Pembina Pipeline Corp (PBA) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Pembina Pipeline Income Fund Q2 results conference call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions.

(OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded on Wednesday, August 1st, 2007 at 4 PM Eastern time. I will now turn the conference over to Bob Michaleski, President and Chief Executive Officer. Go ahead.

Good afternoon, everyone. I have Peter Robertson, Pembina's Vice President of Finance and CFO; and Glenys Hermanutz, our VP of corporate affairs here with the today with me here today to discuss Pembina's second quarter 2007 financial and operating results.

Following our brief review of the quarter I will provide a discussion of new developments at Pembina and provide our outlook for the balance of the year. After I have completed my comments Peter, Glenys and I will be happy to respond to any questions that you may have.

Many of my comments today will be forward-looking statements in nature. As such Pembina's lawyers have asked me to advise you of the following. The actual results could differ materially from the conclusions forecasted or projections in the forward-looking information. Certain material factors or assumptions were applied in drawing the conclusions or making the forecasts or projections as reflected in the forward-looking information.

Additional information about the material factors that could cause actual results to differ materially from the conclusions, forecast, or projection in the forward-looking information and the material factors or assumptions that were applied in drawing the conclusions or making the forecast or projections as reflected in the forward-looking information is contained in the second-quarter [internal] reports of the (inaudible) which is available online both at Pembina's Website located at www.pembina.com and on the SEDAR Website.

Now looking at second quarter highlights, earlier today the Fund announced an increase to its monthly distribution rates to $0.12 per trust unit or $1.44 per trust unit annually to become effective with the August 2007 distribution. This represents a 9% increase from the previous monthly rate of $0.11 per trust unit or $1.32 per trust unit annually.

This is the second time Pembina has increased its monthly distribution rate in 2007 with the first distribution rates increase taking effect with the January distribution. A cumulative 24% increase in the distribution rates has been recorded this year. Pembina's business segments generated a $2 million increase in the no flow distribution reserve during the second quarter resulting in a no flow balance on reserve of $29 million on June 30th, 2007.

As we approach our 10-year anniversary as a publicly traded income fund I am pleased to report that we have met our distribution objective each year. At June 30th, 2007, Pembina had distributed a cumulative total of $915 million or $10.08 per unit on a $10.00 trust unit original issue price almost 10 years ago.

Other highlights of this quarter include second quarter aggregate net operating income of $63 million represents an 18% year-over-year increase; net earnings of $31 million for the second quarter of 2007 which are 83% higher than for the same period of 2006; and cash distribution to unitholders totaled $42 million, a 24% increase over the second quarter of 2006.

Now during the quarter, the second quarter [throughputs] on Pembina's conventional pipeline systems were marginally higher year-over-year. Three new pipeline connections and one facility upgrade on the Albertus systems were completed during the quarter. These connections and ongoing industry development saw Pembina's mature service areas as offset declines throughput on these systems in receipt years. Net operating income contribution from the conventional pipeline's totaled $37 million for the quarter which is a 16% increase year-over-year.

The oil sands business segment contributed $10 million in net operating income during the second quarter, up 4% over the same period of 2006. This increase can be largely attributed to the addition of the Cheecham Lateral which was sealed and put into service during the month of April 2007.

During the second quarter, Pembina's midstream business generated net operating income of $15 million, a 33% increase over the same quarter of 2006. Midstream services are now fully operational in the Swan Hills, Cremona and Drayton Valley pipeline systems and further expansion of this business segment is underway.

Substantial growth in midstream services over the past 18 months has resulted in another year-over-year increase in cash flow contribution from this unit. Capital expenditures were significantly higher compared to the same period of 2006. The majority of the increase relates to the Horizon Pipeline project. Activities for the second phase of construction of this pipeline are well underway and we expect to meet the target completion date of July 1st, 2008.

Pembina's thrift plan raised $24 million during the quarter and $47 million for the first six months of 2007. As of June 30th of 2007, Pembina's has prorated its thrift to 0. Subsequent to the end of the quarter the revolving credit facilities were increased from $230 million to $500 million for a period of five years. We will use these lower-cost credit facilities to finance current projects. We may resume the plan in the future should we desire to raise new equity.

Looking at new developments and outlooks. Pembina's outlook for the midstream business remains positive as midstream operations on the Drayton Valley system prepares to full potential over the next few months. Pembina expects to be able to profitably expand this business segment as we continue to develop expertise in this area. Based on current conditions and expectations, we anticipate midstream operating income to improve over the first half of the year by roughly 25 to 30%.

In 2008, Pembina forecast that the net operating income contribution of the midstream business could approach the $100 million level, based on current market and operating conditions. This forecast will be refined in the coming months as Pembina begins the 2008 budget process which will be completed during the fourth quarter of this year.

Pembina is currently evaluating a proposed pipeline project targeting (inaudible) Lake and (inaudible) heavy oil producers in response to industry needs for reliable [diluente] and takeaway capacity. This project could include a 22,000 barrel per day diluente line and over 100,000 barrels a day heavy oil diluente blend pipeline with a total invested new capital estimated at approximately $325 million. Pembina expects to use a combination of new and existing infrastructure and facilities to offer this new service and we will work diligently to obtain shipper commitments by the end of 2007 for a potential start up as early as 2009.

There are a number of new projects under development on the conventional systems with [four] new connections expected to come onstream in the coming months. Pembina has commenced work on a $25 million product segregation facilities on the [P] Systems which are anticipated to the available in early 2008. Product segregation facilities on our Drayton Valley and P Systems serve to maintain and possibly enhance the stream quality on these systems as receipts continue to trend toward higher sulfur content.

The British Columbia Utilities Commission accepted Pembina's application for higher tools on the Western system on an internal basis and the new tools took affect July 1st, 2007. Pembina expects revenue on the Western system to increase over the second half of 2007, as a result.

In closing we are pleased to be announcing a second increase this year in the monthly 2007 distribution rates. This increase demonstrates our confidence and our ability to successfully execute on our business plan and continue on our commitment to Pembina's unitholders. Halfway through 2007 we are pleased to report continued growth across all segments of business and our expectation, based upon knowledge available to us at this time, is that this trend should persist into the foreseeable future.

Thanks for participating in the call this afternoon. I will now turn the call over to [Karen] for questions.

(OPERATOR INSTRUCTIONS). Linda Ezergailis from TD Newcrest.

Just wondering if I can get some clarification on your midstream guidance which I appreciate? So the second half of 2007 would be higher to the whole midstream business or just the non ethylene business?

The whole business.

So then I have a first half of $33 million which implies a $40 million to $43 million?

25 to 30% increase whatever that -- I haven't done the math on that (multiple speakers).

Then similarly for 2008 it would be for the whole midstream?

That is correct.

So 2006 was $44.8 million. Then can you maybe give us an update on the sensitivities or main drivers with respect to midstream earnings? I guess we've had various conversations over the quarters but it is always helpful to get an update and a refinement of our understanding.

I think what maybe I will do is just give you -- here's one estimate. If we have oil prices were at $60 and they increased to $70 and they stayed at $70 for the year, it is about -- it's less than 4% of the difference or change up or change in the amount of midstream revenue we had earned. So it's not a huge -- I guess maybe the long and short of it on a $100 million it's $3.5 million, roughly.

So then what is the rest of it? It's just a flat line steady-state sustainable?

Not really. There have been three phases of activity that are underway so this is only one element of it. But what we're doing is providing the guidance that we are seeing that if oil prices are staying where they are today and everything else stays equal to where we are today, that will be the revenue we expect to generate for the second half of the year, and the revenue we expect to generate from that business for the full year in 2008.

So the oil price underlying assumption is about $75 that you are using?

No. It's roughly, no, I think we're closer to $70 than $75.

So you are assuming $70 oil. What about heavy light differentials or any other assumptions that might cause some variability?

Those I do not have and I have been cautioned by people in our merchants area that there is just too many variables to try to be able to correlate the midstream revenue. That is why we are giving you the guidance that we have to say that based on where we are today, based on the conditions that we have, the differentials that are here today that is what we predict. We project our midstream contribution to be for 2007.

Can you give us some bookends in terms of possibilities five years down the road as to where this might be? I just -- it's very difficult to model on a sustainable basis.

You know what I would think for the next five years we are projecting our volumes to stay fairly constant and we would expect our midstream contribution to be fairly constant over that five-year period. So I think for modeling purposes you would be well-served to use the guidance we are giving you for 2008 seeing that is representative of what we expect, all things being equal going beyond 2008. Now there may be other opportunities that come along, other -- if we get additional volumes coming through our systems and so on which will change that. But I think for model purposes that's the guidance we would give right now.

Okay. Maybe moving on to your financing plans. I see that you've increased your credit facility which is great. Can you give us a sense of what sort of permanent financing you are thinking of putting in place whether it be potentially issuing equity once Horizon is in-service? Or do you plan to leverage up the balance sheet and to what levels?

I will let Peter answer that question.

Yes, no, we will likely do some sort of (technical difficulties) once Horizon is complete in mid 2008. That may be a combination of both equity and term debt, depending what the market place is like for both those (inaudible) at that time.

We retain some flexibility as to what our capital structure is and it may well depend what we plan to do over the next number of years as to how high a level we would care to go at this stage.

Yes. I think it is fair to say in our based modeling that when we look at it we would be looking at taking our leverage up over the next three to four years as we approach the end of our tax grace period.

So I think we are in looking at a structure, you know, the types of projects we are working on, they typically lend themselves to quite a bit of leverage. So 60% debt, 40% equity might be inappropriate longer-term capital structure for a company like ourselves.

So 60% debt and 40% leverage?

40% equity.

Equity, sorry, and what about hybrids?

You mean like converts or other things? No.

Yes.

No. I'm just -- this is really -- we are looking at our traditional financing here. We are not looking at anything -- any hybrids at this stage.

Bob Hastings from Canaccord.

Just a question about your (inaudible) [Stateline]. The original bottom Stateline. Is that project basically dead at this point or what is going on with that?

It is on the back burner still at this stage. We still have ongoing discussions with some of the First Nations along the road to the proposed pipeline. But I don't -- like our customers, our prospective customers I think are still starting out sorting out their longer-term [connaissance] requirements and as a result I think it's going to take months before they sort out what the longer-term needs will be.

So in the meantime we are carrying that project on our own, but we are not spending an awful lot of money on it until we can be certain that there is going to be customers that will be requiring that service. In the meantime the [Nicosee] Project that I talked to a bit about in our script is a project potentially that could effectively replace the C5 initiative in a way that we would be utilizing some of the capacity that we expected to utilize from the condensate initiative but be utilized by that particular project.

So that project would take on -- would have to take on a bit of a new light in view of the fact that there is a potential to utilize on this capacity that we've got here.

Yes. Of course that's where I was going with this, but I guess what I wonder then is that you have been expensing everything you've spent so far on the condensate line?

Yes. Our -- in our income statement there's about $2 million showing up in Other. That is our portion of the expense associated with that line and I think we are planning on spending may be another $.5 million by the end of this year on that initiative.

And then the new line would you be spending very much there or are your customers actually supporting those expenditures?

Yes, we've already spent some amount of money. A lot of the money that we would have spent would have been based on some of the knowledge that we gained from our C5 initiative. So we are not getting very much money on it now and we expect I think, hopefully, that within a month or so we are going to hear back from the [special] customers on that line as well.

How many customers would be in that area that could be (multiple speakers).

Potentially there could be -- I'm going to say guessing maybe seven or eight. There's a number of heavy oil producers in the area currently and so that would be the type or that would be sort of the customer base we would be looking at ultimately going to.

Did some of those customers come up with that proposal or is that --?

Yes, some of them did.

One last question on that. If we were to go ahead, do you envision sort of what structure that might be in terms of across the service structure or incentive structure and then when -- what's the financial structure going to be?

All right now, Bob, I think we would model it a lot like we would something like our Horizon project. Flat returns for let's just say pick a period of time but Horizon we model for 25 years. You know, you could use something like that as well. So it's just set a return on vested capital and flow through operating cost and that would be the way to look at it.

So sort of pseudoregulate it in terms of structure?

Not really. You know, this is a contract and so we are not modeling it off the typical [NEB] type pipeline model. We've looked at a fixed return on vested capital over a period of time and if we (inaudible) sufficient to recover our cost of capital plus, now, in this case, factor for income taxes.

Good job. Thank you.

Tony Courtright from Scotia Capital.

Maybe some of what you've just been saying to Bob leads to an answer, but a simple question on the conventional pipeline system. You have relatively flat throughput, revenue is up sharply, operating expense is relatively flat. How are you getting away with this? Is it because you are recovering cost of capital or capital recovery in your totals? Because your operating expenses certainly are flatlining it.

Yes. I think you have to look at this as -- one, first in response to your question or your observation on operating expenses. The fact that our operating expenses do vary over time. We have got a number of onetime projects where you have not yet incurred the expenditures so those will be coming in the second half of the year and so that will have an influence on operating costs for the second half of the year. And then looking at the pipelines, you have to look at individual pipelines to the extent that volumes have been declining on pipelines or where we have specific programs in place to deal with integrity and repair cost we will have increased the totals to offset the impact of those items and the other items considered is that the sour crude segregation initiative on the Drayton Valley system is ready for service. But it has allowed for us to increase tolls by about $0.25 per barrel and that was the beginning of this year. So that will make a contribution to the conventional systems as well.

So there's a number of factors to consider. So our strategy for the conventional pipeline business is to maintain our margins so, in some cases, like as we are experiencing this first half of the year there will be timing issues. But that is the way we imagined at the end of the day that margin for year-to-year should stay the same.

Karen Taylor from BMO Capital Markets.

I just need to come back to the midstream second segment for a second. So you mentioned a bunch of initiatives that you got going on in the midstream segment, so the guidance that you are giving then of 25 to 30% increase in operating income, second half, all of these things are already washed through that guidance. Is that right?

That's right. That's right. And I did say there are other things that we will be working on, but they are not going to have an impact in 2007 or much of an impact in 2008. There may be projects or initiatives that come on beyond that. But I think for planning purposes, remodeling purposes the guidance that we provided, I think, is fairly -- sort of solid.

So in 2008 you said approaching $100 million?

Yes.

Approaching, can you just give me some --?

That's close enough. I'd say rounded to $100 million in the year is going to be close enough.

You know there is what I would call frac-related businesses mixed in there and I appreciate there's a number of moving variables. But we've got other than just the light/heavy differential and the price of crude oil generally, you've got some products margins in there as well.

So can you give me some sort of indication about what level if we are well in excess of the 6 to 1 ratio of oil and gas, when do I need to start worrying about the guidance, the combination of price? (inaudible) light/heavy differentials and then what sort of product margins do I need to worry about? Can you not provide any parameters on any of these things?

Difficult for us to focus just on one variable. I think, given that there are three elements to our merchants activity and two of which we have some influence on, I think from a company perspective, we are pretty confident that we can maintain the operating income at the levels we are providing guidance at. So I don't think there's a lot of risk to those numbers. I mean, if there is, I mean we will (multiple speakers)

Well, you can say that because you know, but we don't know and I guess what I'm trying to say is or ask is if the reasons that you have confidence we need a little bit more transparency on. Maybe you just leave that for you guys to figure out how to express it but you are throwing a number out there but it's not substantiated in any way.

I guess you are just going to have to take the numbers that we're -- take the information at our word. And then you'll watch as the quarters unfolds and see whether or not you can have any confidence in those numbers. But that's all we are prepared to release at this time.

Okay. The increases in the capital budget, so basically all of this is going to be debt financed going forward. Is that fair?

That's fair for now, yes.

Fai Lee from RBC Capital Markets.

I just want to clarify something. You mentioned when you are talking about the (inaudible) the midstream about oil being at $70 and about 4% possibly on fluctuating with oil prices. What was the base off of?

The base would have been off of about $70. Sorry. $60 was the base so that variability between $60 and $70 was the 3.5% that I had mentioned to you. So it came -- sorry $10 a barrel change in commodity prices yield a 3.5% variance in our operating income from the midstream business unit.

Then, right now, the $100 million, approaching $100 million, is based off of $70 then?

Yes.

And then, in terms of just looking at corollary results it looks like midstream was down a little bit from the first quarter?

Yes.

And what was like oil prices looked like they were increasing (inaudible) -- what was it?

One of the other elements is that there is equalization scales that are adjusted every six months so there was an adjustment that was -- resulted in a lower scale for the second quarter of the year. So that partially offset some of the positive contribution we had for the first quarter, but it is not significant. I think it would -- I would focus more on what guidance we are providing because I think that will give you a better sense as to what to expect for that division.

What are these equalization scales about?

These are set by industry. They have to deal with density penalties on crude oil.

The other question I had with respect to the Cheecham -- did you mention your contribution from Cheecham? I think you talked to revenues. Do you have that --?

Yes I don't know if I've got a number. Do you, Peter, have the number of the contributions? Are you just looking for the contribution for the first six months of the year?

Or even just the quarter what the operating margin contribution was.

Just one sec. About $2 million for the quarter Peter? $2 million. Is that $2 million for the quarter or is that for the first six months?

That was (inaudible) for the first six months.

Yes. The first six months is $2 million.

Contribution from Cheecham?

Yes.

And maintenance cap tax. There was none this quarter. Is that something just to catch up later or just do you expect (multiple speakers).

No. We just reclassified. In the past we have had [Meeting and Capital] showing as a separate item in our distributable cash-flow statement. We just -- we're calling it operating expenses now. As I say, you won't see it in the future again. It's all part of the operating expense.

The last question I have is with respect to your distribution rate. You had increased the distribution today and one of your objectives is to maintain a stable distribution over the long term. Have you done any projections -- the potentially past 2011 or 2010? And how -- whether you can maintain the current distribution rate relative to the new trust tax?

Well, we have done projections and those projections would have to take two assumptions. One, where we stated the trust and we pay a distribution tax to see what the impact of that is; and the other is assuming that we revert to corporate form and pay corporate taxes.

So, yes, we have done projections beyond. But my sense at this stage is I'm not going to talk about what our distributions will be in 2011 or 2012. We are looking at the distributions being sustainable for the foreseeable future which in our view is -- that's at least three to four years.

So I said 2010, but just doesn't -- we should not automatically assume that you are going to be able to maintain this in 2011?

I don't think you just assume that. No you've got to do your own estimates in what do you think our cash flows will be and then factor in taxes, and see what you calculate our (inaudible) cash to be.

Right. Okay, no, that's fair. I just wanted to make sure that -- yes. Just trying to coordinate my calculations with what you might be expecting. Thanks.

Alda Pavao of CIBC World Markets.

I was wondering if you could give us preliminary indications of your CapEx budget for 2008? I guess excluding the Nicosee, the proposed Nicosee pipeline for now?

I don't have that information available at this time. I guess when it -- probably, we probably won't have a good estimate of that until we complete our budget which is typically in the -- generally, for the fourth quarter of the year.

So I think what you can assume is we've got a number of projects that are being completed this year. We are going have some carryover. I think the [P] sour crude segregation project we probably have maybe -- what do you think, Peter? $10 million carrying over in the 2008? We are going to have the balance of the Horizon project completed in 2008 and I am not at this stage aware of any other major capital initiative that we have planned at this time. But clearly if the year progresses and we look into 2008, 2009 we will have a better sense as to what capital we will be spending at that stage.

I would like to move on to what's going on with the WESTERN system at this time as it relates to negotiations around the tolls? I understand one of your larger customers has filed a complaint against the proposed toll increase?

Yes, that's right.

And I believe negotiations are ongoing at this time. You've kind of come to some resolution. I wonder if you can give us a sense as to how those negotiations are going and if they are not able to come to an end that's amenable to both parties, how do you see this proceeding before the BCUC?

I guess first of all, we've got [further] history here. But the position that we put the BC Utility Commission is that the tolls that have been calculated are in accordance with the decision they rendered in 2001. So we are in compliance with that order.

You may recall that the parties, too, who were involved in British Columbia recognized that the decision that was made at the time perhaps didn't provide us an adequate return. So they -- we negotiated a settlement which has now expired.

So in terms of looking how the negotiations go, those same parties that entered into that settlement agreement agreed that the BCUC decision would be a backstop and event that they were unsatisfied with the way we proceeded going forward. So our position is we are in compliance with the decision, the methodology that was used and therefore that's all (inaudible).

If somebody opposes it and they decide that they want to take it to the BC Utility Commission, I guess we can do that. But all we are going to be doing is contesting a decision that's already been made.

Right. But to the extent that you are currently in negotiations to come to some sort of middle ground on this issue?

Not really middle grounds. I think we've given one of the parties an opportunity to look at the commercial arrangements a little bit differently, but it is not a material change in what is been put before the Utility Commission.

I guess what's the timeline, I guess, in terms of when you expect resolution to this tolling issue?

I don't know. If it goes to a hearing, which I don't think it will, I mean a hearing could take some time. And in the meantime, we are going to be charging the tolls that have been set as interruptibles by the BC Tolling Commission.

Then I just want to clarify the note as it relates to the deferred payment for the managements buy in. And I guess my understanding is that -- the $5.4 million that is calculated as of June, end of June. That would not presumably include a distribution increased amount.

Right? That wouldn't represent the distribution increase?

Not certain where the number -- your $5.4 million number came from out that.

Note 4.

(multiple speakers) for release to what the payment that would be made paid from now to the end of December 2008 equates to results that we obtained from the period January 1, 2006, to to date.

So what we are seeing then is if the results for the past -- is it 18 months, Peter? Are the same for the next 18 months it would yield a payment as indicated and that's tied to distributable cash, not what we distribute on it. So it would be the distributed cash is the number that we focus on. Distributable cash, sorry.

Then I guess I want to go back to this -- the midstream guidance. I don't want to beat a dead horse but I do want to have a little bit and better clarity as to the delta that you're guiding to between the first half versus the second half. How much of the delta, the $10 million, the $15 million let's say over second half over first half is related to improved pricing versus, let's say, new product offerings that are ramping up in the second half of the year?

I think most of it is just -- you have to assume that like this is a bit transitional so some of these initiatives were underway during the year, so we wouldn't attribute any of the increase to pricing. I think it's just going to be to continue to roll out of the initiatives in the second half of the year that we are only on for part of the first half of the year.

Then as it relates to the full year, (inaudible) 2008 and the delta between that and the 2007 contributions. Again is that reflective of new product offerings predominantly?

(multiple speakers) Well, I think it's just running at full run rate on all of our pipelines in the full year 2008. There may be some in for sour crude segregation on the Peace Pipeline system and that's -- sorry that may not be applicable.

So I think it is just really going to be full run rate based on what we expect for the second half of this year to apply that same logic to the full year 2008, plus the opening storage facility. I think it will get you a number that is going to approach $100 million.

But does $100 million include new projects that [haven't] necessarily been fully announced in detail?

There would be a significant amount of them.

Karen Taylor from BMO Capital Markets.

Just to follow up on all those last questions you answered and then I think you corrected yourself. So does the $100 million include anything from the sour crude on Peace?

No.

So how much incremental to the $100 million in 2008 would come from Peace?

Well, this would be, the Peace sour crude segregation would be a part of the conventional pipeline services. So we don't have -- and there isn't a -- I'm not going to -- it's not a significant contribution in 2008 just because of the timing of the start up which is going to be sort of second quarter of 2008. So for modeling purposes I think I would ignore it.

Just want to make sure on the segment and capital expense update that was posted to the Web site, at the bottom it says that you've recovered $5.6 million for the shippers on the C5 project.

Yes.

That's not flown through the income statement at all anywhere, is it?

No.

That's just going to cash flow?

It just reduces the capital.

That amount was [previously] capitalized and now we are recovering that capital from the shippers. So it's not an income statement.

Right. Just wanted to make sure.

Yes the only thing I mentioned. Somebody asked a question earlier about what we fund through our income statement. It's roughly $2 million that's showing up in Other on our income statement.

Yes, no, I heard, that, I just want to make sure that the 5.6 wasn't some other place.

No.

(OPERATOR INSTRUCTIONS). Mr. Michaleski, there are no further questions at this time.

Well, if there are any follow-up questions, Peter and I are available to respond to some of these [for] today and tomorrow. So thanks for participating in the call and we look forward to talking to you again soon.

Ladies and gentlemen, this concludes the conference call for today.