桑普拉能源 (SRE) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Sempra Energy second quarter earnings results conference call. [OPERATOR INSTRUCTIONS] Thank you. Mr.Arriola, you may begin your conference.

Thank you very much and good afternoon. Thanks again for joining us to discuss Sempra Energy second quarter 2006 financial results. A live webcast of this teleconference and slide presentation is available on our website at www.sempra.com under our investor section. With us today here in San Diego from the Company are several members of our management team, including Don Felsinger, our Chairman and Chief Executive Officer, Neal Schmale, President and Chief Operating Officer; Mark Snell, our Executive Vice President and Chief Financial Officer; Ed Guiles, Group President of Sempra Utilities; Joe Householder, our Senior Vice President and Controller.

Slide 2 contains our Safe Harbor statement. I'd like to remind that you this call contains forward-looking statements that are not historical fact and constitute forward-looking statements within the meaning of the Private Securities 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 will be discussing today contains non-GAAP financial measures. In those cases, we will reconcile those financial measures to the most directly comparable GAAP figures and the reconciliations will be attached as appendices to our slide presentation that's also available on the web. With that, I'd now like to turn it over to Don, who will begin with slide 3 of the presentation.

Thanks, Dennis. And thanks to all of you for joining us on the call today. Before continuing, I just wanted to say how pleased I am with the performance of our business this year, and our outlook for the remainder of the year. We are continuing to improve Sempra's positioning in the natural gas infrastructure market place and I look forward to updating you on some of these developments. I'm also very pleased with the results of our asset sales and the significant cash proceeds generated. As part of this call, I'll go into greater detail on each of these issues.

Now, let me talk about the quarter. Earlier this morning we reported second quarter 2006 net income of $373 million or $1.43 per diluted share compared with net income of $121 million or $0.48 per diluted share in the same period last year. Income from continuing operations was $185 million in the second quarter or $0.71 per diluted share and included a $7 million impairment charge related to the sake of the Texas gas plants. This $185 million from continuing operations is a 55% increase over the $119 million or $0.47 per diluted share we reported in the second quarter of 2005. Total earnings in the second quarter of 2006 included $188 million in discontinued operations, primarily related to gains from asset sales offset by impairment charges from asset sales held for sale.

For the first 6 months of 2006, Sempra Energy's net income increased to $628 million or $2.42 per diluted share from $344 million or $1.40 per diluted share during the first 6 months of 2005. Earnings per share from continuing operations for the same 6 month period increased 17% to $1.61 year-to-date compared with $1.38 for the first 6 months of 2005. Based on our strong performance through the second quarter and the high degree of confidence we have on our plan for the second half of this year, we are reaffirming our 2006 earnings per share guidance of $3.40 to $3.60, which includes -- which excludes gains from our asset sales.

It's also important to point out that income from continuing operations improved in spite of a higher effective tax rate. Earnings in the first half of 2006 reflect a tax rate of 34% versus 12% for the same period last year. Another key metric we focus on, earnings before interest, taxes, depreciation, and amortization or EBITDA was up over 33% in the first half of 2006 compared with the first 6 months of 2005. By all accounts, the first half of 2006 was one of the most successful periods in the history of Sempra Energy.

For analysis of our comparable earnings, please go to slide 4. After eliminating unusual items, Sempra Energy's comparable second quarter net income was $165 million or $0.63 per diluted share versus comparable net income of $118 million or $0.47 per diluted share for the same period last year. Representing a 34% increase. For the first 6 months of 2006, Sempra Energy had comparable earnings of 418 million or $1.61 per diluted share, up 40% compared with 2005 results of $283 million or $1.15 per diluted share.

Now let's go to slide 5 and I'll provide a little more detail in each of our major business segments beginning with our California utilities. The Sempra utilities reported second quarter 2006 net income of $123 million compared with $87 million in the second quarter of 2005. Net income for Sempra utilities for the first six months of 2006 was $219 million compared with $215 million in the first 6 months of 2005.

At San Diego Gas & Electric, net income in the second quarter 2006 was $65 million compared with $29 million in the second quarter 2005. Second quarter 2006 results included $12 million in benefits from favorable regulatory matters and $4 million in performance-based rate making awards, both of which of we anticipated in our earnings plan. The remaining increase in earnings is due primarily to higher authorized revenue from the Oakford nuclear generating station and the addition of the Palomar Energy Center which was placed in service ahead of schedule in the beginning of the second quarter.

At southern California gas, second quarter 2006 net income was flat at $58 million. Second quarter 2006 results included a $3 million litigation credit offset by increased revenue sharing, higher interest expense, and higher operating costs. For the 6 months ended June 30, 2006, SoCal gas recorded net income of $107 million compared with net income of $127 million for the same period last year. Results for the first 6 months of 2005 benefited from a favorable regulatory adjustment and a favorable resolution of tax issues.

For the past several weeks, southern California, like much of the country, has been experiencing record temperatures. Our electric utility, San Diego Gas & Electric, has done an exceptional job of maintaining reliability of the electrical system during this trying time. On July 22, SDG&E customers set a new all-time record for power consumption of 4 ,502 megawatts. What is so interesting about this new record is that it occurred on a Saturday and was 50% higher than experienced -- expected for a typical weekend load. At one point, our two major transmission corridors were threatened by wildfires, further endangering our ability to provide service to thousands of customers. Our employees work closely with local and state firefighters and were able to avoid any major disruptions. These events reinforce the need for a third transmission corridor for our service territory, which the sunrise power link will provide. This 500kb transmission line was endorsed by the independent system operator staff last week and before the ISO's Board of Governors today. SDG&E's objective is to have the California Public Utilities Commission approval of the Sunrise power lane by mid2007 and have it operational in 2010.

Now, let's go to slide 6 for an update on the utilities general rate case filing. On Tuesday, SDG&E and SoCal gas filed a notice of intent for the general rate case for rates effective January 1, 2008. The rate case covers operational and capital cost. In general, the rate belt line and notice of intent are consistent with the financial plans we provided at our analyst conference in March. It is also important to note that commodity costs are a pass-through to customers and are not part of this proceeding. Similarly, the utilities authorized returns and capital structures are also determined in a separate proceeding. The rate case application will be made in December of this year, followed by hearings with a final decision expected in December, 2007.

Now please go to slide 7 for an update on Sempra Commodities results. Second quarter 2006 net income for Sempra Commodities was $69 million compared with 26 million in the year earlier period. In the quarter, we had strong results from our North American natural gas business, driven by continued market volatility. North American Power also produced robust results in this period. These results included the positive impact of a natural gas marketing agreement entered into with Sempra LNG for market gas from the Energia Costa Azul LNG facility. Sempra Commodities synthetic fuel tax credits contributed $10 million in net income in the first half of 2006. At our analyst conference in March, we forecasted that 2006 earnings from tax credits at commodities would be $15 million. Down from the $36 million last year. The decrease is due to an assumed phaseout of the credits. We continue to expect a net income contribution of approximately $15 million for the full year 2006.

Commodities second quarter 2006 mark-to-market earnings were $83 million compared with $77 million in the year-ago period. Sempra Commodities is ahead of last year's pace with $243 million in mark-to-market earnings for the first 6 months of 2006 compared with $129 million for the first 6 months of 2005. Commodities excellent results continue the positive trend we have seen over the past several quarters and represents commodities 30th consecutive quarter of profitability. Since we acquired this business in 1997, commodities has contributed approximately $1.6 billion in earnings to Sempra Energy.

Now, please go to slide 8. Sempra Generation second quarter net income was $17 million in 2006 compared with $22 million in 2005. Earnings for the quarter were negatively impacted by the $7 million impairment related to the sale of the Texas gas plants. The sale of the Texas gas plants as well as a Coleto Creek coal-fired plant closed on June 10. Applicable accounting rules require us to record the gas plant impairment in the second quarter and the Coleto Creek after-tax gain of $208 million in the third quarter. Both the impairment and sale will be recorded as continuing operations.

To assist you in understanding the accounting impact of our asset sales, we have provided a summary of the asset sales on slide 12 and a breakout of discontinued operations in the appendix to this presentation. As a result of our asset sales, Sempra Generation is now focused on natural gas-fired generation in the southwest. We own or have interest in five facilities that have over 2600 megawatts of on-peak capacity. These are all new gas-fired combined cycle power plants with 7,000 btu per kilowatt hour heat rates and at the contracts we have signed, approximately 80% of our capacity remains hedged through 2010 which means predictable earnings and cash flow. We anticipate increased operating earnings from our generation business during the second half of the year, due to the normal ramp-up of deliveries under the California Department of Water Resources contract. The contract of deliveries increased from an average on-peak amount of 1550 megawatts in the first half of the year to 19 megawatts in the second half.

Now, let's go to slide 9 and cover pipelines and storage. For the second quarter 2006, Sempra pipelines and storage reported net income of $28 million compared with $16 million in the same period in 2005. The increase is primarily due to a $9 million benefit related to the favorable resolution of prior years' income tax issues. Last year second quarter included a $3 million gain related to the sale of 25% of the liberty gas storage project.

Let me now give you an update on our rocket express pipeline project with Kinder Morgan. In June, ConocoPhillips exercised an option to join the Rockies Express pipeline, bringing Sempra Energy share of the $4.4 billion project to 25%. This is the ownership percentage we assumed in our financial projections provided at our analyst conference in March. On July 14, Rockies Express pipeline completed an open season for 100-mile extension to the east, which would give us greater access to eastern markets. Over 1 billion cubic feet a day of capacity subscription has been received and negotiations will continue with perspective shippers to finalize the size and scope for the project. The Rockies Express pipeline is an important project for producers and shippers and we are excited about the additional opportunities it can present to Sempra Energy in the future.

Now let's go to slide 10 for an update on our LNG business. For the second quarter 2006, Sempra LNG recorded a net loss of $17 million compared with a net loss of $5 million in the second quarter of 2005. As I mentioned earlier, LNG recorded a $12 million mark-to-market loss in the quarter on an intercompany sales agreement with Sempra Commodities. Construction on both the Energia Costa Azul terminal in Baja California, Mexico and the Cameron LNG terminal in Louisiana is on schedule. Last week, the Energia Costa Azul project reached an important milestone when the roof of the second tank was raised successfully.

During the second quarter, we held an open season for interest in expansion capacity at the 1 billion cubic feet a day Energia Costa Azul terminal. We are now conducting formal negotiation's with parties to enter into definitive terminal service agreements. We also continue to negotiate definitive agreements for the initial 1.5 billion cubic feet a day capacity at our Cameron facility.

Now, please go to slide 11 for a summary of our business unit results including parent and other. In the second quarter, parent and other reported a net loss of $35 million compared with a $27 million net loss in the second quarter 2005. Sempra financial is now combined with parent and other in our financial tables. Last month, we effectively sold our affordable housing tax credit business for $83 million. Sempra financial had a second quarter 2006 net loss of $5 million compared with net income of $7 million in the prior year's quarter. Due to the effective sale of Sempra financial's affordable housing and synthetic fuel tax credit business, we do not expect any material income or loss from this business going forward.

A summary of our asset sales is provided on slide 12. Combining the expected sales proceeds from all of these businesses, we will generate close to $1.3 billion in pretax proceeds. Significantly exceeding the $965 million estimate we provided in our analyst conference in March. The after-tax gain on these sales are estimated at approximately 560 million of which approximately 310 million will be recorded in the next quarter.

In June, 2006, we commenced the sales process of Sempra pipeline and storage's natural gas distribution companies located in Bangor, Maine, and North Carolina. Related to this sale, we recorded an after-tax impairment in discontinued operations of $35 million in the second quarter. In July, we completed the sale of our exploration and production business, which will result in a third quarter after-tax gain of approximately 110 million. With these sales, we have now effectively exited all of our nonstrategic businesses with the exception of our South American investments.

Please go to slide 13. Overall, Sempra Energy had a very strong second quarter. What is particularly encouraging is the ability of operating units to demonstrate continued earnings growth even at significantly higher tax rates as compared with prior periods. Our balance sheet continues to improve. Based on our operating results, which were excellent and the proceeds from our asset sales. As of June 30th, 2006, debts to total capital improved to 44% from 48% at year-end. And today, we have a $1.4 billion cash position and over $7 billion in credit lines with over 6.3 billion available to support our businesses. Our outlook for the second half of 2006 is encouraging. We expect to see continued increased earnings from SDG&E generation assets as well as greater contribution from Sempra Generation, whose contract with the California Department of Water Resources ramps up power deliveries in the third and fourth quarter.

Volatility in the energy commodity markets continues to be high with no near-term change anticipated. We also expect the majority of the mark-to-market earnings accounting adjustments for Sempra Commodities to turn around by the end of this year, adding to commodities' already strong results. We are reaffirming our 2006 earnings guidance of $3.40 to $3.60 per share, excluding asset sales. Our strategy is on course. Our asset sales are ahead of schedule and producing proceeds well above our forecast. We are also redeploying capital to help solve some of North America's most pressing infrastructure challenges. We are making good progress on our natural gas projects, all of which are on schedule and on budget. And we are investing to expand the energy delivery capabilities of our California utilities. With that, I'll now open the call up to your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Lasan Johong with RBC Capital Markets.

Thank you. Good quarter, first of all. Yesterday, there was a ruling by the 9th Circuit Court about some noise on -- open up investigation of California energy crisis overcharge, et cetera. What impact do you see from that going forward?

Well, Lasan, let me turn this over to Javade Chaudhri, our General Counsel, but let me just say from my perspective and from the initial weed of this, the thing that I'm most concerned about is were our reserves adequate and the answer is yes, we're adequately reserved, but with that, let me have Javade give you some more flavor.

Thanks, Lasan. I think the key point is that we have reviewed the decision and our reserves are entirely appropriate. Generally speaking, this is a good result from our perspective. And a lot of the potentially big items of liability that had been sought have been rejected by the 9th Circuit. The court did ask FERC to reconsider the issue of whether any tariff violations might have occurred in the summer of 2000 that might justify a remedy. But that issue will be now before FERC, which will do something with it. Or may not. We are comfortable with where we are and our reserve profile.

This is also good for California because we're now getting to the last chapter of the energy crisis. So as we get this behind us, there are very few remaining issues of any magnitude that are still outstanding.

Great. On Sempra's commodities business, a couple questions. I mean, there was information on volumes here, but it doesn't really tell you kind of how active the market is. Can you kind of talk about the velocity of trading on some of these commodities and how if the pace is picking up, slowing down, overall and most importantly, how are the margins on a per-unit basis? Are they up, down, flat?

Let me turn this over to Mark Snell. But it's -- once again, it just reinforces the position we took to stay in this business. Because the reason there's so much activity in this marketplace is because customers are running for cover, looking for help and support and we're able to help them. Let me ask Mark to give you some more detail.

Hi, Lasan. The key is on our physical business, you noted on our physical statistics that those are really relatively in line with what they've been in prior periods. So our physical business while very profitable, is relatively steady. And then the activity that we have in trading some of the optionality that develops around that physical business, that's picked up a bit, especially on a year-to-date basis. Remember last year, we came in from the fourth quarter of last year with very, very high activity. That spilled over until the first quarter of this year and I would say the second quarter, it's been more of an -- more consistent with what we've seen in prior periods. But it's a good market for us. There's lots of opportunities for us to make money in this market. And we've been pretty successful in capitalizing on those opportunities.

How are the margins?

Margins are pretty good.

Are they holding steady or are they increasing decreasing?

I would say they are consistent with where they've been in prior periods.

Okay. And I heard you correctly I think when, Don, you said that the rate case will not include the capital structure nor the ROE?

Yes. This is mainly the deal with higher operating cost. Things like labor and fuel for vehicles and -- but really maintenance and O&M. The issues that really drive our earnings cost of capital and how much capital we get to include will be in separate proceedings.

Great. Thank you much.

Your next question is from the line of Craig Shere with Calyon Securities.

Hi, good quarter. Two questions. In late March, I think it was David who mentioned that coal trading ethanol expansion to Asian markets were possible future growth opportunities per commodities. First question is, are we seeing any notable progress in any of these areas? And the second question, Don, on the 80% hedged position on the gas-fired plants, can you comment on that from an enterprise basis? Because doesn't commodities have an offtick for maybe 250 megawatts from those plants starting next year?

Let me ask Mark to address that.

On the first part of your question, on the trading of ethanol, that's still, it is still a relatively small market. We have affected some ethanol trades, but they're really very, very small and have not had any material effect on our earnings profile. We expect that market to grow in the future. We'd like to participate in it, but right now, we don't -- it's a very, very small market for us.

Coal trading and maybe other geographies?

Coal trading we're seeing a little bit of activity, but still that's an emerging area. And it's not contributing significantly to our profit picture at this time. As far as new areas go we do have strong trading relationships with counter parties in China and in Asia and we've done a lot of trades with them. Most of those are done through our London or Geneva offices -- and those have been good businesses in the past. But we haven't any significant growth in those businesses in this period compared to prior periods. Then the other question on addressing the hedge?

I didn't quite understand what the second question was. This is Neal Schmale. Would you repeat that?

Sure, Neal. The 2600 megawatts of gas-fired generation is roughly 80% hedged through the end of the decade? But I guess I'm trying to get at is that just a segment disclosure or is that a company-wide enterprise disclosure? Because if one segment has an off take agreement from another, then that's not a hedge from an enterprise perspective.

Oh, I know what he's getting to.

Yes, the first of all, from a segment standpoint, what you're talking about in terms of the, in terms of the generation, in terms of the generation business, is all, of course, within the generation business. Now, to the extent that any portion -- by the way, the large majority of this, almost all of it is, is under the CDWR contract. So the nonCDWR piece is very small. And furthermore of that small piece, that's nonCDWR, the portion that's with the trading company is a small portion of that piece. So it's pretty small in any event. The trading company in turn would build that into their portfolio, and based on their value and risk and so forth, a significant portion of that would be hedged out as well. So as a practical matter, it does reflect a hedged position for the entity.

Okay. That's helpful. And just to follow-up on the first question, is there any kind of time line that you all are envisions for more diversification in terms of significant value add from new markets or geographies where you're trading?

No, we don't have a set time line. But I mean we are actively pursuing new markets all the time. And as we see opportunities to make money in those markets, we'll establish kind of a beachhead and then continue to grow.

Great. Thank you.

Your next question is from the line of -- Faisel Khan with Citigroup.

On the working capital from trading, was there an outflow or inflow in the quarter?

I'll have Mark take a look at this. But I think it's been pretty constant. We have about $2.3 billion of working capital outstanding right now. That's about where we were the end of last quarter, I believe.

Okay, got you.

And Lasan, for you -- somebody just passed me a note that one of the things I didn't mention that's in this rate case filing, the one thing that would impact earnings is that we do have our CapEx request in that filing. Or capital adds.

A follow-up to that comment you just made there. As you add the CapEx in at SDG&E, how do the earnings come in? While these facilities are under construction, do you earn AFDUC?

We do. Ed Guiles is here. Ed, do you want to add anything to that?

No, Faisel, we earn FDUC, and one comment I'd also make back on the rate case -- recall that very large projects that are over $50 million, those have their own separate CPCN application such as our Sunrise project or a big generation project. So think of the rate case as you know to be more routine capital expenditures for ongoing business.

Okay. And then in terms of the new gas coming in and Mexico and the ability to input that into this SoCal and SDG&E system, has the SPUC taken a look at that and whether you would be able to get regulatory treatment for increasing capacity in the pipeline to bring more gas into the L.A. and San Diego areas?

The California Commission has addressed this. Let me have Ed Guiles give you an update.

Yes, Faisel. We're currently in hearings and in the process. The first phase of this was looking at the integration of the transmission system. The commission has approved that. It's intended to go in place and in service when the [Otay]Mesa receipt point facility goes in service and that will be in 2008. The remaining parts we're looking at, which would include firm rights, include gas quality, include sort of the rate making treatment, whether there will be rolled-in rates or whether the developers will simply put up the capital up front, and then once the projects go in service, I think it's very likely what will end up happening is that the developers will put the capital up front. Once the project goes in service, then there will be a throughput rate that will allow us to recover the investment. So I think that's the way this is going to play out. But we would expect these remaining gas system issues on accessibility and how the system's going to operate once LNG comes in place to be resolved through commission decision before the end of the year.

Okay. And what kind of capital requirements are we talking about to expand systems itself?

It depends. At least it depends on how many facilities go in service and where. Initially, with the Otay Mesa receipt point, the first 400 million cubic feet a day is a very small expenditure, roughly $10 million. And then it just goes up from there, probably in the 1 to $300 million range.

Okay, fair enough. In terms of along the lines of LNG I think the timing of binding commitments at Cost Azul, I know you held an open season. What should we look for in terms of a timing or milestone there to see finalization on the expansion?

Let me ask Neal Schmale to answer that.

Well, s you know, we had a very successful open season from the standpoint of the nonbinding indications that we received for Cost Azul, and we're following up on that with negotiations with various parties to firm those commitments up. Having said that, we really haven't set any deadlines internally for when our expectations, when those would be resolved. And we're optimistic that we'll do well there.

Okay. There's no CRE requirement that they have to close binding commitments by a certain time or anything?

No.

And then in terms of the unhedged portion of generation, you have in -- with regard to access in Southern California, what are you seeing right now in the market? And obviously the heat wave has had an effect on the market. How much exposure do you guys really have there?

Well, go ahead, Neal.

Once again, of course the key point is that in the generation business, the -- we are 80% hedged largely through the DWR contract and as a consequence, the exposure in that business to increases in the sparc spreads is relatively small.

Okay. Fair enough. Thank you for your time.

Your next question comes from the line of Paul Patterson.

Hi, guys.

Hi, Paul, how are you?

All right. Just back on this 9th Circuit Court ruling, just to understand it. I had you guys around 780 million worth of reserves that you guys had. And about 600 million were associated with the Forge, Continental Forge I guess, is that correct?

I'm not sure that we broke it out like that, Paul.

Oh, okay. I thought that you guys had the 10-Q. I can double check that. What are the reserves -- I'm trying to get an idea of what are the reserves that you guys have that haven't been accounted for that would sort of take care of this thing, if you follow me? I mean, what are you guys thinking might be the additional exposure is I'm trying to get an idea that this court ruling actually brings up.

Let me ask Javade to give you some color.

Paul, we have not historically broken out by individual matter our reserves, our 10-Q does and the one we will file here shortly you will see, does update those numbers. On June 30, 2006, the reserves for litigation matters was 691 million. Of which I think maybe this is the number you had, 585 million related to the settlements we reached in the Continental Forge case that we announced at the beginning of the year. And which has now been signed off by the judge. I think just to clear up this matter of 9th Circuit decision, you might have seen some very big numbers thrown about in the press. Candidly, we have no idea where they came from or certainly how somebody came to conclude that was the right number. What I can tell you is those numbers don't have any meaning for us. We've already told you earlier in this call that we -- our reserves are appropriate for what we think our liability is. I can tell you that it is a very small fraction indeed of the numbers you may have seen in the press.

Okay, great. And then just in terms of timing, when are we going to finally get the stuff -- I don't know if can you answer that. But what's the process from here out, I guess?

To god's ears, I think. Look, our perspective as Don said, a minute ago, we're -- we are happy that most of these things are behind us. It's the right answer for California and for our customers. In this particular case, I think the decision from the 9th Circuit simplifies things a great deal. In my opinion, a number of these things, while they could be appealed, are unlikely to make much traction, for example, at the U.S. Supreme Court and I would guess that now one of two things will happen. One is the 9th Circuit will try to facilitate some settlement discussions on the couple of open items as with these potential tariff violations and any possible remedies that might flow. And otherwise, the matter will go back to FERC, which will hold some hearings. But in the scheme of things, it's a very small and narrow window of remaining open issue.

I think there's two things, here, Paul. One is remember the piece that we have reserved is adequate from our standpoint and it's a small fraction of what is -- the State of California is claiming. But I think also is that remember, it was SDG&E that initiated this entire process. Filing for refunds on behalf of its customers. So this process was started by SDG&E going back many years ago and we're finding now coming to a conclusion.

Okay, great. And then I guess, and I apologize if you guys addressed this with another question. But in terms of the Sempra LNG and commodities contract, how is it that, I mean, what drives this mark-to-market gain on the one hand for one of the guys and a loss on the other? Is it a timing as to when the contract happened, and the end of the quarter? Or is there a gain on sale or a gain on transaction? At the time of the transaction?

Let me have Mark address this. But basically, remember that we, we have responsibility for marketing half of the gas that goes through that terminal. And Sempra LNG is arranging to have Sempra Commodities be the marketing entity to handle that gas. So in preparation for marketing that gas which will start coming on the end of next year, beginning of 2008, Sempra Commodities is out right now marketing some of that gas. With that, Mark?

Thanks, Don. Exactly right. Sempra Commodities is out now marketing that gas. And the contract that was signed between Sempra Commodities and Sempra LNG was deemed to be a derivative contract which had to be mark-to-market. And so we marked that contract to market both sides and the loss that the LNG facility essentially reflects the marketing costs on a mark-to-market basis, that they're incurring to market that contract. The contract obviously has profits much higher than that. So we took the loss in the current period and it's completely offset by the gain at Commodities and frankly, on a consolidated basis, this whole thing eliminates and doesn't really have an impact at all on our financial statements.

Right, but the change actually happened because of when the contract was signed and the change in prices?

That's correct.

Okay.

It happens because the contract -- when the derivative contract was signed, which was in this most recent quarter, that triggered the accounting.

Okay. Great, thank you.

Your next question comes from the line of Paul Gaboss with Valueline.

Hi. What tax rate do you expect to use for the full year?

35% is what we're looking at right now.

No. That's for '07.

And about the same for 07.

Thank you.

Your next question comes from the line of Sam Brothwell with Wachovia Securities.

Hi, good morning.

Good morning, Sam.

Question for you on the balance sheet. Obviously, your asset sale proceeds have been better than what you outlined in the analyst conference book. And that's certainly a positive. But maybe if you could just spend a minute updating us on your thinking about where capitalization needs to be going forward, with all the CapEx plans you have and so forth. And also, in the context of the continued growth of the commodities unit, which, as I look at where you're at year-to-date, you're pushing 200 million I would think that the earnings contribution, given the volatility we're seeing right now, is going to turn into another banner year for Sempra Commodities, which is good, but I wonder, does that increase your need to have, to lean in the direction of being conservative on the balance sheet?

Your questions are all things that we think about. So let me have Mark give you some of our thoughts.

Well, we do think about this a lot. Currently with the proceeds that we have, we have exceeded our expectation on the net cash. But our current plan, given the capital program that we have, and just to remind everyone that we have a $2 billion a year capital program for about the next 5 years, so $10 billion in total, we anticipated these sales and we also, in -- when we did our analysts' conference, I was fairly emphatic that I thought with these sales that we would not have to issue equity to fund that program. I believe the results being more positive and given where we are, that that is clearly the case. We will not have to issue equity to fund the program.

That said, we're not currently contemplating any major stock repurchases or rebalancing of our capital structure. But we will look at it on a regular basis. And if we, if we believe that at any point in time that it needs adjusting, we'll make those kinds of changes. But right now, we have the capital we need for our CapEx program and also the capital that trading is using, even though the prices have been higher and the last two months we've experienced some high volatility, our capital requirements for trading are within the estimates that we had at the beginning of the year. And we don't -- we feel comfortable about where we are with them, too.

I guess just to follow-up on that if I may.

Sure.

As I look at your slide from the analysts conference, you have an expectation of the commodities business kind of being in roughly a 200 to $300 million income range. And your debt to capital going out somewhere sub40% by 2010. Are you still comfortable with that relationship?

We are -- if trading earns more money they could have a slight inverse in capital usage, but our CapEx for the current period for the current year is -- since our net proceeds are higher and you net that against our CapEx program, we're running a little behind on our net CapEx spending and I think we have an adequate margin of cushion in all of this to handle the increased earnings from trading.

Okay. Thanks a lot.

Okay.

Your next question comes from the line of John Khani with Deutsche Bank.

Can you please update us on your interest or your thoughts on placing some of the gas assets, once they begin commercial operation like the Rockies Express, and U.S. based LNG into an MLP?

One of the things that we do, John, and as we go through and look at the contracts around these assets. We have them all set up so that at the appropriate time, should we desire to do so, we could put these in an MLP structure. As soon as we get close to the point where these assets are cash flowing and have some earnings, we'll look at the interest rates in the marketplace and then make a decision, what's the right thing for our shareholders to do? But we definitely have that flexibility and we're thinking about it right now.

Thanks. That's helpful. And then, getting back on the comments on the recent weather and demand increases you've seen in California in particular in Southern California, do you have any comments on any acceleration of more organized capacity markets in the state?

Well, I think that that's something that the State of California thinks a lot about. I think the good news is is even though we had a very, very demanding weather pattern that we experienced for about two weeks, the California system survived it. And unlike other parts of the country, we didn't have as many customers out of service as parts of the East do or did. But the discussion about how to go forward is a real-time topic. Let me have Ed guiles give you the flavor of that.

Yes, I think on the subject of the capacity markets, the Public Utilities Commission in concert with discussions with the ISO continues to look at this. The issue for the utilities is really dealt with in the long-term resource plan and resource adequacy proceedings at the commission and kind of right now, we have to have, as you may know, John, the 15 to 17% reserve margin. So the question then coming forward is, and yet to be resolved, what are we going to do with respect to direct access? And that has really not been resolved. And I see not being resolved for a couple of years. The ISO is continuing to look at implementing its new market structure. They are on track in their minds to do that in the late 2007, 2008 time period. This is going to continue to play out.

And this issue has been on the front burner of both the governor and Mike Peevey, the President of the California Utility Commission. They both are focused on making sure that there's a robust market in California to encourage the development of new generation.

And, Don, I wanted to just add something. If you take a look at our strategy, it really is to continue to build new infrastructure. We covered at the analyst conference for the utilities in particular, new generation, new transmission. And is very much in line with the energy policy of the state both from the governor and the Public Utilities Commission's perspective. So we see this as continuing to grow our business and meet the needs of our customers

Thanks, that's helpful. And just one last question. Can you talk a little bit about looks like VA increased kind of year-over-year for the quarter? I guess it ramped up to about 20 million and I guess year-to-date it went from 13 million in '05 to about 25 or 26 million year-to-date in '06. Is that really just an increase in your forward volatility assumptions as you run your VAR models, or is it something else?

It actually is a function of absolute prices with the commodities that we have in our business. And I think when I look today at what the VAR is from the report I saw yesterday, it's dropped off to the $7 million range. But it really is driven by commodity prices.

Okay. Thank you very much.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Carl Kirst with Credit Suisse.

Good morning, everybody. I'm not sure if this has been asked. Has the ISO signed off on the powerline project yet?

Let me ask Ed Guiles to answer that.

Carl, that's a good question. And a timely one. We are -- two things. The ISO Board is considering today while this meeting is going on, the need for the project. We received a staff report that was very strongly supporting the project. It was showing a significant economic benefit to customers. So, the process now going forward, the ISO Board is considering the need. We will be filing an update to our application at the Public Utilities Commission on Friday. That's to update the certificate of public convenience and necessity that includes the environmental review.

At our analysts conference, we had given you a range of cost for SDG&E from about 700 million to a little over $1 billion. We've refined that cost estimate. It will be in our filing on Friday. It will be just under $1 billion for SDG&E. The project looks very positive from the standpoint of increasing import capability, providing cost reduction to customers, and then importantly connecting us with the Imperial Valley to provide a path for new renewable energy. So that's kind of the current plan. The PUC has promised us that given our application being filed this Friday, they will deal with that by next summer at this time. And then our objective is to have the line in service as early in 2010 as we can.

Great. If I could just slip one other thing in with respect to the LNG open season, that's something we may see--?

Carl, you're breaking up.

The LNG open season, I was wondering if that was something that is a conclusion that is measured in weeks or month, if that's something you can answer?

The LNG open season, weeks or months, timing?

In terms of converting the LNG open season from the nonbinding indications to firm contracts. Well, that's more likely the question of months, rather than weeks certainly.

Great. Thank you.

Your next question comes from the line of Annie Sao with Alliance Bernstein.

I have two questions, one is just a follow-up question after I think Dan's question. The capital requirements for trading. As you're trading going forward have more and more opportunities. Do you think eventually you need to JV with someone in terms for -- to get the working capital that you need to expand the business and increase the opportunity?

Annie, Don Felsinger. I have said many times that one of the great success stories is how we have grown this business. And we have been so successful that we may at some point in time outgrow Sempra's ability to be a home for it. That's still several years away. But it's something we think about. And we, today, have all the financial strength we need to keep owning this business. But if we continue to be on a track record like we have been, and this business continues to grow, then at some point in time, we may in fact be looking for a partner.

A second question has to do with your Transmission project. The Sunrise project. And I heard there's another project which is Greenpath in California. Is that project going to compete with you?

Ed Guiles.

Hi, Annie. This is Ed Guiles. That Greenpath project is really in concert with this project. What we did when we were first working on the planning, we were working with the imperial irrigation district. And they're out in the Imperial Valley area. And they were looking at a separate project. What we've done is entered into an agreement with the Imperial irrigation district so we will do this project jointly. And the Greenpath portion, they'll have an ownership within their service territory and we'll pick it up at our boundary and bring it into San Diego. And then their line will go on to Los Angeles. So, we are doing this project jointly with them.

All right. Okay. Can you update us on the Sunrise project? Did you file? And what's the next step--?

Annie, this is Ed again. Yes, we will be filing on Friday at the Public Utilities Commission our CPCN filing, which includes an update of our environmental review and details on the route. We would expect the PUC to deal well that in the form of a decision by about this time next year. And importantly, as a separate matter, before we make that filing, we need a positive need determination from the California independent system operator. That's before their Board today for consideration. And we have a very strong positive report from their staff recommending that the project is needed.

Okay. Thank you.

There is a follow-up question from the line of Lasan Johong with RBC Capital Markets.

Yes. Any status updates on Port Arthur? And, second, there's an article that I read recently that the legislature of California is thinking about passing a pretty onerous carbon law which prohibits new contracts from being signed by anybody in California with coal-fired assets that do not have carbon sequestration technology. How does that change your thinking about generation, and the need for power procurement?

Let me have Neal address the Port Arthur issue. But from our standpoint, Lasan, as you know, we have changed our strategic direction and we are really focused on our capital investments on looking at natural gas infrastructure and investing on the California Utilities.

Right.

The coal plants that we were at one time thinking about building in Nevada and Idaho, that would have been an issue or us to sell into the California market. That's not something we think about today because in fact we're putting money someplace else, but let me have Neal talk about Port Arthur.

Well, before you do that, what about in terms of procurement of power for San Diego Gas & Electric?

Ed, you want to address that?

In terms of our procurement strategy going forward, it will essentially be made up of combined cycle facilities utilizing natural gas, significantly the big increase going forward for us is in the renewable energy area where we have to have 20% of our resource mix by 2010 coming from renewables. We're presently at 6%. We've contracted for 13. So we'll be working on the remainder of that and that -- that is tied significantly to our ability to get new electric transmission built. So basically looking at our resource mix, we'll have nuclear, we'll have natural gas fired through both combined cycle and peaking generation and renewable. So it's not a coal-driven strategy.

Okay.

In terms of Port Arthur, of course we got the permit to build Port Arthur. Now, in terms of when that might occur, we're going to follow the same risk management strategy with respect to Port Arthur that we followed with respect to the power plants and the other LNG terminals. That is, when we blocked up enough in terms of firm margin with terminal services agreements, we would then deal with the construction decision that we, of course, continue to talk to various people about these terminal service agreements at Port Arthur.

Great. This last question for Mark. Mark, the housing credits, I notice that in the presentation, it said that this is a financing for accounting purposes in the sale for tax purposes. I'm assuming. Does that mean that there's some sort of a pay as you go structure on the credit or is this a sale of the credit up front?

No. There's not a pay as you go structure. We were paid up front. The $83 million we received. But because we have some residual interest in the assets, at the end of their -- essentially at the end of this--.

Credit area.

We were not able to account for it as a sale and we had to account for it as a financing. And we do have some guarantees in place on the amount of credit that the buyer will be able to use. But those are -- we think those are fairly low-risk type of guarantees because this is a very automatic structure.

I see. So you shoved this into a partnership with a general partner and limited partner and had a flip structure and all that nice things?

Essentially, yes.

Okay. Thank you.

There is another follow-up question from the line of Faisel Khan with Citigroup.

Yes, sorry, just one more question. In terms of your asset sales, what would you say the overall contribution in those assets was last year in terms of earnings?

Last year.

Relatively small. Something under 20 million.

Let us get that for you.

Okay.

On page 15 in the slides?

Yes.

It shows that the earnings contribution was very small, about 2 million last year. 6 months 4 million.

From the $1.3 billion in asset sales, contributions last year was--?

No. No. This is from all the discontinued operations. That doesn't include the Coleto Creek and Texas, but those are also small, 1 million for three months and 7 million for six months.

Thank you very much.

There is a follow-up question from Paul Gaboss.

Is there anything new going on with the negotiations with Calpine for that plant?

Let me ask Ed Guiles to cover that.

Yes, Paul. Since our analyst conference, we have been working with Calpine and very recently in July, we actually filed a proposal, we call it a petition for modification with the Public Utilities Commission. We negotiated a letter of intent with Calpine for the Otay Mesa plant and to remind you that's a 573 megawatt combined cycle plant. The approach we've taken is to continue with a 10-year power purchase agreement whereby Calpine will construct the facility, the new addition is that as part of our agreement, we have a put and call option, a call option for SDG&E, and those prices on the put and call are confidential. But we have the ability to buy the plant so our customers would have a plant in 2019.

Calpine as the ability to put the plant to us. We have filed this as a petition for modification in the existing proceeding at the commission. And we worked hard with the interveeners in the case, specifically DRA the Division of Rate Payor Advocates, Turn and UCAN and they joined us in this settlement and approach going to the Public Utilities Commission. We would expect a decision from the PUC by November of this year. We're working with Calpine to execute the definitive agreement and our intent is to have the plant in service by May to June of 2009. So that project is moving forward expeditiously.

So really it would just hinge on getting the definitive agreement and then getting from the approval if the CPUC?

Yes.

Thank you.

Your final question comes from the line of Carl Kirst with Credit Suisse.

Yes. Just a very quick follow-up with respect to commodities. The invested capital level, is that still roughly at the 2 billion mark? If we were looking at that between debt and equity, could you capitalize that for us?

Mark do this.

Our investment and commodities currently is running at about 2.4 billion. Does that answer your question?

It does. And I was just basically looking at it to see if I couldn't look at it on annualized ROE basis in addition to the [Inaudible] that you publish.

Yes. The addition to that, the 2.3 is our original, you add back in our original purchase prices for both the metals business and for the trading business adds about another 350 million to that number and then you can -- that number should hold for the rest -- the rest of the year. So for your -- for a return on invested capital number, you can use that as the asset part.

Okay. And then as far as any debt associated with--?

That's a total investment. It represents our intercompany debt and all of our -- all the bank loans that we have into the business that we guarantee. So it's really a complete number.

Okay. But as far as the debt, meaning a percentage of is it roughly 50/50?

No. It's actually the amount of debt that would be on the business, that includes all of the intercompany borrowings and things and there's maybe another 4 or $500 million of outside debt.

This is Neal, $2.5 billion round numbers invested in the business, 5 or 600 million of that will be intercompany debt. The balance will be either retained earnings or the initial investment we put into the business.

Great. Thanks for the help.

At this time, there are no further questions. I would now like to turn the call over to Don Felsinger.

Well, thank you for joining us this afternoon. As you can tell, we had a fantastic second quarter here with great results from the asset sales. We have got a strong balance sheet, a great cash position and the thing that's most impressive is all of our businesses are on track. We're also in a great position for the future in terms of the types of assets we are building, looking at natural gas infrastructure, investing in our California utilities. These are all things that will pay dividends going forward. So thank you for your time. If you have any follow-up questions, get a hold of Karen or Dennis or Glen, and we'll talk to you in a few months.

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