Plains All American Pipeline LP (PAA) 2009 Q2 法說會逐字稿

Welcome to Plains All American Pipeline Second Quarter 2009 Results Conference Call. During today's call, in addition to reviewing the results of the prior period, the participants will provide forward-looking comments on the Partnership's outlook for the future. Accordingly, in doing so, they will use words such as "believe", "estimate", "expect", "anticipate", etc. The Partnership intends to avail itself of Safe Harbor precepts that encourage companies to provide this information, and directs you to the risks and warnings set forth in Plains All American Pipeline's most recently filed 10-K, 10-Q, 8-K, and other current and future filings with the Securities and Exchange Commission.

In addition, the Partnership encourages you to visit its website at www.paalp.com. In particular, the second entitled "Non-GAAP Reconciliations", which represents certain commonly used non-GAAP financial measures, such as EBITDA and EBIT, which may be used here today in the prepared remarks, or in the Q&A session. This section of the website also reconciles the non-GAAP financial measures to the most directly comparable GAAP financial measures, and includes a table of selected items that comparability with respect to the Partnership's reported financial information.

Any references during today's call to adjusted EBITDA, adjusted net income, and the like is a reference to the financial measurement excluding the effects of selected items impacting comparability.

Today's conference call will be chaired by Greg L. Armstrong, Chairman and CEO of Plains All American Pipeline. Also participating in the call are Harry Pefanis, Plains All American's President and COO, and Al Swanson, Plains All American's Senior Vice President and CFO.

I will now turn the conference over to Mr. Greg Armstrong. Please, go ahead.

Thank you. Good morning, and welcome to everyone.

In addition to Harry and Al, we also have several other members of our Management Team, including Pat Diamond, our Vice President responsible for strategic planning, and Roy Lamoreaux, Manager of Investor Relations, present and available for the question-and-answer session that will follow the end of our prepared remarks.

As a reminder, the slide presentation we will be referring to in this call is available on our website at www.paalp.com.

Before I discuss the details of our results, I would mention that in the beginning of June, we held an analyst meeting, in which 10 members of our Senior Management Team provided a comprehensive overview of various aspects of our Partnership. That information is available on our website.

Accordingly, our comments today are brief. I would mention that we have included several supplemental slides in the Appendix of today's slide presentation that are not addressed by our prepared remarks.

As illustrated on slide three, for the second quarter of 2009, yesterday, Plains All American reported EBITDA of $246 million, and net income of $136 million, or $0.78 per diluted unit. Excluding the selected items impacting comparability, which are identified in the table at the bottom of slide three, our adjusted EBITDA was $240 million, and adjusted net income was $130 million, or $0.74 per diluted unit, which represents an increase of 1% and decreases of 2% and 11% respectively compared with the corresponding results in last year's second quarter.

These solid results were underpinned by strong performance from our Fee-Based Transportation and Facility segments, relative to performance in both the second quarter of 2008, and our guidance for the second quarter of this year. Performance from these segments was more than off-set weaker relative performance from our Marketing segment. These results reaffirm the strength, durability, and favorable competitive positioning of our asset base and business model.

As shown, slide four, this represents the 30th consecutive quarter in which we have delivered results in line with our operating financial guidance.

I'll now turn the call over to Harry.

Thanks, Greg.

During my portion of the call, I'll review our second quarter operating results compared to the midpoint of our guidance, issued on May 6, 2009, discuss the operational assumptions used to generate our third quarter 2009 guidance, and then discuss the progress of our expansion capital program. And let me start with the operating results for the second quarter.

And as shown on slide five, adjusted segment profit for the Transportation segment was $122 million, or $0.44 per barrel, which is about $11 million higher than the midpoint of the guidance range. Although there were some ups and downs on balance, volumes of approximately 3.1 million barrels per day were in line with our guidance. This relative over-performance was generally attributed to higher revenues, primarily associated with pipeline loss, a lot of oil, and lower expenses. Let me highlight a couple of the volume variances.

First, volumes in our Basin pipeline were about 70,000 barrels a day higher than forecast, as the Midland to Cushing differential made it more attractive for shippers to transport crude oil to Cushing. Volumes on Capline were about 20,000 barrels per day lower than forecast, primarily due to an unplanned maintenance in June by one of our shippers. Also, volumes in our Canadian pipelines were lower than forecast, which is due in part to narrower Canadian crude oil differentials, which are making certain historical movements less economic. We've also seen a bit of a negative impact on our Canadian pipeline volumes due to a reduction in the oil field activities amongst some of the Canadian producers.

Adjusted segment profit for the Facility segment was $54 million, or $0.30 per barrel, which is approximately $10 million higher than the midpoint of our guidance range. The average capacity of 60 million barrels per month for the second quarter was up modestly from guidance of 59 million barrels per month, as we had some capacity remain in service, originally forecasted to be removed.

The over-performance over guidance reflects a number of factors including higher revenues from our LPG processing facilities, higher [frequent] revenues, contributions from recent acquisitions, slightly stronger than forecast results from our national gas storage activities, and the slight increase in volumes. Although the majority of our Facility segment profitability is driven by lease rates remain consistent regardless of facility utilization, certain of our contracts allow for additional throughput charges, as well as for special services provided at certain of our facilities. I would also note that lower operating expenses, primarily associated with the scheduling delays for certain tank inspections forecasted for the second quarter were largely offset by higher internal allocations of general and administrative expenses.

Moving onto our Marketing segment, overall market conditions during the second quarter were fairly volatile, with respect to the outright price in market structures. Specifically, crude oil prices during the second quarter ranged from a low of $44.55 in mid-April, to a high of $72.92 per barrel in mid-June. And the contango spread ranged from a high of $3.11 per barrel to a low of $0.43 per barrel, which is closing out the quarter at $0.45 per barrel. In addition, basis differentials among the various grades of domestic and foreign crude oil, particularly Sweet Sour, Light Heavy, and Light-Heavy differentials remained much tighter than historical average.

Against this backdrop, our business model performed well, demonstrating the countercyclical balance provided by the strategic location and complementary nature of our assets and business activities. Adjusted segment profit for the Marketing segment was $59 million, or $0.84 per barrel, and that's compared to the guidance midpoint of $68 million and $0.99 per barrel, respectively.

Marketing volumes are 776,000 barrels per day, which is just slightly higher than the 760,000 barrels per day in our guidance. Segment profitability was negatively impacted by the tighter crude oil grade differentials. This was partially offset by a favorable tango market structure and higher-than-forecasted LPG margins. I would also note that the marketing segments' results include a negative impact of about $3 million, relating to prior period settlement and billing issues.

Maintenance capital expenditures were $22 million for the second quarter. We expect maintenance capital expenditures for the full year of 2009 to range from about $85 million to approximately $95 million, and that's up from our previous estimate of $80 million, due primarily to increased maintenance costs on our non-DOT jurisdictional pipeline, and the fact that we've been able to get more work completed this year than originally expected.

As mentioned in previous investor presentations, we've elected to proactively expand an integrity screening and maintenance program to these non-jurisdictional pipelines, which we believe, in the long-term, will reduce environmental risks and lower future operating expenses.

Let me now review the operational assumptions used to generate our third quarter 2009 guidance, which was furnished in our form 8-K issued last night and shown on slide six. For the Transportation segment, we expect volumes to be approximately 3.1 million barrels a day, which is in line with our second quarter volumes. This forecast takes into account tariff increases that are effective July 1, 2009, which is the primary reason for the forecasted increase in segment profits.

Facilities segment guidance is based on forecasted volumes of 57 million barrels per month of crude oil, refined products, and LPG storage. An average of 20 DCF per month of natural gas storage capacity, and an average of about 17 barrels per day of LPG Processing crude refines for a total of 60 million barrels of capacity per month. The average segment profit per barrel associated with the midpoint of our guidance is in line with the actual results generated during the second quarter of 2009.

Marketing segment guidance includes lease gathering volumes of approximately 615,000 barrels per day, LPG sales volumes of 70,000 barrels per day, refined product sales, 35,000 barrels per day, and the Waterborne foreign crude volumes of 45,000 barrels per day.

Sum of these volumes total 765,000 barrels per day for the Marketing segment at a projected midpoint for segment profit per barrel of $0.60 per barrel, which reflects our outlook on certain activities, such as our foreign important, Canadian marketing activities, and profitability will continue to be adversely impacted by the tight differentials, as well as the seasonal impact of our LPG activities.

Our third-quarter 2009 guidance assumes that the contango market conditions continue through the third quarter at levels similar to those experienced during the second quarter, and incorporates reductions in tankage related to API 653 discussed in the May conference call.

As presented on slide seven, our 2009 capital program totals approximately $370 million, which is up approximately $20 million from the May 2009 guidance. This increase reflects additional capital for a Phase III expansion of Patoka and several small additional projects in Canada, and also includes the net impact of timing shifts and the refinement of cost estimates among existing projects.

Overall, we remain on track with our project slate, and expected in-service timing of our larger projects is shown on slide eight. During the second quarter, we placed the final 700,000 barrels of St. James Phase II tankage, and the remaining 550,000 barrels of Paulsboro refined product tankage into service. Also, in July, we received the necessary permits to begin construction of the condensate tankage associated with the St. James Phase III project, which we expect to come into service in the second half of 2010.

The new Patoka Phase III expansion I mentioned earlier consists of construction two new crude oil tanks for a total of 800,000 barrels. Subject to timely receipt of permits, we target bringing this capacity into service in the fourth quarter of 2010. We estimate the total cost of this project at $30 million, with $10 million of this amount to be invested in 2009.

I'll now share a progress report on our natural gas storage venture. Our leaching operations are progressing well on our third and final cavern wells, and our Phase I development program at our Pine Prairie facility. As a result, we remain on schedule to place this cavern into service during the second quarter of 2010. Our Phase I development is permitted for a total of 24 bcf, spread among three cavern wells.

As we discussed in our first-quarter conference call, in February we submitted a permit application to the FERC and Louisiana Department of Natural Resources to conduct a Phase II expansion, which will increase our total permitted capacity to 48 billion cubic feet, doubling our permitted storage capacity. Our Phase II permit includes installing two new cavern wells and expanding two of our existing cavern wells. We received the environmental impact review from the FERC last month and received our FERC order approving the expansion yesterday. We expect to receive approval from the Louisiana state authorities in the next month or so.

Also, in July 2009, we completed an interconnect with the newly constructed Kinder Morgan Louisiana Pipeline that originates near the Texas-Louisiana state border, and is connected to the Sabine Pass LNG re-gasification facility. This is a 42-inch interconnect that provides direct access to LNG imports. This connection raises the total number of interconnects at Pine Prairie to nine. These are large-diameter interconnects that range in size from 30 inches to 42 inches in diameter and provide our customers with significant interconnectivity among eight different pipelines.

Finally, we recently completed an open season for the balance of the Phase I capacity we had available at Pine Prairie. We are pleased with the results of the open season, as bids for capacity significantly exceeded the amount we had available and the contracted rates we achieved were favorable relative to our previously contracted rates. Excluding additional capacity associated with our Phase II permit application, we are essentially fully leased at Pine Prairie.

On the acquisition front, we have a number of smaller opportunities that we are pursuing and expect to be able to complete our target of $200 million to $300 million of acquisitions this year.

And with that, I'll turn it over to Al.

Thanks, Harry. During my portion of the call, I will address our capitalization, liquidity and third-quarter and full-year 2009 guidance.

As summarized on slide 9, we ended the second quarter of 2009 with a solid capitalization and liquidity position, which was well in-line with our targeted credit metrics. At June 30, our long-term debt-to-total cap ratio was 48%, total debt-to-capitalization ratio was 54%. Our adjusted EBITDA-to-interest coverage multiple was 4.3-times, and our long-term debt-to-adjusted EBITDA ratio was 3.4-times.

Short-term debt at the end of the second quarter was approximately $938 million. This short-term debt is primarily associated with hedged inventory that will be repaid with the cash proceeds received when the inventory is liquidated.

In July, we completed a $500 million offering of three-year senior notes which resulted in net proceeds of $497 million. The offering was priced to yield 4.3%. This capital is being used to supplement the capital available under our existing hedged inventory facility, and to fund working capital needs associated with the base levels of routine foreign crude oil import and seasonal LPG inventory requirements. The hedged inventory facility, which we renew annually, matures in November 2009. Although the availability of bank capital has improved since last November, the cost of this bank capital has increased significantly. As a result, we believed it was prudent to lock in a tranche of capital to support these base-line activities. Since the proceeds are being used as a surrogate for bank capital, we swapped $150 million of the note back to floating for three years, and another $150 million back to floating for two years. The current weighted average effective interest rate for the $500 million note is 3.5%. Given that this note will be classified on our balance sheet as long-term debt, we will provide disclosures each quarter as to how much of it relates to hedged inventory and would be classified as short-term debt if funded on our bank facilities. This will allow you to may make the necessary adjustments to our long-term debt numbers to arrive at inventory-adjusted, long-term debt credit ratios.

Pro forma for the $500 million offering, at June 30, we had $1.8 billion of available committed liquidity, which, in addition to the offering, includes $1.2 billion of availability under our $1.6 billion revolving credit facility, and approximately $100 million of availability under our $525 million hedged inventory facility.

The Partnership's long-term debt balance at June 30, was approximately $3.4 billion. As shown on slide 10, pro forma for the recent offering, our long-term debt is 92% fixed. That is 100% fixed if you exclude the swaps associated with the three-year note. At an average rate of 6.3%, and has a weighted average tenor of 11 years.

Slide 11 illustrates the amount of initial margin and variation margin we have posted with the New York Mercantile Exchange and the Intercontinental Exchange. As of June 30, our initial margin requirement was $71 million, while the variation margin returned $66 million back to us, effectively resulting in $5 million of aggregate cash margin. On future calls, I will only comment on our margin if it is meaningful. However, we will continue to include the slide in the Appendix section.

Let me now move onto guidance. The highlights of our guidance, which exclude selected items impacting comparability between periods, are summarized on slide 12. For more detailed information, please refer to the 8-K that we furnished last night.

We forecast third-quarter adjusted EBITDA to range from $210 million to $235 million, with adjusted net income ranging from $89 million to $118 million, or $0.41 to $0.63 per diluted unit.

For the full year of 2009, we are forecasting adjusted EBITDA to range from $962 million to just over $1 billion, with adjusted net income ranging from $499 million to $557 million, or $2.78 to $3.22 per diluted unit. The midpoint of this adjusted EBITDA range represents an increase of $27 million, or 3%, over our original guidance for the year. The guidance reflects our cautious view regarding potential impacts from weaker demand for petroleum products as a result of the recession, including lower expected margins from quality arbitrage opportunities as a result of tighter differentials between grades. Additionally, our third quarter guidance for the marketing segment takes into account the realization of higher LPG margins during the first half of 2009, which negatively impacts third quarter. This is a timing issue and results from inventory costing methodologies.

While marketing segment profit is expected to be negatively impacted for 3Q, the midpoint of our annual 2009 marketing segment profit is $275 million, or $0.92 per barrel, which is slightly higher than our original guidance for the year, which was $273 million or $0.88 a barrel. This is illustrated by slides 13 and 14, which show our segment profit per barrel for each of our segments on a quarterly and annual basis. Consistent with past practice, our forecast assumes the contango market that we have experienced in the first half of 2009 will not extend beyond the third quarter.

As shown on slide 15, based on achieving our mid-point guidance and maintaining our current distribution level, our implied distribution coverage ratio for the year is a healthy 111%. Further, we have sufficient coverage to support a meaningful increase in distributions and still maintain solid coverage ratios.

With that, I will turn the call back over to Greg.

Thanks, Al.

We are pleased with PAA's solid second-quarter performance, our financial positioning, and our outlook for the remainder of the year.

Throughout the year we've discussed our decision to position the Partnership as if the uncertain global economic and financial market conditions could linger into early-to-mid 2010, if not throughout 2010. Despite a rally in the financial market over the last several months, we continue to believe our cautious approach is prudent as it positions PAA to endure potential weakness in the economy, while allowing us to capitalize on attractive opportunities in such an environment, as well as to participate in any early economic recovery.

In summary, our assets and business model are performing as designed and we have excellent capitalization and liquidity. We are cautiously optimistic about the future and believe PAA continues to represent an attractive investment opportunity that combines a substantial current yield with a solid foundation for continued growth.

One final comment, for those participants on today's call that did not participate in our June 10th investor presentation, I want to invite you to review the webcast replay, or the audio and PDF versions of the printed materials, each of which are available under the Partnership Presentations section of the Investor Relations page of our website. The investor presentation included over 180 slides covering topics ranging from PAA's positioning in the current environment and the impact on our business of an extended weakness in the economy, to details regarding the drivers of each of our business segments, with a special focus on the composition and durability of the cash flow derived from our marketing activities. We also provided overviews of PAA Natural Gas Storage and Plains Midstream Canada.

This concludes our prepared remarks this morning. We thank you for joining us today. We appreciate your continued support and we look forward to updating you on our next call.

Operator, at this time, we're ready for questions.

Thank you.

(OPERATOR INSTRUCTIONS)

And our first question comes from the line of Ross Payne with Wells Fargo. Please go ahead.

Morning, guys.

Morning, Ross.

First question, I might've missed it, what is the gross CapEx number for the quarter, or the total CapEx number for the quarter?

The question was what's the total CapEx--.

Yeah, total. I think I've got the maintenance number for the quarter, but I don't know that I got the total--.

The maintenance was 22. Hang on. We'll dig that up for you, Ross, and announce it here just in a minute, but I--.

--Okay--.

--I'd call it from memory, but I don't have it right here.

No problem on that. You guys, you mentioned that the Sweet Sour differential has decreased. I was curious if you could kind opine on what's driving that and your thoughts on how that's going to play out here in the near future.

Could you repeat the question?

Sure. You guys mentioned that the Sweet Sour differential has decreased somewhat here recently, and I was wondering if you could opine on your thoughts on what's driving that and if that's going to change in the immediate future.

Probably mostly driven by OPEC cuts is kind of the heavier sour barrels they could cut first. So, it puts more pressure on the Light-Heavy differentials and then next is Sweet-Sour differential.

Yeah. I think, Ross, it's probably -- Harry's quite right. The anchor issue is probably just the fact that I think OPEC's probably pulled several million barrels off the market, and they pulled the lower value off initially, which has tightened up the market. That combined with, if you recall a lot of the refineries have made modifications and upgrades to try and run a heavier sour crude, which has increased the demand at the same time that you're shrinking some of the supply. And then, you've also had -- some of you recall after Hurricane Ike, some particular barrels in the Gulf of Mexico were pulled off. So, it's really a combination of factors. But, it's definitely tightened up.

I mean, for example, WTI-WTS differentials were probably around a buck, buck and a half, and that normally is around $4.50. And then, some of the differentials in Canada have been significantly wider than what they are right now. So, it's tightened up across the whole complex.

Even Canadian volumes have probably been lagging what -- I expect if you go back a few years, go where people thought the Canadian production would be, I would venture to say it'd be higher than where it is today.

Also, in one of your slides, you show how you're getting more per barrel out of your Transportation. Primarily, the lockstep increase was the Pacific acquisition. Just want to ask you what within that acquisition is really driving that?

Ross, both with Pacific and actually following the Rainbow acquisition, just the business mix shifted significantly. The average tariff on the Pacific pipes relative to ours, and then the average tariffs on the Rainbow ended up bringing those average per-barrel numbers up.

One other housekeeping item. I assume the cash balance was pretty low for the quarter.

Yes.

Yeah. I agree. We're $10 million or less. We try to run a zero balance.

And Ross, before I let you get off, on the CapEx issue, through the six months, we spent $158 million and $78 million was spent during the second quarter, so it's roughly equally split between the first and second.

Okay. Thanks so much, guys.

Thank you.

Thank you.

And our next question comes from the line of Brian [Zerin] with Barclays Capital. Please go ahead.

Good morning.

Morning.

You mentioned you're on-target for two to 300 million of acquisition spending. What was the acquisition spending in the first half of '09.

We really just completed the two acquisitions of roughly 60 million. So, we've got 140-plus to go to get into that. But, we're chasing a lot of things right now, but they're more of the smaller items right -- that aggregate, I think, will probably get us in that range.

And are those more storage-related assets?

They're across the board. I mean, they're primarily in the crude oil. And certainly we're chasing also some natural gas opportunities, as well, but, both storage and pipeline on crude oil.

And can you just give your observations on what you're seeing in the M&A market. We've seen the cost of capital decline precipitously over the past six months. Is that impacting what sellers are looking for?

I think you're 100% on point there. In March, the body postures appeared to be where buyers and sellers were getting pretty close together on several issues. When the market started to rally, I don't think it really changed the mindset of the buyers as much as it changed the expectations of the sellers. And so, we've seen those numbers widen out quite a bit. And so, the bigger package is primarily, Brian, I think if somebody doesn't have to sell, they're not, unless people are going to reach up for it a little bit. On the smaller things that are just kind of niche fits, where there's a lot of synergies, those seem to be the things that are actually getting a little bit attraction, or what I won't call distressed sellers, but sellers that are more motivated just to kind of clean out the closet a little bit seems to be where the smaller assets are coming.

Thanks, Greg.

Thank you.

Thank you.

And our next question comes from the line of John Edwards with Morgan Keegan. Please go ahead.

Yeah. Good morning, everybody.

Good morning, John.

Yeah, I came on late, so I missed -- could you describe just in the marketing, why the margins, I guess, came in a little bit below what you were expecting?

Yeah. Well, couple things, I think Harry mentioned, there was a $3 million debit or reduction just associated with some prior period disputes that came up that we just made a reserve to pending settlement of those. And that affected it a little bit.

The other one is just the really tight differentials out there affect primarily a lot in our Canadian operations. You've seen Sweet-Sour and Light-Heavy differentials tighten up quite a bit over the last several months, and that kind of manifest itself in the second quarter.

And then, if you'll notice in the guidance, for the third quarter, we're actually assuming that continues. Overall, for the year, Al commented that we're really about where we thought we would be overall for the year, in terms of our guidance. But, it really just impacted the second and the third quarters.

Okay, great. So, okay, so you're taking a conservative posture for third quarter. That's why you're pulling that down just for the third quarter.

Yeah. I don't know if it's conservative. I think it's realistic. I mean, the bottom line is the differentials are tighter right now and they're--.

--Okay--.

--Affecting it. But, I don't think it's a permanent shift, as one of the questions, and you may've missed it was, is, "Why are they so tight?" And part of it is, is just the amount of oil that's been pulled off the market that was a heavier or more sour barrel, primarily related to OPEC. And then, of course, we had Hurricane Ike which pulled some type barrels off that are just now coming back on. And then, some of the Canadian activities are quite candidly just behind schedule. So, back to [mind] with the refiners who have just finished up a lot of investments that enable them to run a heavier sour crude, the competition for that element of the crude slate's been pretty tight.

Then one other thing, if you're looking at the third quarter, typically the weakest, sort of, period of time for the LPG segment, and that coupled with -- we've had larger draws of our LPG inventory earlier in the year. And as Al mentioned, in his part, the way the inventories cost, it can impact quarterly profitability. So, in total, for the year, we're where we thought we were going to be, just sliding between quarters. And third quarter looks like it may have a little bit of a negative, whereas earlier in the first quarter, we saw some of that benefit on the LPG draws.

Okay, great. And then, on the Facilities segment, I guess your margins, you were already guiding they were going to come up a little bit in the second half. Did it come up a little sooner than you expected? Was that behind what we looked at as a little bit of a beat there in the Facilities area?

A little bit, because you're looking at segment profit per barrel. There's some--.

--Yeah--.

--Shifting of expenses between quarters. You scheduled to do work on an API 653 or something like that, and if it happens in the quarter, then you're right where you thought you'd be on segment profit. If you're delayed, well, you have a better segment profit barrel in one quarter and it slides to another. So, it still is a little bit of Kentucky wind. He's been trying to forecast some of those expenses.

But, I would tell you overall, if you're just looking at the top line on the revenue side, when we made the decision late last year or middle of last year to lease more barrels to third parties, we charge our self a lower rate internally, because it's on a short-term basis. So, when we lease it to a third party and it's on a longer term, you're going to get a higher rate. And then a lot of the laddered contract maturities, as they come up, let's face it. They're maturing in a period where you can command a higher value for your storage. And so, we're getting better realizations of that as we go forward.

So, the combination of upward pricing pressure on the value of storage, and also just the shifting of expenses is what's affecting segment profit per barrel.

Okay, great. And then, last question, given how this year has clearly sent a message to all of us that the country is short natural gas storage, I'm just wondering if you're looking forward, as you are building out, is that giving you an opportunity to have some upward negotiating leverage on storage rates?

Yeah. Harry commented in his about -- we just concluded an open season in June, and we were real pleased with the demand volumetrically, and also for the prices. And John, without giving a lot of detail on that, we were able to basically realize forward contracts at higher values than what we had been contracting. So, I think you're correct in your conclusion. People are now starting to recognize the wisdom of owning storage longer term. And even though the price of gas has come down, the spreads have been pretty attractive, and the overall supply-demand issue, with demand being down and supply being up, and LNG coming on, really is constructive for the long-term fundamentals of gas storage.

Okay, great. That's all I have. Thank you.

Thank you, John.

Thank you.

And our next question comes from the line of Darren Horowitz with Raymond James. Please go ahead.

Thank you. Greg, just a couple of quick ones. First, longer term at Patoka beyond Phase II and the 800,000 barrel addition for Phase III that you announced, in terms of capacity, how big of a hub do you think that could be?

We're pretty good set land position, so we're ready to meet demand if it's there. Part of it is going to be a function of the volumes. As Harry mentioned, Canada's running a little bit behind in certain areas on some of the development of their volumes. That's probably to be expected as crude oil went from 50 to 140, and everybody got very euphoric. And then it came down to 30 and now it's back up to 70.

So, I think, if we can see oil prices stay in the $50 to $90 range, call it $70, you're going to see the volumes, a little bit delayed from what was originally thought, are going to make their way into the US. And you're also still going to see the need for condensate to move from south to north, to help dilute, or as a diluent to those heavy volumes, because you're probably not going to see up-graders built in Canada, as much as what was one time thought. So, you do need more diluent.

So, I think we're going to see Patoka continue to expand. It's been a little more rapid, so far, than what we would've originally thought. And so, we may be taking a breather here. But, we're certainly positioned, if need be, to go into Phases IV, V, and VI if situation warrants.

And the 800,000 was tied to one of our permits. That was a batch on one of our permits that we could do right now. So, that's sort of how we came up with the 800,000.

Okay. And then, my second question, when you look at the amount of storage across your entire system that you keep for your marketing purposes, as you look to 2010, has there been any change in your thought process? Or do you still want to kind of call it 11, 12 million barrels out of that 85 million just for arbitrage ops and contango ops?

I think you'll actually see us increasing that to kind of maybe recapture some of the tankage that we put back out to third-party lease. Part of that's a function of the liquidity issues that were on the horizon in August, September of last year, if you recall, following the Lehman, and the massive meltdown in the financial sector. To use those tanks the way we were using them, you needed to have significant financial resources and it was uncertain where that would go.

I think, today, we have certainly gotten more liquidity today than we've ever had, I think in the Company's history. And as the Company grows overall, I think you'll see us maintain some sort of proportion.

So, no, I would expect to see our proprietary tankage volumes grow over the next 12 to 18 months.

I appreciate it. Thanks, Greg.

Thank you.

Thank you.

And our next question comes from the line of Michael Bloom with Wells Fargo. Please go ahead.

All right, thanks.

Morning, Michael.

Good morning. Couple questions. One, within your Marketing segment, is there any way to calibrate, just in rough terms, what's the relative contribution of what you're making on the differentials, versus the contango profits, versus some of those fee-like services, etc., etc.

Boy, if you had 20 hours and our models, I think so. There are a lot of interaction, and we've used the term several times, Michael, of the countercyclical balance. For example, one of the things that you see is that where sometimes you make money in quality arbitrage, if it's not there, it's going to show up in some of our transportation, because instead of leaving crude in a particular area, and you're selling into a local refining market, it's more valuable to ship that. So, in some cases, you'll actually see the pickup being in our Transportation segment in terms of shipping on some of the higher-valued pipelines.

So, I don't think you, from a distance, could do it. It's taken us a lot of years to try and define and keep that balance. But, I think when you look at the overall results and if you look at it on an annual basis -- quarter-to-quarter it gets real tough. If you look at page 13 and 14 of the slide presentation, you'll see our unit margin basis that it really averages out over time. And that's what we try to keep in the balance, is that we have enough assets dedicated and allocated in particular activities, so that, in some cases, they're not being used at all. But, in cases when the market shifts in a different direction, those assets come into service, because they can extract the margin in that activity.

Okay. And then, in terms of your commentary on distribution growth, I don't want to, I guess, [polish] your words too finely, but here I'm going to do it. Are you now also thinking that 2010 potentially you may remain cautious, depending on the environment? Or is that a subtle shift in how you've been thinking about it? Or is that sort of unchanged?

Yeah. I think where we positioned it at the beginning of 2009, and we're still there today is, is we're waiting to see absolute improvement in the fundamental developments. The stock market feels really good right now, because it's up. But, if you actually look at the numbers, and everybody keeps trying to call the turn in. But, you actually look at whether it's -- we'll see what unemployment is tomorrow. But, we really aren't seeing the change in the fundamental environment. I'm talking about the broad economy, and therefore in demand.

Natural gas demand is actually down 3.5% to 4% year-on-year and hasn't turned yet. And the petroleum demand, which was running 20.7 million barrels a day from 2005, '06, and '07 is down to about 18.5 million barrels a day. That's a pretty big decrease. And until you actually start to see some of those elements fundamentally start to filter through the numbers, you can tell me the stock market can double from here. That's not really going to change what people have the ability to consume.

So, I think we're being cautious. Al demonstrated, our numbers are actually showing, obviously, that we can support higher distribution levels and still maintain a 103 to 105, or 107 coverage. We're just simply trying to do what's prudent over long term, and, so far, other than -- all due respect to our leaders in Washington DC. Other than somebody telling us it's a better economy, there isn't really a lot of support for that.

So, we'll continue to maintain a fundamentally conservative posture. Having said that, we think if there are opportunities out there, we're going to have the financial resources to move aggressively and build our distributable cash flow. What we choose to distribute will be based upon an outlook of whether we think the economy's actually stabilized, because we don't want to be in a situation where we've paid out capital, and then have to raise it back at a much, much higher cost, because the markets migrate back down to the fundamental economy level.

Thanks, Greg.

Thank you.

Thank you.

And our next question comes from the line of Yves Siegel with Credit Suisse. Please go ahead.

Yeah, good morning.

Good morning, Yves.

Just keeping along those lines of thinking, so one of the side benefits of the market going up is that the cost of capital has improved dramatically. So, I'm wondering, how does that enter into your thinking, and sort of couple that with when you think about potential organic growth projects, 2010 and beyond, can you give us some insight into a potential backlog of stuff that you might be thinking about, and how does that go from natural gas storage to more crude tankage, etc?

Well, I think it's certainly very much a positive. I mean, today, if we saw a significant either expansion opportunity, or a significant acquisition opportunity, it doesn't take as much a leap of faith to say, "What's our cost of capital?" Whereas, in November of 2008 to February of 2009, you weren't sure whether, one, access was available. And then, two, what the cost would have been. So, we were certainly very cautious in setting our margin, if you would, of expected return above what we assumed our cost of capital would be, because we had to have some execution risk, not on the acquisition of the expansion opportunities, but on the financing of that.

We've kind of taken care of that by pre-funding, and loading up our balance sheet right now. So, it's taken part of that risk out. We want to maintain a high level of liquidity. So, we announced the transaction tomorrow, you wouldn't necessarily, "We'll just find it out of our existing war chest." We would probably still want to try and replenish part of that, because we still think there's going to be a lot of opportunities.

But, I would tell you, our weighted cost of capital today, versus where it was at the beginning of 2009, is probably down about 150 to 200 basis points. That's pretty significant. And it has caused projects that may have been marginal before to look better, and you've seen us grow our CapEx from 300 million at the beginning of the year to, we're about 370. And we're still trying to control the expectations of our engineers saying, "We like to build things," to saying, "We'd like to build it, too, if it makes a good rate of returns." So far, we've been able to achieve our rates of return, and we've seen our customers and our potential customers acknowledge that we have to make a inacceptable margin there.

So, I think, as we look out to 2010, we're going to feel pretty good about being able to lay out a fairly attractive CapEx program. A little bit early to be talking about it, but since you've raised it -- and I think that will include not only the crude oil tankage that we've already started, and certainly some of this is going to carry over. There's some refined products opportunities, natural gas storage. As Harry mentioned, we just got the permit in yesterday that allows us to move forward on that. We just had a very successful open season, and that certainly sets the stage to make us believe that we're going to be able to build something at a cost that we can define, and generate a return above our cost of capital that's very attractive. And so, I think we're well-positioned there.

When you try that end, say, "Well, why wouldn't you go ahead and start aggressively raising the distribution?" Well, there's still some execution that goes in between those plans that I just talked about and the realization of it. And also, the opportunities that we want to make sure that we position ourselves to maintain a very high credit rating, and the ability to move aggressively on those opportunities when they show up.

I would say this. I think people are starting to realize the importance of investment-grade rating versus not-investment grade rating. You've seen the cost of that capital widen out from probably in middle of '07. The difference between investment grade and not-investment grade may've only been a hundred basis points. Today, that number's probably upwards of 400 or 500, and as well as just the ability to access it.

So, we're managing a lot of different things, and our whole attitude right now is we want to stay cautious. We got one foot on the gas and one foot on the brake. When it comes to opportunities to expand, we're going to press a little bit harder on the accelerator. When it comes to financial discipline, we're going to have a little bit more on the brake.

Got it. Greg, can I just push it? Two other last questions, one is, in addition to the cost of capital having come down, have your engineers come back to you and said also that, "Hey, these projects, now the cost has come down as well."

For the investors, yes, if there's any of our vendors on there, no. No, clearly, there has been pressure on service and supply cost. And Yves, and we highlighted this in the prior call, but there's other examples of this is when we started off the year, I think we were going to build three tanks in Cushing for a certain amount of money. And we were actually going to be able to build four tanks in Cushing now for the same amount of money. That's about a third reduction. Now, that's not something you can extrapolate across the entire complex of service and supply costs. But, you're clearly seeing the pressures on prices and costs going down, and we're extracting part of that to our benefit.

We've had a very favorable, knock-on-wood, hurricane season, or lack of hurricane season so far. If you recall what kind of ignited the fire on service and supply cost was in 2005, we had Hurricanes Rita and Katrina back-to-back, and a point in time when also the EMP business was going great again. So, it's not to say it can't turn around and go the other direction on short notice. But, right now we're real pleased with our ability to get good prices. But, probably, more importantly, Yves, we're getting the best quality vendors and field hands. And so that somebody who's manning a particular piece of equipment didn't just learn how to do it last week. We're getting good execution. So, I would say the competence level and us being able to build something at a targeted price has certainly improved quite a bit, and the price has come down.

And the last question, and fully recognizing the different constituencies that you have, is there any room for further ability to hammer down OPEC's across?

Well, I mean, you're seeing it right now. When I think quarter-to-quarter, if you look at second quarter of '09 versus second quarter of '08, expenses are up. When you see our 10-Q, which will be filed in the next 24 or 48 hours, you'll actually see, we give you some commentary in the Q that says, "If you take out the impact of acquisitions, expenses are actually down." Some of that is down just because of commodities. Clearly, electricity cost and utilities cost are indexed somewhat, although they tend to lag. But, they're indexed somewhat to commodity prices. So, you're seeing that come down. And you're also seeing us be able to be fair with our vendors, so that we don't run them out of business. But, they actually maybe extract some of the war premium that showed up after, as I mentioned, that 2005 when Katrina, Rita, and the shale plays all took off. And so, you're seeing some of that, I think, adjust out.

So, no, I think you're seeing that. Certainly our diesel costs on our trucks, things have gotten more reasonable. So, you're seeing that impact start to percolate through. We haven't yet put together our 2010 plan, but that'll be, I'm sure, a interesting process. Where in trend analysis, people like to say, "Here, it's been this high in this forecast based off that." We try to do a combination of both trend analysis and zero-based budgeting, so that we get a realistic forecast, but also not one that just has rose-colored glasses on.

But, some of those cost savings are going to be offset by the increased integrity costs that, in our effort, that will be geared towards some of our non-jurisdictional assets that haven't been subject to integrity testing historically. So, that'll create a little bit of an offset to some of the cost-savings that we see, too.

All right, thank you very much.

Thank you, Yves.

Thank you. And we have no more questions in queue.

At that, we'll wrap up the phone call. Thanks to everybody for participating in the call, and also to all of our investors and stakeholders for helping us support and grow the Company. And we look to update you on the next call, which will be held either late October or early November. Thank you.

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.