歐尼克 (OKE) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your ONEOK fourth-quarter 2006 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Dan Harrison.

Good morning and welcome, everyone. As we begin this morning's conference call, I remind you that any statements that might include ONEOK or ONEOK Partners' expectations or predictions should be considered forward-looking statements, which are covered by the Safe Harbor provision of the Securities Act of 1933 and 1934. It's important to note that actual results could differ materially from those projected in such forward-looking statements. For a discussion of factors that could cause actual results to differ, please refer to ONEOK's and ONEOK Partners' filings with the Securities and Exchange Commission. And now, David Kyle, who serves as Chairman of ONEOK and ONEOK Partners. David?

Thanks, Dan, and good morning, everyone. Both ONEOK and ONEOK Partners had strong financial performances in 2006, benefiting from the transaction we completed last year that dropped down $3 billion in ONEOK assets into the partnership and made ONEOK the sole general partner. 2006 was also a year that rewarded our owners. At ONEOK our share price appreciated by 52% and at ONEOK Partners the unit price rose by more than 50% during the year. Clearly, the transforming transactions between ONEOK and ONEOK Partners have created value in 2006 and will continue to do so in the future as the partnership grows.

The success this Company enjoyed in 2006 would not have been possible without the hard work, dedication and commitment of my fellow employees. I thank them for their performance this year and for their role in making this a great Company that begins its second 100 years of service in 2007.

On a personal note I also want to thank them for the support they've given me over the last several years. I have one final comment before I turn this call over to John Gibson to emcee. As you know, I have assumed the role of Chairman for both ONEOK and ONEOK Partners and will focus my efforts this year in supporting John in his new role until I retire as an employee next January. This will be my final quarterly call with you and I want you to know that I have the highest confidence in John and his team. Finally I have enjoyed these meetings with you and I appreciate your interest in our Company. I wish you all the very best. John?

Thanks, David. Speaking as a ONEOK employee and on behalf of all ONEOK employees, thank you, David for the 33 years of service to this Company. As a member of your leadership team and on behalf of those who have been part of that team, thank you for your solid leadership. Our Company has grown significantly and very soundly, I might add, under your leadership. You have led us through some difficult times and some challenging times. You have had a consistent vision, along with constantly ensuring that we do things the ONEOK way, which is just simply always doing the right thing for our Company, employees, shareholders, and customers. You have always stressed the importance of teamwork and we're proud to be part of your team. The bar has been set high but the example you have set will show us the way. We thank you, David.

ONEOK's 2006 performance was driven by a record year for Energy Services and a strong performance by ONEOK Partners, in which we have a 45.7% interest. ONEOK's Distribution business benefited from the first full year of new rates in Oklahoma. ONEOK Partners turned in strong 2006 results, benefiting from the assets it purchased from ONEOK as well as exceptional results in gathering and processing, which benefited from strong commodity prices and wider gross processing spreads. I will talk more about that in a few minutes.

Clearly the transforming transactions between ONEOK and ONEOK Partners have created value in 2006, and we will continue to do so in the future as we grow the partnership.

Joining us today are Curtis Dinan, Chief Financial Officer of both ONEOK and ONEOK Partners and Jim Kneale, President and Chief Operating Officer of ONEOK. In keeping with our past practice, we will have comments from those individuals and me prior to our question-and-answer period.

First, I would like to call on Curtis Dinan. Curtis?

Thanks, John, and good morning. As mentioned, ONEOK and ONEOK Partners each had strong quarters to end a very successful year. Both companies were affected by events that had significant impacts when comparing 2006 with 2005. In particular, 2006 for both entities was affected by the drop-down of the ONEOK assets into ONEOK Partners and ONEOK Partners' sale of a 20% interest in Northern Border Pipeline Company. ONEOK's 2005 results were affected by the sales of its production business, its Texas gathering and processing assets and the Spring Creek power plant.

First, let's review the financial results for ONEOK Partners. Fourth-quarter net income was $80 million compared to $36 million last year while EBITDA increased 51% to $142 million. These increases for 2006 primarily relate to the drop-down of the ONEOK assets. For the year, the partnership's 2006 net income increased to $445 million compared to $147 million in 2005. Each business segment had strong performances during the year, especially the gathering and processing segment, which benefited from strong commodity prices and wider processing spreads.

The partnership's 2006 results are also affected by the drop-down of the ONEOK assets and also include the $114 million gain on the sale of 20% of Northern Border Pipeline to an affiliate of TC Pipeline's, which was completed in the second quarter. Excluding that gain, earnings increased 125% over last year. Also for the year and excluding the gain, EBITDA was $615 million compared with $372 million last year. Distributable cash flow increased 21% over 2005 to $4.49 per unit.

For 2006, ONEOK Partners increased its quarterly distribution from $0.80 per unit to $0.97 per unit and recently paid a fourth-quarter distribution of $0.98 per unit. These increases represent a 23% increase in distributions per unit since the drop-down of the ONEOK assets. The partnership ended 2006 with $21 million of cash and temporary investments, $6 million of short-term debt, 740 million available under its revolving credit agreement and a debt to capital ratio of 48%.

Turning to ONEOK, earnings were also strong in the fourth quarter. Net income for the fourth quarter of 2006 was $75 million or $0.66 per share. For the year, ONEOK reported net income of $306 million. Excluding the effects of asset sales in 2006 and 2005, earnings increased to $274 million in 2006 compared to $268 million in 2005.

In addition to the strong results at ONEOK Partners, the Energy Services segment reported record operating income of $229 million compared with $166 million in 2005. These higher results primarily relate to transportation margins that increased approximately $58 million in 2006 due to improved natural gas basis differentials between the Mid-continent and Gulf Coast regions.

The Distribution segment also had improved performance, primarily from a full year of higher rates in Oklahoma and new rates in several Texas cities. Keep in mind that the effects of the recently settled rate case in Kansas, which are expected to increase earnings by approximately $45 million, will not be reflected in ONEOK's results until 2007.

On a stand-alone basis, ONEOK ended 2006 with no short-term debt, $78 million of cash and temporary investments, $727 million of natural gas in storage and a debt to capital ratio of 48%.

Stand-alone cash flows from operations, excluding the effects of working capital, exceeded capital expenditures and dividends by $96 million. This amount does not yet reflect a full year of increased distributions from ONEOK Partners following the drop-down of the ONEOK assets, as the partnership's fourth-quarter distribution was not made until 2007 when ONEOK received $49 million. During 2006, ONEOK increased its dividend by 14% and by another 6% in January to $0.34 per share. John, that concludes my remarks.

Thanks, Curtis. Now, Jim Kneale will add his comments regarding the performance of ONEOK. Jim?

Thank you, John. We're very pleased with ONEOK's 2006 results. And, before I review them, I want to remind you that after the transaction with ONEOK Partners in April, ONEOK began reporting its results in three segments. ONEOK Partners, Distribution, and Energy Services.

In the ONEOK Partners segment, operating income for 2006, excluding the gains Curtis talked about, was $396 million, up from $259 million last year. Cash distributions received by ONEOK from ONEOK Partners were $148 million compared with only $17 million last year. As John indicated, he will talk more about ONEOK Partners' results in a few moments.

The Distribution segment realized higher operating income in 2006 despite some of the warmest weather on record due to a full year of new rates in Oklahoma and new rates in several Texas jurisdictions. Our efforts to control bad debt expenses also helped as they were below industry averages as a percentage of revenue and below last year's level. The impact of the warmer weather, although mitigated by weather normalization and other rate strategies we have implemented, reduced margin in 2006 and higher employee costs increased operating expenses.

As Curtis indicated in November, we settled our rate case in Kansas, which will increase annual operating income beginning in 2007. This will significantly close the earnings gap in our distribution segment as compared with allowed returns.

The Energy Services segment had a strong finish to close out, as John indicated, our best year ever. During 2006, we received an award that ranked us as the top major natural gas marketer in the United States. The award measured customer service, operations, products and services offered, Company reputation and image and pricing.

Transportation margins for 2006 were up as we continued to take advantage of opportunities to hedge transportation spreads throughout the year. These hedges, combined with monthly optimization of our transport positions, generated the higher 2006 margins. Looking forward, transportation margins are 83% hedged for 2007 and 75% hedged for 2008.

2006 storage margins were up slightly as a result of higher demand premiums collected from local distribution companies for winter peaking services and our ability to retain a significant portion of those demand premiums by efficient daily management of these services.

Due to the warm weather, we finished 2006 with 74 Bcf of gas in the ground compared with 62 last year. However, the weather did turn cold in mid-January and continued until about a week ago. We ended January with 53 Bcf in the ground and have had significant withdrawals in February.

John, that concludes my remarks.

Thanks, Jim. I would now like to spend a few minutes reviewing the partnership and end the discussion by making a few closing remarks before we open it up for questions. The partnership had an exceptional year by all measures. The drop-down of the ONEOK assets along with strong performance of the gathering and processing segment, contributed to a strong year-over-year performance. Also, last year, we announced and are now executing, more than $1.1 billion of internally generated growth projects that will deliver future earnings to our partnership.

Starting with gathering and processing, let's briefly review 2006 performance. Gathering and processing benefited from favorable commodity prices and wider processing spreads. The realized gross processing spread was $5.05 per MMbtu, significantly higher than 2005's $3.07 and the five-year average of $2.55 per MMbtu.

The widening spread was due to higher NGL prices and lower gas prices. The segment continues to experience about 15% volume growth in both the Wilson basin and Powder River Basin through new well-connects and gathering system expansions. We recently announced an expansion that will double the capacity of the Fort Union Gas Gathering system, a system in which one of our subsidiaries owns a 37% interest. The system is located in the Powder River Basin and gathers coalbed methane gas in northeast Wyoming. When completed, the system will have a capacity of 1.3 Bcf per day. Looking ahead, we expect an increase in volumes gathered with continued growth in the Rockies, offsetting volume declines in the Mid-continent.

Work also continues on our contract portfolio. Currently, as measured by volume, 12% of our volume is under keep-whole contracts, 27% under percent of proceeds, and 61% under fee. Of our keep-whole contracts, approximately 50% have conditioning language that converts to fee when the processing spread turns negative. The combination of this contract restructuring work, along with the volumes added due to the drop-down assets, continue to reduce greatly this segment's sensitivity to natural gas prices.

Our current sensitivities, excluding hedging, are a $0.10 per MMbtu increase in the price of natural gas decreases the annual net margin by approximately $100,000. A $0.01 per gallon increase in the price of natural gas liquids increases annual net margin by approximately $2.1 million. And a $1.00 per barrel increase in the price of crude oil increases our annual margin by about $400,000. As evidenced by these sensitivities, over the years, we have been successful in reducing the effect rising gas prices have on our processing margins.

The Natural Gas Liquids segment had a good year, its first full year under the ONEOK umbrella. Mid-continent NGL raw feed supply grew by 9% during the year with raw feed growing from about 193,000 barrels per day to 211,000 barrels per day in the fourth quarter. New plant connections and growth behind existing plants were the key drivers in this increase. During the year, we added five new plant connections to our system, and anticipate that by year-end 2007, our raw feed supply in the Mid-continent will be near 260,000 barrels per day.

We also completed the acquisition of Valero's 14.7 million barrel Mont Belvieu storage facility, giving us additional NGL storage infrastructure in the Gulf Coast area, which allows us to offer more services to our customers.

Our Pipelines and Storage segment also benefited from the first full year of ownership of the regulated natural gas liquids gathering and distribution pipelines, purchased from Coke Industries. The growing natural gas liquid volumes in the Mid-continent contributed to stronger earnings in our FERC-regulated gathering and distribution businesses.

Also during the year, we entered into a series of agreements with Williams to construct the 110,000 barrel per day 750 mile Overland Pass Pipeline and associated downstream expansions. The project is on schedule with construction set to begin this summer and completion by early 2008. We have approximately 60,000 barrels per day committed to the pipeline and are close to reaching an agreement, which will add significant volumes to the system. This segment's results also benefited from its natural gas pipelines, having increased throughput, primarily related to power generation during last summer.

The Interstate Natural Gas Pipeline segment had a busy year with the sale of 20% of Northern Border Pipeline and the purchase of the remaining interests of Guardian Pipeline. Also the FERC approved a rate settlement in the Northern Border Pipeline case, resulting in an expected 5% decrease in Northern Border Pipeline's revenues starting in 2007, due primarily to our lower rate base investment level. We estimate that this reduction in revenues will reduce equity income by $10 million. Despite this decrease we feel the settlement was positive overall for Northern Border because we were able to make several important changes to the design of our rates.

We are also in the final stages of completing the transition of operating responsibility for Northern Border Pipeline to TransCanada and moving personnel from Omaha to Tulsa. We appreciate all the extra effort by employees during this difficult time. Going forward, we will realize the benefits of having all of our partnership operations in one location.

The Guardian expansion project is progressing. We're moving along with our regulatory filings and right-of-way acquisitions and expect to be in service in November 2008.

In summary, it was a good year, as the financial results indicate. It has also been a year of significant change, starting with these transforming transactions and ending with a series of leadership changes. This team remains committed to growing in a disciplined, well thought-out and strategic manner. We will continue to pursue acquisitions but we will also continue to focus on internal growth. But our growth will not be at the expense of our balance sheet. The bottom line is, expect no change in our strategic direction, however, expect continued change.

Over the past few weeks I've had the opportunity to visit with many of our employees and remain encouraged by both their dedication and hard work. As David said, they have played, and will continue to play, a large role in our success. They serve as examples of the ONEOK way.

I've had the opportunity to meet many of you at various conferences over the last several years and look forward to seeing you again or meeting you during this year. At this time, we will open the line for questions and answers.

(OPERATOR INSTRUCTIONS). Carl Kirst, Credit Suisse.

I guess Curtis or John, Jim, could you comment a little bit on the '07 guidance just as inasmuch as there wasn't any update in the year-end results. Should we still look at what was given kind of late November -- the $2.35 to $2.75-ish range is kind of still, what you guys are looking at for the year? And then with that, can you give us a little bit better sense of where you were looking at Energy Services for this year? In particular, trying to get a better sense of what -- how much of say for instance the roughly $200 million of operating income that could come from that unit. How much of that is, say, for instance, already locked in and how much sort of needs to -- is dependent on volatility if you will?

Carl, this is John. Let me try to answer some of those and then we -- if I don't meet your expectations, run at us again and we will ask for -- Jim can help clarify, particularly on Energy Services.

First, as it relates to guidance, you are right, we put guidance out November I think the 28th, thereabouts, and we did not update guidance. As you know, or there are several factors that input -- that affect our performance, one of which is weather, which affects throughput. Another is fundamentals of supply and demand and volatility that is associated with prices and bases. And so at this point in time it's premature for us to reflect on or give any thought to changing our range of guidance. As we have done in the past we will continue to look for opportunities to lock in more of our operating earnings. And as we have done in the past -- as we complete those we will then give consideration to updating our guidance. But at this point in time, we are still looking at the same fairway for both ONEOK and ONEOK Partners.

As it relates to Energy Services, I'm not sure that I can specifically answer that question. So, Jim, is there -- boot this one to you.

Carl, let me -- I will address that from several different angles. First, I would talk about our 2007 guidance, which was $205 million, and I think as we have discussed, that doesn't include any trading revenue. So, that always -- we expect to have trading revenue. It's just really difficult to estimate at any given time what that would be.

In terms of the rest of their operating plan, I mentioned that our transportation margins are effectively 83% hedged for 2007. So, it does leave us a little exposure to the upside or the downside. But, that's pretty typical the way we operate the business. We will come into the year and then take advantage of opportunities in the market to capture that value.

On storage, again, I mentioned that we had 53 Bcf in the ground at January 31. We've withdrawn a substantial amount in February. What's left in the ground is hedged. So, again, that part of the '07 margin is sort of locked down. And then again, as always, we will begin injecting gas soon and then take advantage of opportunities to hedge some of that to November, December and even into '08. But again as part of our strategy, we leave some of that exposure open because there are always movements in the market that allow us to take advantage of that volatility. So, all in all, we are confident in our guidance for 2007.

Great, I appreciate that color. And just lastly if I could, I'm sure everyone has got their own numbers sort of before common dividends.

[Now to] OKE, we see you guys as having about $335 million of free cash -- nicely free cash positive; obviously it should only grow as OKS grows. On sort of a long-term basis, how should we think about you guys redeploying that cash? I know it's a question you get often. But should we kind of look at it as sort of a half and half pay down debt, buy back stock until material opportunities come along? Is that fair or is that earmarked for something different?

It's John again. I think I would answer you this way. If you look back at our history, it's never been a 50-50 this, that or the other. We've focused on being opportunistic as it relates to making acquisitions. So that's our first priority. And then, of course, we will look for opportunities from the ONEOK level to help fund ONEOK Partners' growth. And then we have some debt that's due in 2008 and as I mentioned earlier, we will continue to focus on our balance sheet with our strategy being to maintain our current credit rating. And then, you know, we always have the options to look at raising the dividend or purchasing shares back. So, that's maybe a textbook answer but candidly and historically, we have looked at all of those alternatives and we also look to see what the market -- what opportunities the market is providing.

Kathleen Vuchetich, W.H. Reaves.

Good morning. We vote for the dividend by the by. Could you tell me what the weather impact was in cents per share?

I'll boot that one to Jim. I'm not sure.

Kathleen, the impact pretax was about $10 million. So, that rough math -- that's about $0.05 a share.

Thanks, Jim. When you guys look at additional storage capacity, how do you decide whether that storage capacity should go in the OKE business or whether it should go in the OKS? Are you looking at expanding storage in either of those areas and how do you decide where incremental storage fits best?

Kathleen, this is John. When we look at the opportunity to invest in building and operating storage, whether it's natural gas liquids or natural gas, we look at that inside of ONEOK Partners. That's where those assets are currently housed and where we intend to grow. So, from the standpoint of developing an opportunity that would provide that service to the marketplace, that will take place inside ONEOK Partners.

From the standpoint of leasing additional storage space from storage providers to use to provide services to downstream customers, that takes place inside ONEOK and in particular inside Energy Services.

Okay, so, really the Energy Services would not look at owning the facility as much as they would be leasing the capacity?

That's correct. The ownership and the operating would take place inside of ONEOK Partners.

I understand. Finally, there was a mention of increased operating expense. Can you tell us what that is?

Jim?

Kathleen, it was a couple of items. And of course, ONEOK Partners and ONEOK have about 4600 employees and I think about 2500 of those are in the Distribution company. So it tends to show up there more. But primarily what it was especially compared to 2005, the discount rate on our defined benefit plan and some of the trend factors on our medical caused those employee benefits to increase.

Also, as a practice, when we set targets to achieve in terms of short-term incentives, those are set by the Board and any accrual for short-term incentive payments are not included in our budget forecasts. So effectively we have to earn those payments to pay them out. And when it appears we're going to hit the targets, we will record those. And so, a lot of that was recorded in the fourth quarter of 2006.

(OPERATOR INSTRUCTIONS). John Edwards, Morgan Keegan.

Just can you remind us what your target growth rate is for distributions at the partnership?

We've not -- we don't have one. It's just to grow it as fast as we can.

Okay, all right. And on the $1.1 billion of capital projects that you have, is that just over the next year or is that stretching out beyond that?

It's over the next three years, John. And I might add, it does not include the Fort Union expansion. That is just what we call an internal growth project inside gathering and processing.

And how much is the Fort Union expansion?

How much is what?

The Fort Union expansion.

It is 37%. It's about $40 million to us of capital, net to ONEOK Partners.

Great. Then as far as providing for that, do you have plans to issue equity on -- to provide for these expansion projects over the next couple of years?

Let me turn that one over to Curtis.

John, this is Curtis. That project, if you're talking about Fort Union, that's actually being project financed within that entity.

I was actually talking about the $1.1 billion -- your overall capital expansion -- is it going to fund internally or are you guys -- you guys are planning to come to market?

Right, no. As I had mentioned in my remarks at the partnership, there's $740 million available under its revolving credit facility and our '07 plans include financing those activities with that facility as well as just our normal cash flows.

[Louish Shami], Zimmer Lucas.

Actually it's Alex Meier. A couple of questions for you. Just related to the gas and storage, you cite about 727 million of gas in storage. How much of that is related to Energy Services and how much is related to the LDC?

Jim?

Alex, we can get that for you. I don't have the exact number but I believe about -- I'm trying to think -- I think about $500 million is Energy Services and the rest might be the Distribution companies. But we'll have to get that -- we can get that number for you.

Great. And then in terms of the GNP volume mix that you gave -- the 12%, the 27% and 61% for the volumes on the GNP segment, is that the going forward mix or was that just the Q4 mix?

That is the mix as it is today. It is -- as it has been in the past, constantly evolving.

And are you comfortable with that or do you expect that to change a lot in '07?

I don't expect it to change a lot. We continue to look for opportunities to improve on it but the progress that we've made over the years has got us to this point. I think we are at a pretty good point right now, where increases in natural gas prices don't have a tremendous amount of impact on our earnings.

I know you guys spent north of $50 million in well connects last year. How do you expect volumes to change year-over-year from '06 to '07?

Well, as I indicated, we continue to see most of the growth opportunities in volumes in the Rockies. And we've continued to experience that throughout '06 and we continue to see it in '07. We still have -- are facing maybe 5% to 6% declines in the ONEOK legacy assets in western Oklahoma. But as it stands right now and what we expect through '07 is for continued investment in well connects in both of those regions will offset that decline.

Got you, okay. And then I guess lastly, it looks like in Q4 that the rate appears to be something like $0.53 on your volumes -- your fee-based volumes. Can you maybe talk about that? Maybe I am missing something there.

No. This question has been asked before, and it is a very good question. The thing that I would caution you or ask you to remember is that, that is an average of all the fees collected. That could be treating fees, compression fees, processing fees, gathering fees, and over the years we've just represented that by adding all those fees together. So you can't look at that and draw a conclusion that the average fee charged or received for a particular service is X. It's just -- that's just pure math.

It just looks like it was pretty stable the other three quarters. That's the only reason I brought it up, it looked like an outlier.

Yes, well, nothing strikes me off the top of my head as to why it would've changed other than -- yes, I can't -- sorry, Alex. I can't (multiple speakers).

No, no, no, very helpful. Thanks, guys.

Alex, I might add -- this is Jim. The actual Energy Services inventory number is about $535 million -- not $500 million.

(OPERATOR INSTRUCTIONS). Carl Kirst, Credit Suisse.

Just a quick follow-up, guys. With respect to -- John, you made the comment that you've obviously got the balance sheet to help OKS in its growth. Is there sort of a limit of what you would want your ownership to be? I guess what I'm trying to get at is, is there a situation here where you guys would do a secondary transaction in order -- just kind of opportunistically through the year over the next couple of years -- I'm not looking for a point in time, but just strategically, in order to weight yourself down a bit so that you can gear up when the opportunity arises? Or I guess if you don't, are we going to just kind of continue to see a material creep-up of the ownership in OKS by OKE?

Carl, this is John. Let me take a stab at this and then Jim or Curtis, you can jump in here and help. From the ONEOK perspective when we look at the value of the units and their performance, and the growth projects and opportunities to grow, we think that's a pretty good investment. So we continue to look at our interest in the partnership. As we had said in the past, we look at it as potentially an opportunity for us to invest more money. Relative to other alternatives it just represents a good investment.

Now we don't have any hard, fast rules that we're going to do this or going to do that. Kind of going back to the earlier statement, we just look at all of the opportunities that the market is providing and have -- [we can] apply that discipline to try to make the right ones at the right time.

Okay so no -- the upshot there is no -- there's no amount of ownership that makes you uncomfortable?

Yes, I guess -- I guess I should have just said that.

No, no, just to make sure I completely understand. I appreciate the color. Thanks, guys.

(OPERATOR INSTRUCTIONS).

Okay. This concludes the ONEOK and ONEOK Partners call. As a reminder, our quiet period for the first quarter will start when we close our books in early April and will extend until earnings have released. We will provide a reporting date and conference call information for the first quarter at a later date.

I will be available throughout the day for follow-up questions. Thanks for joining us. Have a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference, and you may now disconnect.