OGE Energy Corp (OGE) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2011 OGE Energy earnings conference call. My name is Kesha, and I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct the question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Todd Tidwell, Director of Investor Relations. Please proceed, sir.

Thank you, Kesha. Good morning,everyone, andwelcome to OGE Energy Corp's second quarter 2011 earnings call. I'm Todd Tidwell, Director of Investor Relations, and with me today I have Pete Delaney, Chairman and CEO of OGE Energy Corp.;Sean Trauschke, Vice President and CFO of OGE; 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 second results, and an overview of the Oklahoma rate filing from Sean, andand finally as always we will answer your questions.

I would like to remind you that this conference is being webcast, and you can follow along on our website at oge.com. In addition, the conference call andaccompanying 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 today.

I will now turn the call over to Pete Delaney for his opening comments. Pete?

Thank you, Todd. Good morning, everyone, and welcome to our call.

This quarter's financial performance was driven by extraordinary hot summer weather, and to a lesser extent, increased NGL pricing. As of this call we have experienced 40 days of daytime highs in Oklahoma City since June 14 over 100 degrees. Normally, we would have about 10 days per year over 100 degrees, so this summer is really shaping up to be one of the hottest on record here in Oklahoma. Enogex's is on plan to meet their financial target, helped again by higher NGL prices over the prior year.

Operationally we are make good progress on key initiatives in both businesses. As you may recall, this is a major build year for us, with a record $1.4 billion capital budget.

The second quarter we reported earnings of $1.04 per share, compared to $0.78 in the second quarter of 2010. Utility gross margins were higher primarily for the quarter due to the hot weather I mentioned, regulatory riders associated with preapproved utility investments, and new customer growth. This higher gross margin was partially offset by higher operating expenses.

We established some new all time peak demand. The last couple of days that peak demand has been about 7,000 megawatts. This is an unprecedented 400 megawatt increase in our peak demand over last year's record peak. We believe, obviously, this huge increase in the peak is driven by the weather as opposed to growth, but our planners will be analyzing that data. As in all extreme weather conditions, our infrastructure system and members are seriously challenged, but I'm pleased to report that operations have been able to meet the demand of our service area with minimum disruption. You may recall from our prior quarterly call, we increased our spend last year as part of a mechanical integrity plan. Those investments have clearly paid off so far in the performance of our power plants in meeting record demand.

The recovery of the infrastructure investments is a key component of our regulatory filing made with the Oklahoma Corporation Commission. Since our last rate case, we've invested approximately $500 million in our utility to maintain a high level reliable electric service, which resulted in a $285 million increase in rate base for which we are not currently earning a return. We have requested a base rate increase of $73 million. Sean will get into the details later.

And in the past, Howard Motley, our Vice President of Regulatory Affairs, the one who unexpectedly passed away several weeks ago, would be reviewing our plans. I would like to recognize his contribution, particularly to the regulatory success of this Company.

I did want to update you on some of our initiatives at the utility associated with the largest investment program in our Company's history [at] $1.4 billion. Of that amount, approximately $1 billion is slated for the utility. So far major projects are on track to be completed and operating in either 2011 or 2012 as planned. Transmission investment this year is over $250 million, and these projects are progressing in various stages of planning and design. The 228 megawatt Crossroads Wind Farm is moving forward. A majority of the turbines are expected to be in service by the end of this year. The smart grid rollout is on scheduled, with over 350,000 smart meters now in place.

On the regulatory front, the Arkansas rate case was held in June, with new base rate increase of $8.8 million implemented that same month. We received, I think yesterday, an order approving the settlement reached in our smart grid filing in Arkansas, which will allow us to complete our deployment system-wide.

On the Regional Haze front, aside from filing comments with the EPA in May stating our recommendation of the approval of our state plan as opposed to the federal plan, not much has changed, with the final rule not expected until November. We are evaluating the impact of the Cross-State Air Pollution Rule, whichnow proposes that six additional states, including Oklahoma, be subject to Ozone Season NOX regulation. We continue to work through the best possible solutions to comply not only with Regional Haze, but MAC and any other expected environmental regulation.

The economic front, Oklahoma City and the state continue to perform better than the nation. Our unemployment rate in the metro area is about 5.7%, the lowest -- or one of the lowest in the nation for large metro areas, and the state unemployment is about 5.3. We continue to add customers, 7,000 to the system compare the second quarter of 2010. And industrial and oil field sales continue to do well, driven primarily by the robust energy sector.

Turning to Enogex, the midstream business performed well in the second quarter. Gross margins were up in all segments. Our gathering volume increase of 2% over the prior year does not yet fully reflect our growth potential, as weare still in the early stages of some recently contracted growth areas. We are still are holding to our projections of year-over-year gathering volumes increases of 5% to 7%. Processing volumes were down 8% compared to last year due to the Cox City planned outage, but gross margin was about $11 million higher due to NGL pricing that was 44% higher. Natural gas liquid prices averaged $1.24 per gallon compared to $0.86 last year. Ethane prices were a main driver, as it's become replacement feedstock for North American crack who are due to higher price naphtha.

We expect the Cox City plant back on line the third quarter of this year. And though volume growth for the quarter was below guidance for the year, we still expect to meet our volume growth targets.

Our two new processing plants are on plan to be operational in 2012 to handle our increasing market share of new gathering and processing volumes in the Midcontinent. We continue on our path of moving the processing portfolio's composition towards fixed fee arrangements to reduce volatility in our cash flows. Of course, at these record NGL pricing levels there would be a short term trade off of margin to establish longer term sustainable growth positions. We talked about before, we continue to negotiate the extension of a major contract as part of a fixed fee conversion. Our focus remains on building long term value for our shareholders.

We continue to work multiple new gathering of processing opportunities for Enogex in our footprint. The Board recently approved more than $300 million of capital expenditures associated with acreage dedications. For the first time in many years that I can remember, we have a full plate of projects already identified for 2012 by the summer of the prior year, reflecting the type of growth we have in our areas. As the result of recent wins, we have now about $800 million of growth capital projects at Enogex through 2013.

As part of our planned $1.4 billion total capital investment program, we're focusing on executing our capital projects -- the processing plants, the transmission lines, wind farms, smart grid deployment -- as well as managing our costs, meeting customer expectations and processing our rate case.

We are pleased -- very pleased to be awarded the JD Power award for highest residential customer satisfaction rating in the Southeast region. This reflects improvements in our reliability, our customer response, interaction with field members, et cetera. The point being, it takes many people in our organization to create that experience, and my thanks to many of our members whose are working hard to execute on many projects as well as our day-to-day operations.

Closing the rate case filed last month, the Crossroads Wind Farm, the transmission lines, and the new acreage dedications and processing plant expansions set the stage for 2012. Although the weather cannot be expected to be as favorable next year, we are more importantly focused on continuing to hit our milestones on key business initiatives that position us to meet our long term 5% to 7% earnings growth targets.

Now I would you like to turn the call over to Sean to review our financial performance in more detail.

Thanks, Pete, and good morning.

For the second quarter our net income was $103 million, or $1.04 per average diluted share, as compared to net income of $77.3 million or $0.78 per share for the second quarter of 2010. The contribution by business unit on a comparative basis is listed on the slide.

Turning to OGE, net income for the second quarter was $78.6 million, or $0.79 per share, as compared to net income of $60 million or $0.61 per share in 2010. Gross margin increased $32-point million -- $32.4 million, or nearly 12%, and I will touch on gross margin on the next slide.

Some of the other drivers are as follows. Operation and maintenance expense increased by $9 million, of which $2.5 million was associated with riders that have revenue offsets. And theremaining drivers include higher employee costs, including overtime costs related to the April storms. These higher O&M costs were partially offset by post-retirement benefit experiences due to the retiree medical [claim] modification we discussed earlier this year.

Depreciation amortization expense increased $1.5 million, primarily due to additional assets being placed in the service. Taxes other than income increased $1.6 million, primarily as a result of higher [adval] on taxes.

Net other income increased by $3.6 million, primarily due to an increase in equity AFUDC attributed to construction costs associated with the Crossroads Wind Farm. And, finally, interest expense increased $2.1 million, primarily due to an increase in interest on long term debt that was issued last summer and in May of this year.

Turning to gross margin, the increase of $32.4 million compared to the same period in 2010. The main driver for the higher gross margin was the weather. It's been extremely hot so far this summer, and cooling degree days were 20% higher than last year and 62% above normal. The average daily temperature in June was 84.2 degrees, which was 8.3 degrees higher than average. Hot weather increased gross margins $18.1 million compared to last year, and $24.1 million compared to normal for the second quarter. Various riders increased the gross margin by $5.6 million, in addition to higher transmission revenues of $4 million, as we begin to include CWIP and transmission rates instead of booking AFUDC.

Finally, new customer growth and other items increased gross margins by $4.7 million. Customer growth continued just below 1% compared to 2010, as nearly 7,000 new customers were added to the system. Kilowatt-hour sales growth increased 5.9%, primarily due to the weather, and on a weather normalized basis sales increased 1%.

Now turning to Enogex. OGE's share of net income for the quarter $25 million, or $0.25 per share, as compared to net income of $18.6 million or $0.19 per share in 2010. Gross margin increased by $15 million, and I will discuss those drivers in a moment.

Some of the other drivers are as follows. Operation and maintenance experience increased by $3.3 million in 2011, primarily due to higher employee and contractor costs. Net other income increased $3.7 million due to the sale of the Harrah processing plant and associated gathering assets in the second quarter of 2011. Interest expense was $1.7 million lower compared to 2010, in part due to lower debt levels. And, finally, ArcLight's 13% ownership reduced pretax earnings by approximately $5.8 million.

Looking at gross margin, it increased $15 million in the second quarter of 2011 compared to 2010. Higher natural gas liquids prices was the main driver, as processing gross margins increased by $10.6 million. Average natural gas liquids prices increased 44% quarter over quarter, from $0.86 per gallon to $1.24 per gallon. Also adding to the higher processing margins were higher condensate volumes and prices, which increased gross margins by $3.9 million.

Partially offsetting the higher processing gross margins were processing volumes due to the outage of the Cox City plant, which is expected to be back on line in the third quarter. Gathering volumes continued to increase, as the quarter over quarter growth was 2%, and June set a record for all time gathering volumes.

For a more detailed explanation of the earnings drivers for OGE, I would refer you to the Company's second quarter 10-Q filed with the SEC this morning. In addition, I would refer you to the appendix of this presentation, which we have provided you a updated CapEx table. As Pete mentioned in his remarks, we have increased our CapEx outlook for Enogex, and we are excited for the many opportunities we have there.

Before moving on to the Oklahoma rate filing, I would like to update you on where we are regarding regulatory initiatives. At the utility, with the exception of the Oklahoma rate case, all of our 2011 regulatory initiatives are complete or awaiting commission approval. Just yesterday we received the order in Arkansas approving the smart grid rollout, and we have worked very hard to execute our plan of building the necessary infrastructure and make key investments in renewables and transmission to serve our customers and shareholders alike. We are looking forward to our opportunities in the future for the utility and are pleased with our progress as we reflect on a multi-year utility growth plan.

Now turning to the Oklahoma rate filing. As you know, we filed our rate case last week and are requesting $73.3 million increase in base rates. The key components are an 11% ROE on 53% equity. Since our last filing, rate base has increased approximately $565 million, with nearly $280 million of the increase in base -- rate bases covered in the form of riders. The riders have helped to mitigate rate changes for customers. The remaining $285 million is the rate base addition we are requesting in the case.

The other half of the rate request is for operating expenses. As we have mentioned several in the past, one of the main drivers is the maintenance of our power plants. We feel that this provides good value for our customers, and they are certainly benefiting from that during this record heat.

Even with the proposed rate increase, our rates will still remain below the natural average, and we are working hard as a management team to keep them that way. And finally, as always, ROE will be a major component of the case, and is sensitivity of ROE is every 10 basis point change, revenues will change approximately $3 million and net income of approximately $2 million. We expect the new rates to be in place after the first of the year.

Before we answer your questions, I would like to address our 2011 outlook. It has been a very hot summer, and earnings year to date has been positively impacted $0.22 per share from the weather. We saw record heat in July, and the record heat has continued thus far in August, so it is difficult for us to tell you just how much the weather will drive earnings, especially in the third quarter, which is our largest from an earnings perspective.

At the end of the third quarter we will provide you with updated earnings guidance range. We do know that, given where we are at the end of June, we expect to exceed the top end of our previously issued earnings guidance at $3 to $3.20 per share, assuming no other changes from our previous assumptions.

This concludes our prepared remarks. Now we will open it up for questions.

(Operator Instructions). Your first question comes from the line of Brian Russo with Ladenburg Thalmann. Please proceed.

Hi, good morning.

Good morning, Brian.

It's nice to see the Enogex CapEx starting to trend significantly higher, and I'm just curious if maybe you could talk in more detail on any specification projects and, I don't know, maybe the type of returns you expect. And then how does ArcLight's current 13% ownership play into the incremental CapEx spent?

Hey, Brian, it's Pete. I'm going to turn the first part of the call over to Keith Mitchell, Enogex's Chief Operating Officer. And I think Sean will want to address the ArcLight ownership percentage.

Yes, we've been working hard, and we have been able to expand our systems. There's been a lot of activity in our area with the Cana Woodford primarily, as well as the Granite Wash, and so we have been continuing to get additional acreages dedication as well as [keep] line of site to a lot of extra growth, even where we have acreage dedications. So we do anticipate arc CapEx to be continuing to grow.

Are these gathering and processing projects? What type of projects and type of contracts are we looking at?

Yes, it's gathering project, with compression. A lot of compression, gathering lines, and then that feeds into our processing headers. And as you know, we are expanding our processing capacity, so the processing plant expansions that we are doing will also support that.

The processing agreements, though, are not keep holds. These are fixed free or POP, I believe, Keith?

That's correct. It's fix fee or POP.

And Brian, this is Sean. Regarding the contributions from ArcLight to fund this CapEx, we haven't specified the exact funding percentage or contributions. And the way it's going to work, though, is we are going to analyze the timing of those cash flows, and we will certainly exhaust the cash on hand at Enogex first. And then to the extent that additional capital is required from OGE and ArcLight, OGE will decide between 10% and 50% of the needed contribution how much we will fund, and then ArcLight will fund the rest. We will certainly provide you all of that clarity when we release 2012 guidance. But right what we want to do is we have committed to these projects. We are going to begin building those projects, and we will certainly lay out the funding plan and the contribution schedule once we finalize that at the end of the year.

Is it safe to assume that you won't need any OGE external equity to fund this?

Well, I think at the present time, I think I would argue that the -- using ArcLight as a funding source for equity is cheaper than OGE common stock, and so we are looking at it in terms of what's the cheapest source of equity for us. But at the same time, we are also focused on making sure that we continue to create shareholder value and grow our earnings. So right now we plan to use that funding vehicle through ArcLight.

Okay, great. And you mentioned 5% to 7%, I think gathering volume growth, year over year? I would imagine that that's likely to accelerate next year and beyond with the committed projects?

Brian, this is Sean. Yes, we haven't provided any future guidance around assumptions around gathering or processing volumes. Needless to say, gathering volumes are up 2% year to date over what was considered a pretty big year last year, and we are still expecting five to seven, so we are anticipated a big increase for the back half of this year. And so we will certainly provide our 2012 update around volumes and all of our other assumptions.

Okay, and what type of NGL pricing are you seeing for the remainder of the year?

For the remainder of the year, we are seeing close to $1. And that assumes that ethane is in recovery.

Okay, and then just switching gears to the utility. Can you just give us more detail as to where we are with the EPA and the FIP? Has the Attorney General filed a lawsuit, and is there any timing on when a judge might issue a stay to kind of stop the clock.

We are having -- really hasn't been -- we are not -- there is no time line I think on the suit files by the Attorney General. And, again, with that rule pushed back to November and everything else going on with the EPA, there is nothing really that has happened. We filed our comments on Regional Haze. We are continuing to do the work we need to do to really figure out how our path will move forward to address all these regulations.

And as I mentioned in my comments, we've got the new transport rule, across state rule. We are meeting with the state today, I think it is, really to try to determine the impact of that. If Oklahoma is included and -- so there's a lot of uncertainty yet, although the implications are clear for the state of Oklahoma should that proposed rule move forward. But so really nothing really new to report.

Okay.

From our standpoint.

All right, and then just to clarify on the guidance. On the utility side, the guidance -- or exceeding the high end of the utility guidance is based on year to date as of June 30 weather, so anything in July and in the third quarter would be incremental to you guys already exceeding the high end?

Yes. Brian, this is Sean. Yes, that's correct. We have picked up $0.22 of additional earnings from the weather year to date. We are on plan. All of our assumptions are still valid for the utility, we've just picked up this weather benefit. And as Pete and I remarked, July was a continuation of what we saw in the second quarter, and even this week in August, the first week in August, it's been incredibly hot as well. So your assessment there that this would be incremental is correct.

Do you guys have summer rates so that the hot weather in 3Q has kind of a bigger margin benefit than hot weather in 2Q?

Yes, I think it's -- I think the way I would say that is we have summer rates that -- it impacts the summer more than it does other seasons.

Okay, and then lastly on Enogex, remind us what the original NGL assumption in your original guidance was?

It was $0.90 a gallon.

Okay, thanks a lot, guys.

Thanks, Brian.

(Operator Instructions). Your next question comes from the line of Anthony Crowdell with Jefferies. Please proceed.

Good morning. Just a quick follow-up on Brian with the EPA rules. I just want to verify, you have two coal plants, I guess, Sooner and Muskogee. Are both of them scrubbed or unscrubbed? What type of environmental controls do you have on them?

Sooner and Muskogee are unscrubbed?

Do you have -- have you used trona or anything on those plants, or there's no real emission controls on them, other than maybe crossfired boiler controls?

No. I mean, we are continuing to look at what we can do to comply, buthistorically they have been unscrubbed, and we burn low sulfur coal. We have been well within -- been able to meet our emissions targets. One thing we have done is continue to track that and reduce our output from those units to make sure we comply. As you know, we -- besides the Regional Haze, the EPA is looking at the plants for new source review. We got MACed, and so as you know Anthony, there's no doubt that there will be actions we are going to take with regard to those coal plants in terms of having to invest in them or take other action to comply with the pending rules.

Is there any reason to think that any environmental controls you would now put on would not be included in rate base? It seems obvious that the regulators would have to be supported of it. Is there anything I'm missing as to why that would not be the case?

Well, never say never, right?

Right.

But we have House Bill 1910. Trying to remember what year we passed that. 2007. [Am I correct?] 2005. That's even longer. And that talks about the need to invest dollars associated to meet federal and state environmental regulations and gives a level of support for recovery from the regulators in that instance.

So we -- this issue is well understood. The commission is very much engaged. We have a state implementation plan thatcalls -- gives us flexibility in regards to our coal plants. The commission is onboard, I believe, with that plan, thestate implementation plan, and favors that as well. Federal implementation plans, again, something that we would be forced to do and to comply with federal law. And, generally, regulatory process should allow you to cover those costs.

So -- I just want to make sure -- I guess your utility forecasted CapEx does not include any type of emission controls on these two plants. That would be incremental to what you already announced.

That's correct.

Great. And the last question is on Enogex. I'm not sure how much this impacts you guys. On one of the calls yesterday -- there's a pipeline being built right now I guess between Conway and Mount Belvieu, and I guess the intent there is maybe to lessen that differential that is currently going on there. How will that impact Enogex, or do you not even think the differential changes with the Sand Hills Pipeline -- or Southern Hills Pipeline?

This is Keith. There's certainly has been additional production come on in the Bakken up in the Dakotas as well as the Rockies and in Midcontinent, so that has created the need for additional capacity from Conway, Kansas, down to Belvieu. So we view this as a good thing. Those pipes -- people in those businesses continue to expand their capacity so that they can get down to the petrochemical markets on the Gulf Coast.

Great, thanks for your time, guys.

Thank you.

There are no further questions in queue at this time. I would now like to hand the conference back over to Pete for any closing remarks.

Thank you, operator. I want to thank you again for joining our call. Thank you for your continued interest in OGE Energy, and have a great day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect your lines. Good day.