all times, we have a -- I would say pretty robust backlog. Backlog may not be the right word, but a lot of projects we're working on, and at this point in time, we see that as -- as strong as ever, and so we're very excited about that, and of course, the ArcLIght plays in to that, again, we hope they are able to increase their ownership. The only way that really happens is that we need new equity capital, and they are working hard and we are already meeting with them, looking for opportunities, and I was really talking more about in the mid-continent, but, of course, we see there's opportunities with them to expand our presence outside of the mid-continent and we're already talking about those, so we're very excited about those.

Can you talk about ultimately what that exit strategy would be for this investment?

Our exit strategy. Well, I can't talk for ArcLIght, I just know from telestructuring of it, it's a long-term transaction, and basically we preserve all of the options we have today. Given -- our anticipation is that it will grow -- you know, we'll grow the company dramatically, and have all of the opportunities, do an MLP at some point in the future, and we're going to look at see what the best thing is for shareholders at that time.

Okay. Thank you.

(Operator instructions). Our next question comes from the line of Greg Reese. Your line is open.

Hi, guys. Quick question, could you elaborate a little bit more on this new Enogex processing facility you have in your guidance, and also talk about -- how it's going to be funded?

Yes, Keith, you want to cover that?

Sure. You know, we have a pretty extensive processing header, where we gat ear lot of gas to process in Western Oklahoma as well -- it extends in to the Texas panhandle. And in addition to south Canadian, we have now sited a plant site in wheeler County. There's a lot of development out there in the Granite Wash, a lot of producers that are producing that area, '5 we felt like the right spot to put that was in Wheeler County, Texas. It is a 120 million a day processing skid that we had in our inventory that we'll be installing, and that will go online in early 2012.

And is this going to be primarily funding with equity contributions from Enogex -- from ArcLIght.

This is Sean, that's primarily going to be funded actually out of working capital and cash on hand at Enogex, and to the extent that equity would be required, you know, that would be drawn on by OG&E and ArcLIght. We had some of the materials already procured in previous years, so as Keith said this will come on late in 2011, early 2012, and we're very comfortable with the funding plan.

And in terms of any potential equity contribution, would it be 50/50, or would you guys let ArcLIght take over the majority?

I think we're going to look at those on a case-by-case basis, and that's part of the beauty of this agreement, that gives us the flexibility to decide what our position is, and how we're going to participate, but, again, our preference is, really, to continue to invest in the business with ArcLIght, and to the extent that we can do that and maintain our credit metrics, we're going to continue to do so.

Our next question comes from the line of Rudy Tolentino. Your line is open.

Hi, are regard to the processing facilities, can you give us an idea of what type of contracting facilities you are pursuing? Are you also -- you know, taking on frac spread risk -- you know, frac spread exposure as well.

Yeah, this is Keith. Obviously we have made a tremendous amount of shift towards fixed fee, and you'll see that as we have continued to grow the percentage of our portfolio in fixed fee. Obviously that is our preference, so these agreements are fixed fee, as well as some percent of liquids agreements that we have had. A lot of this has been dedicated under previous agreements. But as you look at our volume forecast, and then the change in the portfolio as we go forward, we continue to see an increase in fixed-fee percentage.

Okay. As far as like the additional contracts, can you give an idea of what percentage incrementally is 60 versus -- you know, a percent of liquids, you know, roughly?

Well, I think if we look at our portfolio, for 2010 by the end of the year we're looking at a 30% fixed-fee percentage of our portfolio, which is up, you know, from previous years, and we certainly see that trend continuing.

Okay. I guess you will -- I guess -- you know, we'll chat about it more at EEI next week.

Okay.

Thank you.

Thanks, Rudy.

Our final question comes from the line of Brian Russo. Your line is open.

Hey, good morning.

Good morning.

Good morning.

Just curious, you know, in terms of the utility projected capital expenditures, are there any projects being considered outside of what you have outlined on 13? Or is this pretty much with cross roads and the two transmission projects, this pretty much a good outlook for the utility CapEx through 2015?

That's a good outlook of where we are today, Brian. This is Sean. And, you know, we're -- you know, as you know the SPP is continuing to several it with additional projects, and we would be very interested in pursuing more projects there. You know, as we look at the generation portfolio at OG&E, as we mentioned before, we aren't necessarily -- we were always open to additional renewable opportunities, and that cross roads opportunity presented itself, and it was very attractive to our customers, so we pursued that, so right now that plan we have laid out is -- we're good with that, but, again, you know, if the SPP were to award some more projects, as we said before, we like that business, and we will certainly go after that. I think the other big wild card out there is -- environmental, and we'll see where that ends up, but obviously, if environmental legislation -- regulations came out, we would have to deal with that.

Okay. And just on the renewable side, is there any more appetite for wind in Oklahoma? I know Oklahoma doesn't have an RPS standard. So I'm just wondering how much of your -- you know, generation or sales are derived from, you know, the wind projects under development, and how that might compare maybe to a Federal RPS.

I think we actually have a goal in Oklahoma of 15%, and when we complete cross roads, and the other PPAs come on line, we'll have about 10% of our generation portfolio with wind, and so there is a goal. It's not a -- it's not a standard or anything like that, so there is certainly appetite, Oklahoma does have a lot of wind resources available, and, again, I think we're going to look at that in terms of what is good for our customers.

Okay. And could you give us a sense of the -- -- your earned ROE in Arkansas that's embedded in your 2010 guidance?

Yeah, I -- think -- Brian, I think we're probably earning close to 5% there in Arkansas. About half of what we're allowed.

Okay. And maybe you could just comment a little bit on -- or elaborate on some comments earlier, it seems as if, or I have been hearing that a lot of the gas drillers are targeting liquids-rich areas, and I'm just wondering if you had any thoughts on how that might impact future NGO pricing, along with how that might impact the future volume growth and processing and gathering volumes.

Yeah, this is Keith, you know, certainly if you look at the NGL pricing as a percent of crude, it has been continuing to go down as a percent of crude, but crude stays strong, and if you look at the petro chemical market, a lot of these folks have switched to the lighter ends, so we have seen good demand response on NGLs, so certainly as the drilling continues, and more NGLs are produced, I think what we cease anyway is that petrochemicals are liking the light engineers, and that they are picking those up.

And just what looks like incremental growth and hence in 2010 and possibly 2011 and 2012. Could you comment on your 5% to 7% CAGR.

That's a long-term growth rate as we said before. That's not just a one, to two-year outlook. We have very clear line of sight to much longer I don't think that. You are exactly right with the two projects Keith has mentioned coming own line late 2011 and 2012, obviously that's helpful for Enogex in the future. You are looking at the same numbers I'm looking at with a lot of the utility transmission lines coming in. So some years it's going to be high -- you know, on the high end of that, some years it is going to be on the low end of that. We're going to put out our 2011 guidance early in February at the year-end call, but we feel very good about the long-term growth rate, and, you know, as we have talked before, some years it will be a lot higher, and some years it will be lower, but we feel pretty good about the long-term prospects.

Okay. Thank you very much.

Thanks, Brian.

We have no further questions at this time. I turn the call back over to the presenters.

Thank you, operator, and I want to thank everybody for dialling in this morning.