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Sempra Energy (NYSE:SRE)

Q1 2009 Earnings Call Transcript

May 5, 2009 1:00 pm ET

Executives

Jeff Martin – VP of IR

Don Felsinger – Chairman and CEO

Mark Snell – EVP and CFO

Joe Householder – SVP, Controller and Chief Accounting Officer

Debbie Reed – President and CEO of Utilities

Neal Schmale – President and COO

Analysts

Lasan Johong – RBC Capital Markets

Paul Patterson – Glenrock Associates

Leslie Rich – Columbia Management

Faisel Khan – Citi

Michael Lapides – Goldman Sachs

Michael Goldenberg – Luminous Management

Leon Dubov – Catapult Capital

Rebecca Followill – Tudor Pickering & Co.

Operator

Good day everyone, and welcome to the Sempra Energy first quarter 2009 earnings results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeff Martin. Please go ahead, sir.

Jeff Martin

Thank you and good morning. I know there are many of you who are traveling or attending the A. J. conference and I want to thank you for joining us, particularly for setting aside time to step out of the meeting schedule. This morning we’ll be discussing Sempra Energy’s first-quarter 2009 financial results. A live webcast of this teleconference and slide presentation is available on our website under the Investor section.

With us today in San Diego 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, Executive Vice President and Chief Financial Officer; Debbie Reed, President and CEO of our utilities; and Joe Householder, Senior Vice President and Controller.

You’ll note that slide two contains our Safe Harbor statement. Please remember that this call contains forward-looking statements that are not historical facts 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. As you know, they involve risks, uncertainties and assumptions, so future results may differ materially from those expressed on our call today.

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. It is also important to note that all the earnings per share amounts in our presentation this morning are shown on a diluted basis.

And with that, I’d now like to turn it over to Don, who will begin with slide three.

Don Felsinger

Thanks, Joe; and again, thank you all for joining us. We met with many of you in March at our analyst conference in New York, where we laid out a plan to continue growing our company. As a testament to our business model, where we are able to grow our profits under a variety of different market conditions, especially in a tough operating environment like we are currently in, and as today's financial results show, we are off to a great start, putting us in a position to meet our financial goals for the year.

2009 is important. As many of you know, we have invested heavily in our infrastructure businesses for the last several years; and now, several major projects including our Cameron LNG receipt terminal and the Rockies Express East pipeline are nearing completion. We are also continuing to ramp up investments in our utility businesses, where we benefit from constructive regulation and earn on those investments during construction.

Now to the financial results. Earlier this morning, we reported first-quarter earnings of $316 million or $1.29 per share, up from first-quarter 2008 earnings of $242 million or $0.92 per share, a 40% increase in quarterly earnings per share.

Now let me hand it over to Mark Snell. He will take you through some of the details of the financial results beginning with slide four.

Mark Snell

Thanks, Don. Before I get into the results of each of our business units, I wanted to quickly point out an accounting change that occurred this quarter. You may have noticed that Don referred to earnings on the previous slide and not net income, like we have in the past. That is because of all new accounting rule, FAS 160, which changes where we report minority interest. With this change, the minority interest adjustment, now called earnings attributable to non-controlling interest, is moved below the net income line. So our bottom-line results will now be referred to as earnings. The key takeaway here is that there is no impact on our reported results.

Now let us go to slide five. At both of our utilities, we saw improved earnings, primarily due to the positive impact of our general rate case decisions that were approved in the third quarter of 2008. At San Diego Gas & Electric, earnings for the first quarter were $99 million, up from earnings of $74 million in the year ago quarter. First quarter 2009 results benefited from $24 million of higher operating margin as a result of the rate case mentioned just a moment ago and $5 million from the favorable resolution of a litigation matter. In addition, first-quarter 2008 did include a $9 million benefit from the favorable resolution of prior year's tax issues. At Southern California Gas, first-quarter 2009 earnings were $59 million compared with $57 million in the first quarter of 2008.

I would like to call your attention to two new line items on our balance sheet relating to the fire litigation at SDG&E. One is an insurance receivable, and the other one is a reserve for wildfire litigation, both for $900 million. We are in negotiations with substantially all of the homeowners insurance carriers, while many details still need to be worked out, the advanced nature of our discussions led us to conclude that we could reasonably estimate the cost of the settlement, and as a result, we recorded that estimate. The accounting rules require the estimated settlement be grossed up, recognizing both the liability and the asset. While we believe the homeowners insurance carriers represent the lion's share of the property losses, there are of course a variety of other claims that may take several years to be fully resolved. At this time, SDG&E doesn't have sufficient information to reasonably estimate the amount of its exposure to the remaining claims. That is why we haven't booked any reserves for them.

However, I would note that if we are successful in this settlement, we would still have $200 million of coverage for any remaining claims. In addition, we have significant claims against Cox Communications for damages caused by one of the fires, and of course, if our liability insurance and other recoveries should prove insufficient, we would ask our regulators for recovery of the excess cost.

On a related issue, I want to note that our insurance premiums for wildfire coverage with substantially increase in the second half of the year, when our current policies expire. The amount of coverage that we can obtain will be substantially reduced as well. This is a broader issue for the rest of the state, as the other utilities are also seeing similar cost and coverage issues. We have been discussing this with CPUC representatives and SDG&E will file a request to have any higher premiums included in rates.

Now let us go to slide six. Sempra Commodities' earnings in the first quarter of 2009 nearly doubled to $114 million from $59 million in the prior year's quarter. The joint venture saw improved results in natural gas and oil marketing, as well as good performance in metals and power. The first-quarter 2008 results benefited from Sempra Energy's 100% ownership of the Commodities business, offset by the negative impact of a $17 million credit reserve.

Now let us move to slide seven. Here we show how income is allocated at the joint venture for the quarter. A couple of highlights: First, the joint venture had income of $154 million during the quarter. After applying the income allocation methodology, the distributable income to Sempra was $114 million. After adjusting to US GAAP and taking into account the impact of the income taxes, Sempra's joint venture equity earnings for the quarter were $116 million. After some small holding company costs, earnings for this segment were $114 million.

Please move to slide eight. First-quarter earnings for our Generation business were $43 million, compared with $45 million in the same quarter in 2008. First-quarter 2009 earnings were impacted $9 million from higher scheduled maintenance and the associated downtime. This was offset by $8 million of lower income tax expense related to planned solar investments and Mexican currency adjustments.

Now please move to slide nine. Sempra Pipelines & Storage earnings in the first quarter of 2009 were $37 million, up over 40% from the $26 million reported in the same period of 2008. Mexican pipeline operations saw $9 million in higher earnings compared with the same quarter in 2008. The increase was primarily due to earnings from LNG-related pipeline contracts. Mobile Gas, which was acquired late last year, contributed $6 million dollars in incremental earnings. Due to their rate structure, the first-quarter is typically the highest earning quarter for Mobile Gas, due to home eating demand. Pipelines & Storage results were negatively impacted $7 million in the quarter from foreign currency exchange rate effects, primarily on investments in Chile.

Now please turn to slide 10. This slide provides a summary of our business unit results. I would like to highlight a couple of things here. Sempra LNG reported a loss of $7 million in the first quarter of 2009. That compares with a loss of $9 million in the prior year. At Parents & Other, we reported a loss of $29 million in the first quarter, compared with a loss of $10 million in the same quarter in 2008. The increase in loss was primarily due to $14 million in higher after-tax interest expense and $8 million in losses on assets in support of non-qualified retirement plans and deferred compensation programs.

Please turn to slide 11. We are really pleased with our financial results. Earnings per share for the first quarter of 2009 were up 40% over 2008 results. We have ample liquidity, enhanced by strong cash flows, which included receiving a $300 million distribution from RBS Sempra Commodities during the first quarter. In the first quarter, we increased our dividend over 11% in accordance with our previously announced dividend policy.

And with that, I would like to turn it back over to Don, who will begin with slide 12.

Don Felsinger

Thanks, Mark. Now let me update you on some of our business activities, starting with our utilities.

In the first quarter, we continued our pre-construction activities for the Sunrise Powerlink transmission project. A $1.9 billion project, which was approved by the California Public Utilities Commission at the end of last year, is expected to be placed into service in the second half of 2012.

Turning to our Smart Meter program, at SDG&E, we began our expanded roll-out in March. Our goal is to have 200,000 meters installed by the end of this year and have all installations completed by year end 2011.

It has been a while since I provided you with an update on the Generation side of our utility business. In the summer of 2007, you will recall that we were worried about leading our summer load, so we added a peaking plant here in San Diego. While in an effort to meet the load we expect this summer, we are now in the process of bringing a second peaking unit online at the same site. Also, the Otay Mesa Energy Center, a 570 megawatt power plant should be online by the end of the year. You will recall that is being built by Calpine has 100% of the output being sold under contract to SDG&E.

And finally, at the San Onofre nuclear plant, of which SDG&E owns 20%, the replacement of the first of two steam generators is scheduled to begin this fall, with the installation expected to be complete in the first quarter of 2010. A second steam generator is scheduled for replacement to begin in 2010 with completion in 2011.

At SoCalGas, we filed with the CPUC in April, requesting the suspension of a current cost of capital adjustment mechanism. As many of you know, SoCalGas' cost of capital is automatically adjusted when 30-year Treasury bond yields deviate from certain benchmarks. Because treasury yields are artificially low due to an unprecedented intervention by the Federal government, we feel a suspension of this mechanism is justified. We anticipate a decision on this request in the third quarter.

Now please go to slide 13. Moving to some of the projects we have under development at our infrastructure businesses; at our Cameron LNG receipt terminal, construction is nearing completion, and later this quarter, we expect to receive our first startup cargo and will begin testing the facility. This should put us on track to commence internal operations in the third quarter of this year. The associated Cameron pipeline is complete and ready to transport gas from the terminal when it comes online.

Before I move on, I would like to also give you an update on some of our Pipeline & Storage projects. Regarding our 25% interest in the Rockies Express pipeline, we anticipate interim service on the east portion of the line later this month, with the line fully complete and in operation by year-end.

Turning to our Liberty Gas Storage project, you will recall that we updated you last quarter about the problems we are having with one of our caverns. To date, our remedial efforts haven't been successful and we are continuing to consider alternatives. As you will recall, we have $65 million on an after-tax basis at risk if we have to write off this asset.

Let us move to slide 14. At Sempra Generation, last month we announced a 48 megawatt solar expansion project that will be located adjacent to our existing El Dorado solar facility. The combined 58 megawatt installation would become the largest operational photovoltaic solar power facility in North America. Construction will commence after we have contracted the sale of facilities output. The project could be fully operational by late 2010.

Now let us move on to slide 15. Now for a quick update on our Commodities joint venture with the Royal Bank of Scotland. Earlier today, the RBS Sempra joint venture announced the appointment of Kaushik Amin as their new CEO. Kaushik was previously the global head of liquid markets, including commodities trading for Lehman Brothers, and built a great business there. We are excited to have him on board. Among many successes, he is credited with building a commodities business from scratch in 2005 to one that was earning more than $500 million in 2008. This commodities (inaudible) business capitalized on the flow of activities from Lehman's other businesses.

While RBS Sempra is only beginning to capitalize on the flow of business from other parts of the Bank, given RBS' larger platform, we anticipate substantial growth. Combining the physical trading strength of Sempra with the derivatives and financial strengths of RBS should yield significant synergies, which we expect to capture over the next one to two years.

Integration activities continue; in August, the joint venture will be moving to a new location in Stanford, Connecticut. The joint venture will be located in a newly constructed RBS building, and co-located with the Bank's North American headquarters. This new building will combine the trading floors of the Bank's other trading operations, including foreign exchange, interest rates, (inaudible) and equities trading, as well as our commodities groups, all with a view toward creating additional synergies between the various business groups. This will be one of the largest trading floors in North America, accommodating over 700 traders.

Now turn to slide 16. I am very pleased with our first quarter results, which put us on track to meet our financial goals for the year. Even in this very challenging economy, we have been able to grow our business and continue growing our dividend at double-digit pace. The growth that we saw last year and expect to continue to see is the result of over $10 billion we have invested in the last four years, and those investments, together with new projects underway at our utilities, should provide us with double-digit near-term earnings growth.

And with that, let me now open up the call and take any questions that you may have.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And we will take our first question from Lasan Johong of RBC Capital Markets.

Lasan Johong – RBC Capital Markets

Thank you. Good afternoon. Nice results. I don't think this is going to be an unexpected question, but I am a little bit more than surprised that the joint venture reached outside of the organization to the point where you actually went to a completely different organization to recruit a CEO and I am kind of at a loss as to why that was even put on the table or even considered. That alone actually pulled the trigger (inaudible).

Don Felsinger

Well, Lasan, thank you for your comments about the quarter, we are also very happy with it. I would say that when we were taking a look at new leadership for the joint venture, we looked both within the Commodities business and within the Bank and although there were a lot of good candidates, I think as I mentioned in our conference in New York, that I think one of the things that David Messer and Steve Prince was hire a lot of capable talent. But at the end, as we and RBS talked about the type of leadership that we needed and somebody that had been working at a bank infrastructure business like Lehman, and to bring that skill set over and to be able to capitalize upon leveraging that opportunity, we felt that Kaushik was the person that would best do that and that is how we got to that decision.

Lasan Johong – RBC Capital Markets

Have any senior people or traders resigned since the announcement of the CEO?

Don Felsinger

No, as a matter of fact, he has been out meeting with them and I think the group is all at ease now of having this transition behind them and as you could have seen from the first quarter results, we basically hit the ball out of the ballpark.

Lasan Johong – RBC Capital Markets

I can't disagree with that. Was the compensation schematic changed?

Don Felsinger

I am sorry. What was that again?

Lasan Johong – RBC Capital Markets

Was the compensation schematic changed at the joint venture?

Don Felsinger

The compensation that we have had is basically the same compensation that we have had since the formation. There have been some structural changes in terms of how it is paid, but it is still all cash. The only change that has been is the timing of it.

Lasan Johong – RBC Capital Markets

Okay, Don, I know if I ask you this directly, you will probably give me a very precisely worded vague answer, so I am going to ask you in a slightly different way. On a scale of 1 to 10, if you looked out in the market for Generation acquisitions, would you say this was a 10 or a 1 with 10 being a very good time to buy and 1 being a very bad time to buy?

Don Felsinger

There is no doubt, with low gas prices and the economy as it is that Generation prices are depressed. That is not a line of business that we currently have an interest in, we are still currently looking at natural gas infrastructure as the long term growth opportunity for this business, but I would just say to answer your question that I think Generation prices are depressed right now.

Lasan Johong – RBC Capital Markets

One last question. It looks like the alliance, Spectra and several of the partners on this pipeline that is going to go from the Rockies kind of parallel into Rockies Express for a while and ending after Chicago is going to go through. Any thoughts on the impact of how that is going to change your business profile on Rockies Express?

Don Felsinger

We look at these, Lasan; and this is a – building large oil pipelines, as we have just been through this learning process with Rockies Express was a very challenging endeavor and so, I wish them good fortune.

Lasan Johong – RBC Capital Markets

Okay. I look forward to the second quarter conference call and the increase in guidance. Thank you.

Don Felsinger

Thank you.

Operator

Now we will go next to Paul Patterson with Glenrock Associates.

Paul Patterson – Glenrock Associates

How are you?

Don Felsinger

Good, thank you.

Paul Patterson – Glenrock Associates

Just a couple of questions here. What is the tax rate? I know that you guys got a little bit of benefit in Generation, but there is also – I think the utilities was pretty good in the first quarter, so I was wondering if you could go through the flavor with what is happening there?

Don Felsinger

Our tax rate for the year has been in the low 30%, but let me have Joe Householder kind of walk you through how we get there.

Joe Householder

There were quite a few different pieces, so let me just go at it a little bit slowly. The major piece of the difference between the first quarter of 2008 and the first quarter of 2009 had to do with the Mexican tax benefit on inflation and FX. This year, we had about an $8 million and last year, in the same quarter, we had about a $7 million decrement; so that was about a 4% swing in the rates. We also had more non-US income in Sempra Commodities, so that is about 2% of the rates and the remainder, as you mentioned was in Generation about 1% for the solar and 1% in the utilities for higher software expenses; and we had a little bit of extra benefits in the Commodities business as we settled some old tax cases from UK benefits. That is the basic difference between the two years' results; but as Don said, it should be in the low 30s to 32 for the year.

Paul Patterson – Glenrock Associates

Okay. And then the oil and gas at RBS you have obviously been through. What was so good there? Was there something in particular that made that business do so well?

Don Felsinger

Well, Mark Snell has been living back there for about the last month. Let me have Mark walk you through what happened.

Mark Snell

Well, I think we just have seen a lot of opportunities on the oil business. We are in a fairly steep and tangled market and so I think that contributed to sort of a cash and carry kind of business, where we have been able to buy fuel, buy oil, put it in inventory and benefit from forward sales. So I think that is in the bulk of it, but it is a pretty straightforward physical trade.

Paul Patterson – Glenrock Associates

On the O&M, just if you can remind me (inaudible).

Don Felsinger

Joe Householder here.

Joe Householder

Yes, really the big decrease there is the lack of having the Commodities business in the consolidated results last year, about $214 million worth of difference, is just the fact that they're not in the results because of the equity method accounting now.

Paul Patterson – Glenrock Associates

Okay, fair enough. And then the trading book back at RBS, I know you guys get less information now since the JV happened, but that has the realization of the trading book changed it all or anything after that?

Don Felsinger

About the tenure of the book?

Paul Patterson – Glenrock Associates

Yes.

Don Felsinger

No, nothing has changed.

Paul Patterson – Glenrock Associates

Okay. Thanks a lot, guys.

Operator

And we will take our next question from Leslie Rich with Columbia Management.

Leslie Rich – Columbia Management

Hi. Could you talk about the distribution from RBS of $305 million, how does that work?

Don Felsinger

I will have Mark take you through it, but as you are aware, Leslie, we have been getting cash now for about the last year of the business, which was something unusual for us.

Mark Snell

Well, Leslie, it is pretty straightforward actually. During the year, we get distributions to pay our taxes every quarter, based on the profitability of the partnership and then at the end of the year, there is a catch-up to pay out, to essentially pay out 100% of the prior year's earnings. And that was the $300 million that we got in the first quarter, which caught us up to the prior year's earnings. And we plan on getting that every year.

Leslie Rich – Columbia Management

Okay, thank you.

Operator

We will go next to Faisel Khan with Citi.

Faisel Khan – Citi

Good morning, guys. This is a question that goes back to I think Mark's prepared comments on the insurance premiums. What is the estimate in terms of how much that is going to cost you this year and going forward?

Don Felsinger

I will have Mark go into some more detail, but we are one of the first utilities in the state to renew the end of – I think it is next month, June. So we will have better numbers, but as we have been talking to our carriers, every indication we get is we are going to pay more, probably have a higher deductible and get less coverage. Mark, you want to expand on that?

Mark Snell

Yes, all I can just say is why we don't have exact numbers yet, because all we are getting is sort of indications of interest from the carriers and a general thought, we have a couple of quotes, but we don't have all of the different layers priced out yet, but it looks to us as that our insurance premiums for this kind of thing in the past to run to about $16 million to $18 million. They are going to be probably at best twice and maybe even higher. But we had anticipated and we are also looking to talking with the PUC representatives about getting recovery for that rate.

Faisel Khan – Citi

Okay, got you. Because the rates are frozen now through 2011, right?

Mark Snell

Well, actually yes, because our rate structure actually contemplates an ability for extraordinary things like this to go in on an interim basis and get some rate relief, so that is a possibility and we are not banking on it but it is certainly a possibility.

Faisel Khan – Citi

Okay. And to the case on your – (inaudible) did the replacement of the steam generation facility – how has the cost of that project changed over time? Is it still roughly the same amount that you guys talked about over the last year or so?

Don Felsinger

You know, our share is something under $200 million and I have received no indications from Debbie that we should exceed that, so – is that correct, Debbie?

Debbie Reed

Our information coming from Edison, who is handling the construction, is that the project is on schedule and on budget, and our share would be about $169 million, including AFCD [ph] space.

Faisel Khan – Citi

Okay, got you. And then just on the tax plan that is proposed by Obama on closing so many foreign tax loopholes, is there any impact that you guys can see from your operations abroad that would affect your tax rate or your cash tax payments?

Don Felsinger

I will have Joe Householder expand on this, Faisel, but remember, his plan is not slated to start until 2011. The legislation has not worked itself either side of Congress yet, so it will probably change. I think we'll probably have more information toward the end of this year as more of these details get worked out. It will obviously, in its current form, have an impact, but I don't think the current form as it is being talked about will be what is implemented. Joe, do you want to –?

Joe Householder

Yes, Faisel, I think it is pretty early in the process, as Don said, to speculate about what might actually happen. You have already heard some of the senior senators saying that they are not really for this and we need to have good international tax laws that are competitive with the rest of the world. So, I think it is fair to say that this proposal would move us in the wrong direction and we are more supportive of policies that would help us invest in US infrastructure, particularly in energy and infrastructure investments like that. That is where our focus is. You know, we have looked at some estimates, but I don't think it would be prudent to talk about them, because this is going to change a lot in the next year or so.

Faisel Khan – Citi

Okay, Joe, I appreciate it.

Operator

And we will go next to (inaudible).

Unidentified Analyst

One thing, can you talk a little bit about what you're seeing in terms of – what you're thinking about in terms of expected LNG flows into the US through the summer and into the fall and kind of then how that might translate into a ten year view you have in terms of natural gas markets and pricing outlook?

Don Felsinger

I am going to have Neal respond to you, but I still think we are still very optimistic that with the amount of LNG that is coming online and the need to have some place to deliver it, that the US is the destination of probably choice, maybe last choice, but we are the largest market that is going to come here when it comes. Neal?

Neal Schmale

Yes, we talked extensively about this at the analyst presentation a month ago and for those of you who were there, you will recall that the demand in the rest of the world is going down with the economy and the consequences of that are that LNG is probably going to come to the US and that will exert a downward pressure on US natural gas prices. What is interesting from Sempra's perspective of course is that our business model in the LNG business is not designed around gas prices. We have contracted long term for the utilization of these facilities and it is consistent with our general approach to things that – where we tend to perform pretty well in all kinds of markets.

Don Felsinger

One of the things that we're seeing and I think you will see more of this later is that almost everyone that is bringing a new liquefaction facility online is getting themselves lined up to deliver spot cargoes, both to Europe and North America and we have had conversations with a lot of people that have an interest in bringing spot cargoes. We will see what eventually evolves, but I think there will be announcements in the industry sometime in the next short time period.

Unidentified Analyst

And in general, in terms of visibility, in terms of what type of cargo flows you are going to have, is it a very short window in which you have visibility because it is pretty variable or can you talk about that a little bit?

Don Felsinger

I just think that with the amount of capacity that is coming online and the fact that there aren't very attractive markets from a price standpoint, any place in the world that what people are looking to do is at least for the short term, and I am talking about a year to two years, just deal with spot cargoes and taking the spot cargoes wherever the market gives the best price. I think beyond that, as people see a firming up of gas prices Indonesia, Europe and North America, there will be more long-term contracts put in place.

Unidentified Analyst

Okay. Thank you very much.

Don Felsinger

Thank you.

Operator

And we’ll go next to Michael Lapides with Goldman Sachs.

Michael Lapides – Goldman Sachs

Hey guys, congrats on a really good quarter. Can you give an update a little bit on Mississippi Hub and Bay Gas in terms of both the construction outlook, but also the contracting outlook and what you’re seeing in the competitive landscape for either pipelines into Florida or other storage projects down in that region?

Don Felsinger

You bet, Michael. I will have Neal give you an update. But let me just paint the big picture for you. Between now and about 2015, we’re going to spend $1 billion developing about 75Es of storage and that’s at three locations, Bay Gas, Mississippi Hub, and Liberty. And Neal, you want to walk in through where we are contracting-wise?

Neal Schmale

Yes the materials we presented once again at the analyst conference is good. But in terms of Bay Gas, we have a little bit over 11 Bcf currently operating and it’s fully contracted. There is 5 Bcf under construction, be in service late 2010. And then we plan to increase the total capacity of Bay Gas to 27 Bcf. At Mississippi Hub, we have 15 Bcf under construction, 4 Bcf of that’s contracted and our plans there is to increase the total capacity to 30 Bcf. And then we expect to have another 17 Bcf in the Liberty – in the Liberty expansion area.

Once again, what we’re looking at here is, is something that’s consistent with the approach that we’ve taken on all of our investments. That is, we have signed up contracts to lock in returns, grew substantial portion of the capacity before we build it. And we try and build in areas and with respect to assets that are in a good position to capitalize on the flows that we’re going to face.

More particularly, if LNG comes in, our assets in the Gulf Coast, we’re going to be well positioned to take advantage of those flows. If the shale gas production and so forth and that part of the country predominates, we will be once again well situation to deal with that. So I’ve come back to the theme that we develop assets and function well over a wide variety of economic downturn.

Michael Lapides – Goldman Sachs

Got it. And what’s the best way for investors to kind of think about the economic – I mean the economics of these types of projects for Sempra mostly similar more of a take or pay like agreements or is there a combination of kind of some variable component to it. I’m just trying to think about the modeling aspect of this.

Neal Schmale

I think once again when we sell out the capacity, we – you should think of that as fundamentally the equivalent, I guess the economic equivalent of take or pay. But there are additional revenues around the edges. But when you adopt a kind of business model that we’ve adopted the fundamental economics for our LNG facilities or for pipelines or for that matter for these storage fields revolve around the contracts that we’ve entered into that provide these stable good returns. But in almost all cases, we have the ability to enhance that and improve the returns around the edges if you will.

Michael Lapides – Goldman Sachs

Got it. Okay, thanks guys.

Don Felsinger

Thank you.

Operator

And we’ll go next to Michael Goldenberg with Luminous Management.

Michael Goldenberg – Luminous Management

Good afternoon. Actually, good morning for you.

Don Felsinger

Hi Michael.

Michael Goldenberg – Luminous Management

Just couple of housekeeping questions. Just so I understand that that lower tax rate has to do with Mexican currency benefit at the Corp, is that why the tax rate is so low?

Don Felsinger

That was one of them. And also the other was the timing of when we take solar credits.

Michael Goldenberg – Luminous Management

How many credits did you bring in this year’s – this quarter from solar?

Don Felsinger

Joe?

Joe Householder

Michael, there is roughly a small – about a 1% of that impact is from solar and we’re estimating to have maybe $20 million of credits for the year. And so using the effect of rate method, maybe about a quarter of those have come in the first quarter. But we also had some other issues. We had lower tax rates because we have non-US income and we had some higher software deductions at the utilities.

Michael Goldenberg – Luminous Management

And the $20 million at the parent, not at Generation. You will book it at the parent.

Joe Householder

It will be in the Generation business unit.

Michael Goldenberg – Luminous Management

At Generation. Okay. Solar, how many megawatt facility do you expect to install this year?

Don Felsinger

Solar, we are looking at adding – it’s 48 megawatts between now and next year, so 20 this year.

Joe Householder

About 20 this year.

Don Felsinger

20 on line this year.

Michael Goldenberg – Luminous Management

20 megawatts and then 28. And then I can take the solar credits proportionality?

Don Felsinger

That’s correct.

Joe Householder

That’s reasonable.

Michael Goldenberg – Luminous Management

Okay. And then other income at SDG&E, was it – why was it so high?

Don Felsinger

Say that again.

Michael Goldenberg – Luminous Management

Other income, SDG&E of $17 million.

Don Felsinger

Well, I’m not sure. Let me ask Debbie to take a look at that.

Michael Goldenberg – Luminous Management

Seems abnormal, right?

Don Felsinger

Joe Householder.

Joe Householder

About $8 million of it was AFUDC equity at SDG&E and SoCal. The utilities combined SDG&E 6 [ph]. And then $10 million of it was in interest rates swap gain at the Calpine, OMEC plant, but because we consolidate that plant, we bring their income in. So really it was not ours, it was Calpine.

Michael Goldenberg – Luminous Management

So hold on. So it was plus (inaudible) SDG&E and minus 10 at the parent?

Joe Householder

No $10 million in our consolidated results. It gets backed out down in the, what used to be minority interest, but now non – earnings attributable is non-consolidated energy.

Michael Goldenberg – Luminous Management

Okay. So this –

Joe Householder

There is no effect on net income.

Michael Goldenberg – Luminous Management

And just so – so this $7 million of minority interest can be just backed out against other income?

Joe Householder

Yes.

Don Felsinger

Yes.

Michael Goldenberg – Luminous Management

And are we’re going to keep seeing minority interest going forward?

Joe Householder

Yes.

Michael Goldenberg – Luminous Management

Okay. Understood, to the tune of like $7 million per quarter?

Joe Householder

It will change obviously because Calpine plant is going to unwind about the third quarter, so it will get bigger.

Michael Goldenberg – Luminous Management

Okay. And why is it minority interest you – because you own majority and you consolidate it?

Debbie Reed

Yes, this is – this is Debbie. And under the FIN 46 rules, since we have a contract with a put and a call, then we have to record it on our books. And I would also stress though when a plant goes into service, we will start seeing earnings off of this, because we are increasing our equity and have the CPUC approve an increase in equity to offset that on our balance sheet. So as the plant goes in service, we will start seeing earnings later this year.

Michael Goldenberg – Luminous Management

Okay, understood. Thank you very much.

Don Felsinger

Thanks Michael.

Operator

Now we’ll go next to Leon Dubov with Catapult Capital.

Leon Dubov – Catapult Capital

Hi good morning.

Don Felsinger

Good morning.

Leon Dubov – Catapult Capital

I just wanted to double check if trading clearly had a really good quarter and you guys pointed out to the gas and oil parts of it. I’m wondering how much of that dynamic you continue to see in the second quarter of what drove the big gains in Q1 and if we should be thinking about similar types of results going forward.

Don Felsinger

Mark, you want to address this.

Mark Snell

Well, look, I think it’s always dangerous to take any one quarter or commodities and try to project that out over the whole year. But I would say if you’re looking at the markets, most of the things that you saw in the – in the first quarter and towards at the end of the first quarter as far as the steep and tangled in the markets, the relatively low volatility in those in the kind of way the markets were behaving that hasn’t changed all that much yet as we go into the second quarter. So as we sit here right now, it looks very similar. And we don’t really give predictions on where we are in the current quarter, but I think the markets looks similar so take that for what it’s worth.

Leon Dubov – Catapult Capital Management

Okay, that – that’s very helpful. Thank you.

Operator

(Operator instructions) And we’ll go next to Rebecca Followill with Tudor Pickering & Co.

Rebecca Followill – Tudor Pickering & Co.

Hi guys. The higher insurance rates for the utilities, is that included in guidance?

Mark Snell

Yes it is. We anticipated that and we haven’t adjusted our guidance for it. So it is included.

Rebecca Followill – Tudor Pickering & Co.

Similar – next question, similar to after any disaster, insurance rates go up across the board. So are you guys seeing significantly higher rates for your LNG facilities?

Mark Snell

We are not. The rates from our other property insurances – I mean, they’ve changed a little bit, but not nearly as significantly as we’ve seen for our fire insurance coverage.

Rebecca Followill – Tudor Pickering & Co.

Thanks. And then the last question on the commodities business, I may be doing the calculation wrong, but it looks like the invested capital is down at RBS. Could you talk about that a little bit?

Mark Snell

Yes. The invested capital is quite a bit lower and the regulatory capital is actually running quite a bit lower than it was last year. And that’s pretty easy to kind of figure out, because it is a function of two things which have both come off dramatically. One is commodity prices as those have dramatically over the peak of last year and the volatility is much lower too. And also as a result of the lower prices, the prices of that volatility is less even though with the absolute reduction in volatility. So both of those things have lower – have much, much lower capital requirements. And that actually for us is as the JV partner, with a cap on our capital, that actually works to our advantage. So we’re getting a larger percentage of the earnings early on this year because of the lower capital than we would have gotten last year.

Rebecca Followill – Tudor Pickering & Co.

So by my calculation, I still back into $1.6 billion capital that you guys have, been have about $500 million from RBS compared to about $2.4 billion a year –

Don Felsinger

Your math is good.

Mark Snell

Your math is good.

Rebecca Followill – Tudor Pickering & Co.

Okay. So that’s not a function, it’s a function of volatility and prices as opposed to any desire on their part to put –

Don Felsinger

Lower commodity prices.

Mark Snell

Yes, just lower commodity prices. It has – actually the total amount of the invested capital in the business is still pretty high. But the regulatory capital which is a function of pricing and volatility is what you’re focused on and how the returns are derived.

And you’re absolutely right the regulatory capital is much less. The actual capital in the business, the actual cash investment in the business is – it’s not – it’s lower than it was last year, but it’s still quite a bit higher than the regulatory capital. And that’s just – that extra capital is just an abnormal kind of borrowing rates.

Rebecca Followill – Tudor Pickering & Co.

Okay, thank you.

Mark Snell

All right.

Operator

And we’ll go next to (inaudible) Ike with Ike Trade International [ph].

Unidentified Analyst

Thanks. Good evening from Europe. Excellent results [ph]. Thank you. And I have a question about the commodity business hasn’t (inaudible) 700 traders. My question is, are you trading all commodities and beside also the currencies and your also business with third partners, for instance in precious metals overnight positions and such things.

Don Felsinger

What I was saying was that we’re about to move our energy commodity traders together with traders from our RBS’ North American headquarters and they will be trading a variety of activities, foreign exchange, interest rates, bonds, and equities, as well as energy commodities. So the entire group is going to be around 700 people.

Neal Schmale

But our group, our joint venture is limited to commodities only. So we’re –

Don Felsinger

Trade energy commodities.

Neal Schmale

Yes energy commodities in metals are really our primary trading activities.

Unidentified Analyst

Thank you.

Operator

And we’ll go next to Michael Lapides with Goldman Sachs.

Michael Lapides – Goldman Sachs

Hi guys, I had a follow up. And this is more of a macro kind of thinking long-term question. Now that it’s – now that we’re well into kind of what’s been our financial crisis and maybe can even look out the other side to see if the world’s improving over the next nine to 18 months. Can you talk a little bit about lessons learned across the industry and how you think the competitive landscape likely will change over the next few years in the natural gas infrastructure business, whether it’s pipelines, LNG, et cetera?

Don Felsinger

Well the key learning is to not to get overleveraged. I think going into this crisis where we had a strong balance sheet, didn’t have that much debt, boded well for this company. I think the other thing that as I look at what made us kind of stand above our peers is the fact the way we approach projects where we do not build on spec, we build a project only when we have customers willing to signup or use of that facility whether it would be 10 years, 15 years or 20 years. I think that coupled with our long-term view that we’ve had about natural gas being a fossil fuel of choice in the political and economical climate that we’re entering that also plays well into where we are going. But I think the key lesson for most companies is that don’t get yourself over leveraged because free money is not a thing that last forever.

Michael Lapides – Goldman Sachs

Okay. In the competitive landscape, can you kind of lookout over the next year or so or two or three years, how do you think that changes if it changes much at all?

Don Felsinger

Well depending on how long this current downturn persists, there will be some companies that probably will end up getting consolidated with other companies just for a survival, because the market is still not opened enough for lows that – that don’t have a good credit rating. So I think there will be some consolidations, but I do think that going forward that you will see companies not being quiet, so free to build a project hoping that people will come and use it later on that you will see more of a discipline that we’ve applied in the past 10 years where we will deploy our shareholders’ equity when in fact we have people willing to step up and sign a contract.

Michael Lapides – Goldman Sachs

Got it. Okay. Thank you.

Don Felsinger

Thank you.

Operator

And with no more questions in the queue, I would like to turn the conference back over Mr. Don Felsinger for any additional or closing remarks.

Don Felsinger

Well, as Jeff said, I know you guys are all busy at AGA and about to travel. But I want to thank you for taking the time to join us. It’s great for us to able to take a few minutes and share with you our first quarter results, but I think I’ll just repeat what we said at the analyst conference that we’re in a great position in terms of the investments we’ve made that are about to start paying dividends to us. And the fact that we’re one of the few companies in our peer group that has a very attractive earnings and build-in growth rate over the next five years, so we’re happy with the way we’re currently positioned. Thanks again for taking the time to join us. If you’ve any follow-on questions, you know how to get a hold of Jeff, Glen, or Scott. You guys all have a great day.

Operator

Again, that does conclude today’s presentation. We thank you for your participation.

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Source: Sempra Energy Q1 2009 Earnings Call Transcript
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