桑普拉能源 (SRE) 2004 Q2 法說會逐字稿

Good afternoon. My name is Christy, and I will be your conference facilitator. At this time I would like to welcome everyone to the Sempra Energy 2nd quarter 2004 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during that time simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question press star, then the number 2 on your telephone keypad. Thank you. I would now like to turn today's conference over to Mr. Dennis Arriola. Sir, you may begin your conference.

Thank you. Good afternoon and thanks for joining to us discuss Sempra Energy's 2nd quarter 2004 financial results. A live webcast of this teleconference and slide presentation is available at www.Sempra.com under our investor section. With us today from the company are several members of our management team, including Steve Baum, Chairman and Chief Executive Officer of Sempra Energy, Don Felsinger, President and Chief Operating Officer of Sempra, Neal Schmale, Executive Vice President and Chief Financial Officer of Sempra, Ed Guiles, Group President of Sempra Energy Utilities, Mark Snell, Group President of Sempra Energy Global Enterprises, and Frank Ault, our Senior Vice President and Controller of Sempra. On slide two you have our safe harbor statement. I'd like to remind you this call contains forward-looking statements that are not historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Future results may differ materially from those expressed in the forward-looking statements. These risks, uncertainties and assumptions are described at the bottom of today's press release and are further discussed in the company's reports filed with the Securities and Exchange Commission. In addition some of the financial information we'll be discussing today may contain non-GAAP financial measures. In those cases we will reconcile the financial measures to the most directly comparable GAAP figures. With that I'd now like to turn it over to Steve who will begin with slide 3.

Thanks, Dennis, and thanks to all of you on the call for joining us today. Earlier this morning we reported 2nd quarter net income of $121 million, or 52 cents per diluted share. Compared with $116 million or 55 cents per diluted share for the same period of 2003. Quarterly earnings included an $8 million loss related to the discontinued operations of Atlantic Electric and Gas, a U.K.-based energy marketer which was sold in April of 2004. Second quarter 2004 earnings from continuing operations were 129 million or 55 cents per share. Sempra Energy's 2nd quarter net income rose on higher profits at Sempra Energy Resources, Sempra Energy Trading, and Southern California Gas but earnings per share were affected by a greater number of common shares outstanding. Overall the results of this quarter were consistent with our outlook for this year. For the 1st six months of 2004 Sempra Energy's earnings increased 56% to 318 million or $1.37 per diluted share from 204 million or 98 cents per diluted share during the 1st six months of 2003. Income from continuing operations for the six months of 2004 was $350 million, or $1.51 per share compared to 233 million or $1.12 per share in the 1st six months of 2003. Net income for Sempra Energy Resource and Sempra Energy Trading more than doubled during the 1st half of 2004 to a combined 158 million from 60 million during the same period last year. Now let's turn to slide 4 and go into a little more detail in each of the major business segments beginning with the California utilities. Sempra Energy utilities reported 2nd quarter net income of $80 million compared with $78 million in the same period last year. Net income for San Diego Gas & Electric was $30 million in the 2nd quarter 2004 compared with 41 million in the year ago period. Last year's results included 16 million related to the incentive rate mechanism for the company's 20% interest in the San 0nofrio nuclear generating station. That rate meant mechanism ended in 2003.

Southern California Gas company recorded 2nd quarter net income of $50 million up from 37 million in the same period of 2003. The increase was due to improved operating results in the quarter. Let me spend a few minutes on the status of several utility regulatory proceedings. In December 2003 the utilities filed settlements on phase 1 of the cost of service rate cases with the California Public Utilities Commission. Phase 1 dealt with the capital and operating costs at each of the utilities. We expect a decision later this year with rates retroactive to January 1, 2004. Beginning in the 1st quarter of 2004 the California utilities are recognizing revenues consistent with the proposed settlements. On July 21st, 2004, the active parties in phase 2 of the cost of service proceeding filed for adoption with all parties settlement for most of the issues including annual inflation adjustments and revenue sharing. Although phase 2 covers performance incentives these were not addressed in the settlement and are expected to be decided later this year. The settlement requires the California utilities to file their next rate cases based on new rates going into effect January 1, 2008. For the interim years of 2005 to 2007, the consumer price index will be used to adjust base rate revenues. During the quarter, SDG&E received approval from the CG&E for its regional energy reliability plan. Under the plan SDG&E will acquire a new 550-megawatt natural gas fire power plant called Palomar Energy, being constructed in Escondito, California by Sempra Energy Resources. We expect the plant to be in operation in 2006. The utility also will contract for renewable energy resources and plans to enter into a ten-year power purchase agreement for up to 570 megawatts of electricity.

The new infrastructure including transmission upgrades will add approximately $640 million to utility rate base. Please turn to slide five. Sempra Energy Trading had another strong quarter reporting 2nd quarter 2004 net income of 40 million compared with 35 million in the same period last year. The increase was the result of higher trading margins in metals and oil partially offset by a loss in electric trading and a provision for litigation expense. We continue to see the successful results of trading's diversified business models both geographically and by product line. Tradings daily value at risk, or VAR, the 95% confidence level averaged 6.4 million in the 2nd quarter. Our trading company continues to focus on shorter term transactions and highly liquid markets. Approximately 82% of its unrealized revenues as of June 30 converts into cash within the next 12 months. During the quarter Sempra Energy Trading completed a $1 billion two-year committed credit facility to help finance its global operations. This credit facility is secured by receivables in inventories at Sempra Energy Trading. Please turn to slide 6. Second quarter net income for Sempra Energy Resources rose to 22 million from 5 million last year. The rise in net income was due to increased power sales under its contracts partially offset by provision for litigation expense. In the 2nd quarter 2004 Sempra Energy Resources delivered nearly 3.9 million megawatt hours of power. Over the 1st six months of 2004 the company delivered 8.4 million megawatt hours. As the contracts ramp up we expect deliveries in the 2nd half of the year to surpass that amount.

Last month a subsidiary of Sempra Energy Resources assumed management of the Colleto Creek power station, a 632-megawatt coal-fired Texas power plant and 8 other Texas power plants jointly acquired on a 50/50 basis from American Electric Power by Sempra Energy's wholly owned subsidiary Sempra Energy Partners and Carlisle Riverstone. The $430 million acquisition which was completed July 1, 2004 was financed on a non recourse basis. Sempra Energy's share of equity in the transaction was $53 million. Colleto Creek is expected to add approximately 10 million to Sempra Energy's earnings in the 2nd half of 2004 and 10 to 15 million annually thereafter. Now let's turn to slide 7. Sempra Energy international and Sempra Energy LNG on a combined basis earned $15 million in the 2nd quarter compared with 18 million in the year earlier period. At Sempra Energy international, tax reserves of 11 million and increased development costs were offset partially by improved results in our Mexican operations and by a $5 million gain on the sale of 14% of our interests in Luz Del Sur in Peru. Second quarter results also included a $12 million benefit from the successful resolution of disputes with gas suppliers in Argentina, and the 2nd quarter of 2003 included an 11 million benefit for the first half of this settlement. For the quarter Sempra Energy LNG recorded a net loss of $2 million due to development costs. Year to date Sempra Energy LNG recorded net income of 4 million including an $8 million benefit in the 1st quarter related to favorable buy-out of a future obligation on the Cameron LNG project. We're finalizing the LNG supply and partnership agreements for our Energia Costa Azul facility in Baha, California. We expect to receive our break water permit later this quarter and commenced site development. Our Louisiana facility is fully permitted and we are in discussions with several parties regarding supply agreements.

Last month we announced the advancement of two natural gas storage projects. Both facilities will be in Louisiana close to Henry Hub, the nation's largest natural gas trading center both of these project provide a good opportunity to bring additional gas storage to the Gulf Coast market while capitalizing on significant demand from LNG and pipeline projects there. The company has filed with the federal energy regulatory commission to construct and operate its Pine Prairie energy center gas storage facility. The facility will have a total working capacity of 24 billion cubic feet of natural gas and will be in operation by the 4th quarter of 2005. We also announced we have acquired the rights to develop a salt cavern gas storage facility called Liberty Gas Storage with a capacity of 17 billion cubic feet of working gas. Sempra Energy global enterprises has completed another gas storage facility called Bluewater Gas Storage in Michigan. This facility has a gas storage capacity of 27 billion cubic feet and began operations in May of 2004. Please turn to slide 8 for a summary of our business unit results. In the 2nd quarter, our retail marketing group, Sempra Energy Solutions, recorded net income of 3 million. Compared with net income of 8 million in the same period last year. The variance is primarily due to lower commodity margins. Solutions is focused on expanding its commodity business.

Last month Sempra Energy Solutions sold 122 megawatts for five years or more from the Colleto Creek power plant recently purchased by Sempra Energy partners. Earlier this week Solutions became the first U.S. company to sign contracts to export electricity to commercial and industrial business customers in Mexico. Sempra Energy financial recorded 2nd quarter net income of 6 million compared with 8 million in the same period last year. The decrease is due to reduced section 42 housing credits. On July 1, Sempra Energy financial sold all of its investments in section 29 tax credits due to the company's alternative minimum tax position. Sempra Energy Trading continues to hold investments in section 29 tax credits. The sale of Sempra Energy financial's credits will marginally reduce net income and increase cash flow from that business unit. This change was anticipated in the updated earnings guidance we provided in June. Overall we expect Sempra Energy financial to earn net income of approximately 25 million in 2004, including the impact from the sale of the 29 credits -- section 29 credits. Expenses impaired and other were 37 million in the 2nd quarter compared with 36 million in the same period of 2003. Expenses for the six months ended June 30th, 2004 were 41 million down from the 60 million in the same period of 2003. The year-over-year decrease in expenses is the result of consolidated tax benefits in 2004 and 5 million of losses on Atlantic Electric & Gas included in 2003 results. Sempra Energy's effective tax rate for the six months of 2004 was 20% and is expected to remain at that level for the full year. Now please turn to slide 9.

As discussed in June at our analyst conference, our 2004 earnings guidance is $2.90 to $3.10 per share. This is based on a net income range of approximately 680 million to 730 million, with earnings to date at 318 million, including discontinued operations of 32 million, you can see that we're on track to meet our earnings outlook. There's some key earnings drivers in the 2nd half of the year that I'd like to highlight. For the last several years SDG&E's revenues have been more weighted toward the 2nd half of the year. We expect this trend to continue in 2004. In addition, the utilities currently have 61 million pretax in incentive awards pending at the Public Utility Commission. Sempra Energy Resources contracts are ramping up with increased contracted volumes to be delivered in the 3rd and 4th quarters. And the acquisition of Colleto Creek in July should add about 10 million in earnings in the 2nd half of the year. All of these factors and our solid performance year to date put us on track to meet our $2.90 to $3.10, which is GAAP, earnings per share guidance. Before opening up the call for questions I want to review some of the recent management changes we've made at Sempra Energy as part of our ongoing management success plan. As we announced in June Don Felsinger was appointed President and Chief Operating Officer of Sempra Energy and is slated to become Chief Executive Officer after I retire at the end of January 2006. Most of you know Don from his role as Group President of Sempra Energy Global Enterprises and you'll be seeing more of him on the road in the future. In addition Don and Neal Schmale our Chief Financial Officer were both elected to the board of directors and Neal is slated to move into the Chief Operating Officer's role when Don becomes Chief Executive Officer in 2006.

Yesterday we announced Mark Snell has been named Group President of Sempra Energy Global Enterprises. Mark previously was our Chief Financial Officer at Global Enterprises and has been a key member of our team. Mark will continue to work closely with our business unit leaders as we focus on new opportunities in the market. I'm pleased we have a solid team in place to lead this company into the future. Now I'll open the call for questions.

At this time I would like to remind everyone in order to ask a question, please press star, then the number 1 on your telephone keypad. To withdraw your question press star, then the number 2. We'll pause for just a moment to compile the Q and A roster. Your first question is from David Maccarrone from Goldman Sachs.

Steve, I was wondering if could you update us on the expected timing of the final LNG supply agreements for each Costa Azul and Cameron and give us a sense for timing of construction spending and the impact that any potential delays from a mid '07 full ramp-up might have on your approach to paying out a higher dividend.

First of all good afternoon David and congratulations on the birth of your daughter.

Thank you.

Must be very excited.

Very.

Don Felsinger will answer that question.

David, let me cover off on the two facilities, Costa Azul and Camaron, Louisiana. Even though we have a confidentiality agreement in place with BP in Indonesia let me repeat what's been said publicly by the government of Indonesia, and that is that they expect to sign supply agreements with us sometime in August or September so we would expect to conclude those arrangements in the next couple of months and we have recently started access to the facility by building a freeway overpass and access road to the site in preparation for construction so we're on our construction spend schedule for that facility. Regarding Cameron, we have all permits in place and we are in commercial discussions with several different upstream shippers, and those should be brought to some conclusion by the end of this year. I think the thing that's important to remember about LNG right now is that there is a shortage of LNG supplies, and as you have read, it looks like that at a time when North America could expect significant quantities, probably in 2008. As we firm up our commercial arrangements we will know exactly when deliveries will take place but right now we have the capability to have these plants in operation the end 2007 but we'll wait and see what the market needs in terms of delivery points.

Okay. Thank you. And with respect to the dividend and timing of the spending?

The capital spending?

Capital spending is on a plan we've announced. We have no information to make any changes to it.

Okay. Thank you.

Your next question is from Sam Brockwell of Merrill Lynch.

Good afternoon.

Hi, Sam.

Couple of quick questions. There was recently some press coverage of some local issues at the Costa Azul facility. Wondering if could you address that. Secondly, as we look out towards the 2nd half of '04, and into '05, do you see any O&M items? I'm thinking specifically of legal expenses, legacy from all the California issues that might be tapering off --.

Sam, you're fading off. Could you repeat that last bit about '04-'05 O&M?

Yea, as we look into '04 and '05, I'm thinking in terms of legal expenses you've been incurring with respect to the California issues. Do you see those tapering off, and finally, with respect to resources, you indicated that you expect a pretty nice uptick in the 2nd half of '04. Can you maybe give us a little more color on the ramp-up in deliveries and how we should think about in that terms of the impact on net income?

Okay. Let me just mention that you should probably ignore the local press on Costa Azul because they're wrong, and there are no pending injunctions or legal problems with respect to that. We've cleared all of that and remain clear, and I don't know -- Don, whether you want to comment further on that.

Steve, what I would say is that state elections took place last week in Baja and because of the elections taking place there's a lot of misinformation about LNG projects. As Steve said we have no injunctions against the site that exists and we are ready to start construction as soon as we have commercial agreements in place.

And the candidate that suggested that the site ought to be moved was defeated. Now, in terms of the O&M issues and legal expenses in '04 and '05, the trial -- well, let me put it this way. We would expect legal expenses to begin to taper off towards the end of -- towards the end of this year and into the 1st quarter of next. I mean, you can never predict precisely what new litigation may appear but if we're seeing most of what we have in terms of the California type litigation, the discovery phase is pretty much completed. That's a very expensive phase of the proceedings, and I would expect that we would not see any great increase in those expenses beyond the end of -- beyond the end of this year. And lastly maybe Don you want to talk about resources. The question was the ramp-up of power and resources.

Our contract with the state of California is a major driver behind the sales and resources and the 1st two quarters of the year are the quarters where because of seasonal requirements we deliver the least amount of volume. The 2nd two quarters of the year are when we deliver the highest volume so we expect an increase in sales and revenue the 2nd half of the year out of the resources business.

Let me give you a little bit more color on the litigation expense. We took a reserve, a combined litigation reserve this quarter of $10 million after tax. The -- that was spread predominantly between -- well, it was spread between trading and resources. The majority of it was at resources. The foundation of that reserve comes from the fact that the FERC has published new gas price numbers which are lower for the calculation of California refunds, and we went back and looked at the reserve we had at the previous higher gas prices, and recalculated that and took an additional reserve which was net 10 million this quarter.

Okay. Then just going back to Costa Azul for a second. You mentioned you're basically ready to commence construction once you get commercial agreements in place. Do you have any kind of rough time frame when you think you'll actually be getting underway there?

We've gone out to bid, we and Shell, so we're waiting for bids due back the 4th quarter of this year, early part of the 4th quarter. We're moving ahead and building freeway off-ramp, access road to the sites in a preconstruction mode but we ought to be in a position to have firm bids in place and start construction in the last quarter of this year.

Thanks a lot.

Your next question is from Mike Heim of A.G. Edwards.

I was hoping to get a little bit more color on the oil margins for the trading. Obviously real good numbers with the volumes. Anything that can help us understand why that was going on?

Don, you want to --.

Well, I mean, so much volatility in the marketplace right now with prices reaching record highs that there's just a lot of activity and opportunities to make money in the oil business as we look forward in the trading book with current sustained high gas prices, with oil prices at a level that we haven't seen before, and metals prices, we continue to see kind of a good outcome for that business unit.

Okay. I think the other questions I had have been answered.

Your next question is from Anatol Feygin with Banc of America.

Good morning, everyone. Couple questions on the regulatory front. We haven't seen obviously the PD yet in phase 1 and if my understanding was correct it had to have been issued by now to be on the early September agenda. Is that correct, and when would you guys expect the next kind of possible date to be for the PD to be issued and then considered by the PUC?

This Ed Guiles. You're right, we have not seen a PD. If you look at the schedule, I think essentially once the PD is issued there's a 30-day comment period. If you look out in August I think it would be about August 24th, then subsequent to that there's a meeting on September 23rd. So that would be kind of the next opportunity here.

Great. And in terms of the 61 million in incentive awards do you guys have a feel for when the PUC will consider those?

I'm sorry, Anatol, I didn't hear the first part of that question. Can you repeat that?

On the 61 million in the performance-based awards is there a sense for when that will be on the agenda?

No, I think it's really, you know, about 8 million of that is concerning operating incentives at SDG&E. We think that will be in the last quarter specifically. With respect to the DSM awards, those are outstanding and could come at any time.

Great.

Let me add, on the timing of rate case decisions and PDs, what we're seeing is, although it seems to have stretched on, compared to what the timing for the Edison and PG&E rate cases that were recently completed it is not particularly out of order in terms of time. Those were very extended processes, so I guess we're not really surprised.

Sure. I just -- you know, I think every time we talk about this issue we think that the PD is a couple days away or a couple weeks away, and that's stretched out for four or five months now, so just wanted to get the latest update there. Also, Steve, you had mentioned, in terms of your guys' sense for how Colleto will do, about 10 million in the 2nd half of this year but I think you mentioned full year '05 expecting a comparable contribution. Just wanted to get some more color on why, you know, full year's impact of Colleto isn't going to be appreciably different than H2 of '04.

We had one extra ordinary pickup with respect to the transaction in this quarter and that accounts for the slight distortion.

Gotcha. One last question on S&P as it relates to two things. One, their analysis of trading businesses and stressed liquidity. Have you guys had further meetings with them and gotten some sense for how they feel about this billion dollar facility at the trading level? And two, again, S&P related, as they have increased the business risk for the overall company have there been follow-up discussions on that and any repercussions from it?

Neal Schmale will take this.

First of all, with respect to the liquidity, we have an ongoing discussion with S&P about the liquidity and I would comment that we have the billion dollar line at trading, we have a couple of billion dollars of additional lines at the parent that are taken into consideration. There's another line of around 250 million above and beyond that, so we have a lot of liquidity. And what we're doing with S&P right now is talking about the details of the calculation. But I'm very comfortable that this company has ample Iiquidity to deal with the trading company with greater than $3 billion of lines that I just described. With respect to the change in the business position, at the same time that they changed the business position they also change the numbers that were required for the performance of things like cash flow from operations to total debt and the effect of that was that even though the business position changed, kind of the targets that two meet to reach, for example, a triple B+ rating didn't change that much.

Great. Thanks very much for your answers everyone.

Your next question is from Ashar Khan of SAC Capital.

Good morning, gentlemen. I was just trying to get a sense as to what is the further loss of earnings expected for the last half of the year?

Well, first of all, hi, Ashar, how are you? Ed can -- or maybe Frank -- why don't you --.

Why don't I go ahead and take that. As we mentioned we did have an isep loss in the 2nd quarter, it was about 16 million, and about 28 million year to date that run rate would put us in the 50, 55 range for the year. I think we've probably said before it's going to be about 50 million or so after tax. We seem to be right on track with our expectation there.

Will that then be ratably more like in the 3rd quarter and then less in the 4th quarter as look at -- as you report earnings?

By quarter it was actually based on the output of the nuclear generating facility in 2003, and I don't have the quarterly information on output so I can't tell you exactly but there was no major outages during either period, so it should be pretty routable over the remaining half of the year.

I just wanted to add a couple of things. One, during this period Edison did get their rate case approved, as you know, which covers the revenue requirement for our piece of 20% ownership. It's essentially for the base O&M and for overhaul expenses at about $100 million a year. When you go back and look at the overall settlement that's been filed and you look at the impact on SDG&E we're recognizing income consistent with the settlement. As you look at the longer terms, it reflect the loss of isep, but also the true-up of rate base at SDG&E. So we've got those two things working.

How much of PBR incentives do you plan to book, I guess in your plan, as you outlined to us month back to meet your projections in the back half of the year?

When we gave you our projections before one of the reasons for the range, as you recall, I think was 380 to 430. We've got, as I mentioned earlier, $61 million outstanding in PBR incentives. We don't recognize them until they're actually approved by the commission. I feel pretty confident about the $8 million in the operating incentives at SDG&E with respect to the DSM there's less of a probability that we'll get those before the end of the year. We've got $48 million outstanding there. We were looking in our range of estimates to receive 24 million pretax and we'll just have to see if we get that in the 4th quarter.

And just going to the trading side of the business, I'm assuming that the volatility in the petroleum, which has continued on into the 3rd quarter, should I guess help going forward. Could you just give us a little bit more information on the metals market, what's happening recently?

This is Don Felsinger. When you think about metals, the primary driver on our metals book has been copper. If you go back to the beginning of this year, worldwide there was probably between 800 million and a billion pounds of -- 800 to a million tons of copper in storage. That basically has been depleted, so there's no inventories right now. The shortage in the supply chain has been mining. There's plenty of smelting and refining capacity. Starting out earlier this year when there was this mud slide or cave in at the Grass Roots mine in Indonesia we started to see a shortage of raw materials going into smelters. That has been fixed. We have seen other mines increase their production. There's been some brown field development, also some green field mining started. It is our expectation that those prices will continue to be strong in the 2nd half of this year and then they'll reach equilibrium next year. I don't expect the 2nd half to be as good as the 1st half. It's going to be strong. I would expect next year would be a normal year for metals.

Thanks, Don, I really appreciate it.

Your next question is from Michael Goldenberg of Luminous Management.

Hey, good morning, guys. Wanted to ask a couple of questions on fuels. Did I hear you right that you have sold the section 29 tax credits at the level that were yielding about [inaudible] net income?

Yes, and, Frank, why don't you just run through that.

We, in our forecast for the year, have anticipated selling those section 29 credits in the midpoint of the year so we actually sold it right on our plan, July 1, and our forecast of earnings for the year took that into consideration as Steve said in his prepared remarks we're anticipating earnings of about 25 million from Sempra Energy financial this year. The basic reason that we sold them was that they carry more value to others than they do to us because of our current tax position it would be a little longer time before we could fully utilize them. There's other entities that could use them sooner so we're going to even though have a slight decline in earnings from that we will have an improvement in our cash flows.

Okay. So let me just get this straight. These tax credits were beyond the 20% AM T rate, so they weren't actually yielding cash because you get enough tax credits with section 42 and trading section 29?

That's correct.

And how much net income did you end up getting for the year? About 4 or 5 mil?

On the net income from the section -- Sempra financial?

Yes.

We are, for the year, on section 29s, at Sempra financial, sitting at about 8.6 million, 9 million.

And this is a one-time transaction? You got one lump-sum payment but there are no kind of ways of -- for the buyer to back out if some IRS issue comes up or something like that?

First of all, let me correct one thing. We did not get a one-time payment. We earn the credits as the other party utilizes then, which, of course, they'll utilize them much more rapidly than we would have utilized it. So the cash will be coming in over the next few years but much quicker than had we used them ourselves.

And going to go through the income statement?

No, we would not anticipate them going through the income statement probably until the 2nd part of next year. Basically we will, as we recover the money, it will go first against our investment and once we have fully recovered our investment then any continued receipt would, in fact, flow to the bottom line.

On trading, can you comment maybe just in terms of [inaudible] California, first it was expectation of really hot weather. I don't know how it's panning out but if this is having negative or positive effects overall on your power trading position and also whatever merchant position you have at your resources portfolio.

Don, you want to take that?

I think if you look at what the state of California said, from the standpoint of getting through this summer that if we have normal weather it shouldn't be an issue but with hot weather the reserve margins will drop down into the 4 to 5% range. As we looked at customers, though, customers have been unwilling, because I guess just where they are to sign up for any long-term electric supply contracts. We have see the spark spread increase which would be a driver for new generation but because of the uncertainty of what role utilities would play and what role the merchant market would play we haven't seen any plants being put forward from. The standpoint of our business at trading it looks like that much like we would do, that people at own power plants would like to sell this forward for three, four, five years at a time and that's a business in trading that we currently are not engaged in so we have not participated in that market.

Makes sense. Final questions just on solutions. In terms of lack of profitability or lack of sustainable profitability is it lack of volume being generated by the business as in new clients coming into the slower than expected, or are the margins lower than you have originally anticipated when you entered the business?

It's really both. It's the universe of customers that are available -- that can enter into transactions, because California and other states have put a halt to direct access, so we're not seeing the markets open up as we thought they would, and then the margins in general are lower than they were a year or two years ago.

Any particular market solution you're focusing on?

Well, we just did a lot of business in Texas earlier this half, so that's an attractive market for us, doing business there.

Thank you very much. Good luck and congratulations to Mark Snell on his new post.

Your next question is from Fifel Khan [ph] of Credit Suisse First Boston.

Couple of questions. If you could just comment on the share count going up about 7 million on a diluted basis from the 4th quarter of '03 to today, then if you can also comment on the negative margins that power what caused that in the quarter and, resources, if you could explain the variability sequentially from the 1st quarter to the 2nd quarter in net income from 37 to 22. Thanks.

Okay. Let me just comment on the share count. I mean, first of all let me -- everyone should understand we're using a 235 million share number for our EPS range calculation, so you can start with that point. We have had in operation at new issue both our dividend reinvestment plan and our savings plan, the 401(k). That is generally the contributor beyond the shares that we issued in the first -- I guess it was the 1st quarter we had the share issuance. Sorry, the 4th quarter is when we had the share issuance so it's really these continuing streams from our plans that are contributing to the increase and number of shares outstanding. We, of course, retain the discretion to modulate that as we see fit. In terms of the negative power margin, Don maybe you want to give a comment on that.

Power margins?

Yes.

There were two issues that had an impact on trading this quarter. As Steve mentioned in his opening remarks we took an additional reserve because of the FERC refund settlement that we're working our way through. Then the other issue was about five years ago we entered into a tolling arrangement to have the ability bring gas to some generation on the East Coast and sell the electricity. We're five years into the agreement. We make monthly payments every month for the right to have that option. As we take a look at gas praises and electric prices we decided to remark that position so that was another driver that changed the earnings in a downward way.

X that adjustment the power back was positive.

How much of that tolling arrangement, that demand payment?

I don't think we disclosed that.

Your last question was about resources and the expected change?

The variability from the 1st quarter to the 2nd quarter today sequentially from 37 to 22 million.

Once again, two main drivers. Part of the FERC refund settlement was allocated to resources, that was mentioned earlier. The second is the variability of the contract sales to BWR as part of the contract, volumes were down 4 or 5% in the 2nd quarter from the 1st quarter so those two are main drivers in the business.

That contracts then ramps up over the summer period so it -- you see increased volumes as you go later into the year.

Okay. Fair enough. Thank you.

Your next question is from Jay Hatfield of Zimmer Lucas.

Good morning. How are you doing?

Fine.

Wanted to see if there was anything unusual about corporate and other. There was, I guess, 37 million for the quarter which was much higher than the sequential quarter and also high relative to your annual guidance and I guess what we would estimate for corporate interest expenses. Anything unusual going on?

There are some timing issues as you deal with the whole issue of parent and other. Remember each of the business units does its own stand-alone tax calculation, and at the consolidated level we have either a benefit or a negative impact depending on the quarter as to how each individual business unit performed compared to where it's expected to do for the full year. As a consequence of that we had on the consolidated level a favorable impact in the 1st quarter and in the 2nd quarter basically reversed. If you are to take a look at our bottom line for the period of the 1st six months we have a loss at the parent level of 41 million and we have interest expense of 35, and that's at a run rate that we would anticipate continuing so we would anticipate probably interest in the 70 million range for the year and probably somewhere on the bottom line maybe in the $80 million or so loss. So on average we're probably running about 20 million other than these consolidated tax timing issues that negate by the end of the year.

So for the quarter if we were trying to get to kind of a ongoing or, you know, ongoing number then you should really add back the 17 million tax?

I would say that, you know, it was timing difference between the two quarters. If you looked at the six months we're really kind of on track to our expected run rate.

Okay. So the 17 is kind of a -- sort of above normal and reversal of the 1st quarter?

That's correct.

Okay. That's very helpful. Thank you.

Your next question is from Paul Patterson of Glenrock Associates.

Good morning. Good afternoon, how are you?

Fine. How are you?

All right. Wanted to ask you about the syn fuel plants. There's been some issues with other companies regarding the in-service date, particular with Marriott and progress, and was wondering if could you comment on your position with respect to that or if the IRS has contacted you.

Frank can deal with this.

We have been audited at both of our facilities, both the one that we just sold and also the one at trading. This issue has not come up in those audits. We believe we have very strong records support ting the inservice date and service has not raised it in spite of the audits we've done so we're not anticipating any difficulties in this area.

Could you remind of us the manufacturer of the plant, the type of plants they are? Are they coball or earthco?

Different ones.

Variety. I don't think we have that information right here.

Touch base with you later.

Get ahold of Dennis and he'll get you that information.

Okay, that's great. The litigation expense, could you just elaborate what you're expecting for 2004 the litigation expense to be?

I don't know that we break that out. I don't think we've broken that out and I'm not sure that we're going to actually.

You don't break it out so out, so okay, there you go. Let me ask you this. On trading CapEx it seems to have gone up substantially from 12 million to the first six months to 82 million.

Yeah, that was if Bluewater -- completion of the Bluewater storage facility which went into operation in May.

That explains the 35. Okay. That makes sense. The 20% tax rate for 2004, what should we expect in 2005? Any outlook we might see in terms of tax rate going out that far? Should we just pretty much assume it will be in that neighborhood in 2005?

I believe 2005 will probably see a little bit of increase so for the 1st six month of this year it was 20% which is where we anticipate for the year. Last year it was about 18% for the 1st six months. Remember we have sold a section 29 credits related to Sempra Energy financial. That will cause by itself a slightly higher effective tax rate next year so I think it will be in the low 20s, probably in the 22 to 25% range.

And then is there any way we might be able to get an idea how much expense might be going away as this litigation stuff is rectified in 2005, or beginning of 2005?

We're not making that estimate right now. We're not discussing anything publicly in that regard.

Okay. Fair enough. Hope all is going well with you guys. Take care.

Steve, there was an earlier question I wanted to clarify. There's a lot of questions about the resource contract. And this is public information but if you look at the contract just to give people a sense of how revenues flow in, the 1st quarter is the strongest with 26% of revenues, 2nd quarter drops off to 20%, last two quarters jump up to 27% each so people can see the revenue from that contract really comes in the 2nd half of the year.

Your next question is from Leslie Rich of Columbia Management Group.

Hi. Just wondered if you could clarify for me your --.

Speak up, please.

Could you please clarify your total expected syn fuel earnings in 2004-2005? I know you said financial year to date it was 8.6 million but if could you say on a consolidated basis what it will be for full year '04 and '05.

Go ahead, Frank.

For the syn fuels for the 1st half of this year we've, bottom line net income made about $20 million and I would anticipate that we will see that number in the 30 to $35 million range by the end of the year remembering that we have sold our section 29 credits with Sempra Energy financial. As we move forward into next year I would anticipate that we will see net income in the 20 to $25 million range from the syn fuel trading company.

Thank you.

There are no further questions at this time. I would now like to turn conference back over to Mr. Dennis Arriola for any closing remarks.

Thank you very much for joining us. As usual, we'll be around to answer any follow-up questions. We look forward to talking to you in the city. We're going to be at several of the sell side conferences in September so hopefully we'll hook up for some meetings. Thanks a lot and have a good day.

This concludes today's conference call. You may now disconnect.