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Pembina Pipeline (NYSE:PBA)

Q1 2013 Earnings Call

May 10, 2013 10:00 am ET

Executives

Robert B. Michaleski - Chief Executive Officer and Director

Peter D. Robertson - Chief Financial Officer and Vice President of Finance

Michael H. Dilger - President and Chief Operating Officer

Analysts

Zayem Lakhani - Canaccord Genuity, Research Division

Linda Ezergailis - TD Securities Equity Research

Robert Kwan - RBC Capital Markets, LLC, Research Division

David Noseworthy - CIBC World Markets Inc., Research Division

Operator

Good morning. My name is Laurel, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Pembina Pipeline Corporation's 2013 First Quarter Results. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Bob Michaleski, Chief Executive Officer. Please go ahead, sir.

Robert B. Michaleski

Thank you, Laurel. Good morning, everyone, and welcome to Pembina's conference call and webcast to review our first quarter 2013 results. I'm Bob Michaleski, Pembina's Chief Executive Officer. Joining me on the call today are Mick Dilger, President and Chief Operating Officer; Peter Robertson, Vice President of Finance and Chief Financial Officer; and Scott Burrows, Vice President of Corporate Development and Investor Relations.

Our agenda today follows our standard process. I'll spend a few minutes reviewing the first quarter 2013 results we released yesterday, provide an update on recent developments, including our $1 billion NGL infrastructure expansion, and then open up the line for questions.

I'd like to remind you that some of the comments made today may be forward-looking in nature and are based on Pembina's current expectations, estimates, projections, risks and assumptions. I must also point out that some of the information provided refers to non-GAAP measures. To learn more about these forward-looking statements and non-GAAP measures, please see Pembina's various financial reports available at pembina.com, and on both SEDAR and EDGAR. Actual results could differ materially from the forward-looking statements we may express or imply today.

Our financial and operating performance during the quarter was very strong and I'm pleased with how our year has begun. Overall, the results generated by our businesses benefited from the enhanced suite of services we are now able to offer and relatively position positive industry fundamentals. I would like to point out, however, that the quarter-over-quarter variances were largely due to the acquisition of Provident. As you all know, we closed the acquisition on April 2 of last year, so the results of these assets are included in the 3 months ended March 31, 2013, but not the comparable period of 2012. Compared to the same quarter last year, we saw an almost 90% jump in adjusted EBITDA and 100% increase in adjusted cash flow from operating activities. On a per-share basis, adjusted cash flow from operating activities grew over 18%. While our adjusted cash flow from operating per share grew mainly due to higher EBITDA, it did benefit from lower interest paid in the quarter due to the timing of the interest payments on our senior notes. The majority of our interest payments fall in Q2 and Q4 each year. On a consolidated basis, revenue net of cost to goods sold increased 79% to $314.9 million, from about $176 million in the first quarter of 2012. Operating margin also saw a substantial increase of about 88%, growing from $128 million during the first quarter of 2012 to $239.8 million during the first quarter of 2013.

Each of our businesses generated strong results during the quarter. By looking first at Conventional Pipelines, we saw an average throughput increase of almost 6% from the same period of last year. Our average daily throughput for this quarter is nearly 5,000 barrels per day, and some of our systems are running at or near capacity, which helps drive increased revenue in this business.

One thing to note, that we are now including results from a pipeline system in Conventional Pipelines, which was previously included in Midstream. While this had no impact on volumes, it did have and will continue to have an impact on revenue for the segments. Offsetting income revenue were higher operating expenses, which increased by nearly 30% compared to the prior period. This was because of ramping up volumes and completing winter-only access work along the pipeline systems. Overall, operating margin in Conventional Pipelines increased approximately 12% during the first quarter compared to the same quarter last year.

Our Oil Sands and Heavy Oil business generated results during the quarter that were virtually unchanged from the first quarter of 2012 due to the contracts and nature of this business. However, we did see a slight uptick of about 5% in operating margin due to additional throughput being transported in the Nipisi and Mitsue Pipelines beyond our contract capacity.

In our Gas Services business, we processed higher volumes at our Cutbank Complex during the quarter and also increased certain fees due to additional capital we invested in the assets. These factors resulted in an increased revenue of 44%, a 43% jump in operating margin when compared to the first quarter of 2012. In our Midstream business, we saw the largest gains on a consolidated basis when comparing the first quarter of 2013 with the first quarter of 2012. This is because of the former Provident business results that are reported for Midstream group, and, of course, we didn't own those assets in April of last year. Operating margin generated by crude oil-related activities increased 44% due to higher volumes, increased activity on Pembina's pipeline systems, wider margin, as well as increased throughput at the crude oil midstream truck terminals.

I'd like to note here that some of the opportunities we are able to take advantage of and execute on during the period, which drove such strong results were not typically seen in the first quarter of past years, especially with respect to margins and storage activities. Since we didn't own the Provident assets in the first quarter of last year, we have not made any comparison of the results of [indiscernible] oil-related Midstream activities but it is important to note that these assets performed very well for the quarter due to strong demand for propane in Western Canada and attractive prices in Eastern Canada and less volumes at the Redwater West and East facilities.

During the quarter, we incurred consolidated G&A expenses of $32.6 million compared to $17.6 million during the first quarter of 2012. This increase is, for the most part, associated with growth of our company since the acquisition of Provident, and is mainly due to an increase in the number of employees over the period, as well as increase in salaries and benefits of employees. Share-based payment accruals have also risen as a result of share price appreciation during the first quarter of this year.

Now with the addition of many new projects in Q1, I am very pleased to report that Pembina has increased its 2013 capital spending plan to over $1 billion from the previously announced budget of $965 million. I'll go over these projects briefly and we can talk more during the Q&A if you have specific questions.

Looking at Gas Services, Pembina announced on March 5 that we will proceed with Saturn II, essentially twinning Saturn I, as a part of a $1 billion NGL infrastructure expansion. This facility will extract valuable NGL oil gas streams in the Berland area of Alberta, and has [indiscernible] service contract with a third-party provider [indiscernible] today -- pardon me, approximately 65 percent of the facility's total capacity for a term of 10 years. We expect the project to be in service by late 2015, subject to regulatory and environmental approval. Capital cost of approximately $170 million. Based on 100% capacity, Saturn II is expected to extract approximately 13,500 barrels per day of NGL, which we transported on the same pipeline lateral that Pembina is currently constructing for Saturn I. Construction of the [indiscernible] contracted Saturn [indiscernible] progressing well. We expect to have the Saturn I facility in service [ph] this year in the third quarter, and the Resthaven facility is in service in the third quarter of next year. As noted in our first quarter report, we are planning to take over operatorship at Resthaven to help [indiscernible] operations of the existing facility while the new shallow cutter is being constructed. We don't expect this to have an impact on [indiscernible] results for Gas Service business.

In our Conventional Pipeline business, we are pursuing numerous crude oil, condensates and NGL capacity expansions for a total capital investment of approximately $800 million. [indiscernible] we reiterate all the details contained in the first quarter report, I'll touch on a few highlights about the progress we're making on these projects. First, in our crude oil and condensate expansions, we are working to complete the Phase 1 expansion and bring 3 pumps into service by October of 2013. This will bump up crude oil condensate capacity on the Peace Pipeline by 40,000 barrels per day at a cost of about $30 million. We are at the same time continuing to replace [indiscernible]. See, our crude oil and condensate capacity at our Peace pipeline reached 150,000 barrels per day in late 2014. We're progressing with detailed design and engineering as [indiscernible] required [indiscernible] potential will occur at existing sites [indiscernible] regulatory process to go quite smoothly.

Turning to our NGL capacity expansion plans. We completed [ph] the 3 pump stations for NGL expansion in April. The pump stations cost a total of approximately $30 million and we expect to have them commissioned and in place -- and placed in service in June. Once they're up and running, we'll have an additional 17,000 barrels per day of capacity on the northern NGL system. By October, we expect bringing a further 35,000 barrels per day on stream in the Phase 1 expansion. We are also progressing regulatory and environmental approvals [ph] [indiscernible]] and detailed engineering design for our Phase II NGL expansion, which we announced on March 5 as part of our $1 billion NGL infrastructure expansion. [indiscernible] expansion, we recently completed a nonbinding open season to invest future demand for transportation services in the areas of our pipelines. Based on initial results, we have sufficient support to proceed with the next steps [indiscernible] and expect to have more sales to discuss in the coming months.

In Midstream, we are also pursuing a variety of crude oil, condensate and NGL-related projects. The most substantial of these investments are RFS II, a new $415 million 70,000 barrel per day fractionate at Redwater site. This project rounds out our $1 billion NGL infrastructure expansion plan and is secured through a 10-year initial term take-or-pay agreement. Leveraging off of engineering for the original Redwater fractionator, RFS II is expected to be in service late in the first quarter of 2015. Ethane produced from RFS II will be sold under a long-term arrangement to NOVA Chemicals Corporation. Storage [indiscernible] and development also continues to be a major focus at our Redwater site. We brought 2 long-term fee-for-service hydrocarbon storage caverns [ph] into service in April, and expect to bring a third cavern into service shortly. With respect to Crude Oil midstream development, we continue to enhance a number of initiatives aimed at increasing the optionality of our Midstream business so we can leverage our assets, take advantage of a variety of market conditions and increase fee-for-service revenue-generating component. We are working toward completing and bringing into service 2 full-service terminal facilities, which will help bring additional volume onto our systems and we are also working to enhance the connectivity of our Pembina Nexus terminal. This applies to not only pipeline connectivity but also to rail, as we will be adding crude oil rail on and off loading services in the next several months. While most of the projects I discussed are eminent, we're also continuing to develop longer-term plans for exporting propane offshore. This project still is in a conceptual thing as we do both something to say about it in the next several months. [indiscernible] execute on our attractive suite of growth projects [indiscernible] opportunity will rely in part on our ability to maintain a strong financial position. To this end, we completed [indiscernible] offering near the end of the first quarter of $345 million in common shares. And in April, we issued $200 million in 30-year notes. As well, in April, we opened our DRIP up to U.S. investors to assist in our growth.

Now at this afternoon's AGM, we'll be asking our shareholders to vote in favor of amending our bylaws to enable us to issue [indiscernible] shares. This will allow us to further diversify our capital structure should we need to, and provide even more confidence in our ability to fund the capital program going forward.

In closing, the first quarter of the year marks the first 12 months of our future as a combined company and was a very positive one [indiscernible]. Our business has pretty solid cash flow and we secured the next chapter of long-term contracted [indiscernible]. We expect to see our existing asset base and growth project generate attractive returns for Pembina and our shareholders for -- in the years to come. Before I open the line up for questions, I want to remind everyone that Pembina's Annual Meeting is scheduled for this afternoon at 2:00 at the Metropolitan Centre here in Calgary. We look forward to seeing those of you who are able to make it. For those of you who are unable to attend, there will be a webcast presentation and the details to -- pardon me, access to webcasts are on our website at www.pembina.com under Investor Centre.

With that, we can start the Q&A. Laurel, please go ahead and open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Zayem Lakhani with Canaccord Genuity.

Zayem Lakhani - Canaccord Genuity, Research Division

I hope you can hear me clearly. I'm getting a lot of static on my end. But with regards to the lower depreciation on the conventional system, are there some onetime items included in the $8.5 million depreciation decline or is this a good run rate going forward?

Robert B. Michaleski

Well, it's bit of a complicated story relating to our adjustments in asset retirement obligations because of the discount. The rate we used at the end of the quarter was higher than the discount rate at the end of 2012, and because of that adjustment, some of the assets that they are all related to were already fully depreciated. As for that result, we'll roll back [ph] the depreciation that we would charge them in previous years. So as discount rates continue to rise, you'll see that impact going forward in future years.

Zayem Lakhani - Canaccord Genuity, Research Division

Okay. And just on the successful nonbinding open season, what -- can you provide a little more color as to what the next steps will be and the timing for this initiative?

Robert B. Michaleski

Well, I think what we can say is that we are now -- we've assembled the information from the various potential customers here and we're just starting to evaluate that information. Next steps will be to actually to really to work forward or move forward with respect to trying to determine sort of the ultimate potential and work with those who have submitted their information to us. So in terms of timing, I think it's going to take us a couple of months to do that, but we're, as I say, we're quite optimistic with respect to that go-forward position on that opportunity.

Operator

Your next question comes from the line of Linda Ezergailis with TD Securities.

Linda Ezergailis - TD Securities Equity Research

I'm just wondering if you could help us maybe stratify the crude oil midstream operating margin growth a little bit. I'm assuming that maybe half would be as a result of higher volumes and activity, and maybe the balance would be wider margins. But perhaps you can just kind of walk us through that, and we're already in May, so maybe provide some comments on what you see in Q2 and for the balance of the year in terms of margins?

Robert B. Michaleski

Well, I actually don't have the breakdown, Linda, that you're looking for. I'm not sure, Scott, whether we have that. All I can say, Linda, really, is the first quarter does represent a pretty strong quarter. I think that I would -- what I would not do, though, is I would not say that results for the first quarter were -- we simply could extrapolate through to the end of the year because the market conditions clearly are changing. They change pretty much every day. So I think, if we [indiscernible] a good strong quarter as far as the month of April is concerned, I think it was a reasonable month. It was not as strong as March. So really, we're off to a good start. I think volumes will continue to stay strong through the balance of the year, that's our projection. We'll certainly, obviously, not see any significant increase in volumes until we get the capacity additions added. And so to the extent there's additional LVP product coming our way by the end of year, that will be positive for the midstream results. So I really can't give you a really good guidance as to what to expect for the balance of the year. I would say that it's looking like, again, another solid year in our Crude Oil Midstream business.

Linda Ezergailis - TD Securities Equity Research

That's helpful. And can you maybe provide us with some similar comments around Empress East as well, and the propane pricing and other dynamics there?

Robert B. Michaleski

Well, it's sort of interesting. We have the -- I think, in our quarter, we identified that Empress East actually had a fairly decent quarter. Propane prices tend to remain fairly very strong. Out east, I think they have inventories [indiscernible]. So...

[Audio Gap]

Peter D. Robertson

Prices at Sarnia. And these hedges are based off of Mont Belvieu price. Whereas we're getting at least a 20% premium to develop this place right now at Sarnia. We're happy with our 50% hedge in our gas supply cost but we'll monitor that -- always monitor that going forward if we see an opportunity to take time to later on additional hedges, if that's appropriate.

Robert B. Michaleski

And Rob, just in terms of pricing, I mean, if you look at Canadian inventory, they were -- they decreased 1 million barrels from the first -- over the first quarter, so we're 64% lower than the 5-year average. So really, that's what's driving the strong Canadian pricing. And in April, we had another cold month. So winter really continued on, all the way through April, so just now it's starting to warm up, and we're starting to see injections versus withdrawals.

Unknown Analyst

Okay. That's helpful. And then my other question had to do with just the capital program. Now that you've had significant customer commitments to move forward with the large part of your program, I'm wondering what you do in the control risk on that $1 billion capital spend this year? And I was wondering if you could address both the materials component and the labor component separately. So, just an update on how you're managing risk on those items?

Robert B. Michaleski

Mick will handle that one Rob.

Michael H. Dilger

Well, let's kind of work step-by-step. The pipeline expansions are mainly pump station additions. So we're putting in, I think, 12 or 15 pumps and they're identical pumps and we know what they cost, so we don't have a linear disturbance there and no landowner impact. So we -- it's quite predictable what those costs might be, most of it's material purchase. With the fractionator, we've been working on the engineering there for many, many months and we are, as you know, twinning an existing asset. So we're building something we've built before and we know how to operate. So again, it's not a science experiment. It's something that we're quite comfortable with. Saturn II would be exactly the same thing. We're twinning something that we've already built and that's working out very well. So when you think about all 3 of those components, it's -- a lot of it is greenfield but it's stuff we've done the twin of in the past. So it takes a lot of risk out of the equation.

Peter D. Robertson

A lot of the long lead items as well, Rob, have been actually ordered already. If you look at Saturn I, we have said that will be starting up here in third quarter of this year and that our expectations are [ph] it will be on time and on budget. Actually, Scott just mentioned that with respect to the fractionator Redwater II, we actually now have a permit from ERCB. We received that permit 3 weeks after we applied for it, so that's good for us. So I think the only area that probably is looking a little different than we thought, we've talked about Resthaven being delayed. There's some scope and design changes there that we are continuing to work on. And so I think the costs are going to be higher. And obviously, when you delay a project, it's going to cost more as well. But we believe that we have justification for adjusting our fees to deal with the modifications that are being made here on Resthaven. So all in all, Rob, we're pretty comfortable with our ability to deliver on the budget. I think, one thing, like we didn't spend as much money probably in the first quarter as we probably anticipated, so there could be a carryforward into 2014, but we're still saying $1 billion or just over $1 billion of capital for the year, which will be, obviously, again, a record for Pembina, but I think we're feeling pretty comfortable about it.

Operator

Your next question comes from the line of Robert Kwan with RBC Capital Markets.

Robert Kwan - RBC Capital Markets, LLC, Research Division

Just on Saturn I, you mentioned that it's going to come in third quarter. I think that's a quarter ahead of its schedule. I'm just wondering, have I read that right, and if so, is that just contingency on timing or did something else go right and is that something that might be repeatable in terms of some of your other projects?

Robert B. Michaleski

Well, I wish they all could be repeatable. I like to be ahead of budget or -- on time and on budget is really pretty attractive at these stages. I don't think there's anything in particular there, Rob. We've got through the pipeline construction in good order, the gas plant, things have worked out quite well there. I mean, it's a good facility for us. Things like land and all that was good. It was little different than when we did Musreau. Musreau was a very tight complex and things were quite difficult working conditions there but Saturn has been good. As I talked about in the call, I mentioned that Resthaven is going to be delayed. So you get some good, some not good, but overall, we're pretty happy with where we are.

Robert Kwan - RBC Capital Markets, LLC, Research Division

And I guess, just with Resthaven, the delay, you'd mentioned, I guess, today and also previously, that some of that was due to scope changes, and you were just mentioning that you think you will be able to recover that in fees. Was that something that -- the scope changes, was that initiated by you or was that initiated by the customer?

Robert B. Michaleski

Make that a bit of both. The customers are planning finding to have more liquids out there than first thought. And so some of the equipment related to liquid handling had to be upsized, which is inconvenient in terms of timing but very good because it's pointing more product to our systems, ultimately, through our fractionator. So that was, let's call it half. And the other half was just design improvements. We took over a design from a producer and that was going to initially do this project and they handed it over to us and we weren't quite comfortable with all the elements of the design, so some of it was changed by us to make the plant a little more robust and a little safer.

Robert Kwan - RBC Capital Markets, LLC, Research Division

Okay. Just wondering if you could provide any additional color on the funding plan generally, but specifically, and we'll assume you get the approval on the prefs, your thoughts on using that product? It's maybe a little bit more expensive than your debt cost on an after-tax basis, but your thoughts on kind of using that sometime this year?

Peter D. Robertson

Funding requirements will dependent a lot on when our capital does get spent, but the pref market will be another option for us going forward. I mean, we have our $1.5 billion bank facility virtually unutilized today. So that gives us a lot of flexibility with respect to timing but we certainly see the pref market as being a good market today, in general, and it will be a good product for us to use going forward. But I can't say anything about timing at this point.

Robert Kwan - RBC Capital Markets, LLC, Research Division

I guess, just on that, Peter, philosophically, you mentioned that it will be driven a little bit by timing, but the pref market's open or, just frankly, any funding option. How much -- how out in front do you want to get in terms of having a more conservative funding plan? Or is your thought that things will be accommodated for quite a while, and therefore, you really do want to just match it directly with the need?

Peter D. Robertson

Yes, I mean, in the short-term, we don't see rates rising but beyond the 18 months to year mark, there's a concern there that rates could well be higher. So as we draw down on our bank facility, I think it's prudent to lock in as much of that kind of long-term basis as we can to match the life of our assets. So we won't -- I mean, we're not likely to be drawing down on our bank facility to the full extent and we'll term out at, generally, perhaps shorter that we might have done a number of years ago.

Operator

Your next question comes from the line of David Noseworthy with CIBC.

David Noseworthy - CIBC World Markets Inc., Research Division

I'm sorry, I missed some of your discussion on Empress East. I think I got disconnected, but just wanted to, in case I missed it, follow-up on what your expectation was in the second half of the year around Mariner East and Mariner West impacting Sarnia prices.

Robert B. Michaleski

Sorry, David, I didn't catch that part. The impact on Sarnia pricing caused by?

David Noseworthy - CIBC World Markets Inc., Research Division

The COD or the commencement of Mariner East and Mariner West pipelines?

Robert B. Michaleski

No, we don't have a view on that at this stage, David. I think, from our perspective, we're going to opportunistically still continue to try to access that premium market for the second half of the year. And at this stage, I think as far as our forecasts are concerned, obviously, we're not -- we don't share our forecast but we do know that the overall NGL business unit will exceed our budget expectations for 2013. So I think we're still expecting a positive result for the balance of the year.

David Noseworthy - CIBC World Markets Inc., Research Division

And then, again, just in case I missed some of this. The Resthaven, just looking at the numbers that you have in your MD&A, both for Saturn and for Resthaven, those looked a little lower to what I've seen in the past. Is it that you've excluded the pipeline associated to these projects? Is that why the CapEx is lower or have the costs come down dramatically?

Peter D. Robertson

No, David, that's correct. We've excluded the pipeline portion. So we're now just showing the pure plant capital.

David Noseworthy - CIBC World Markets Inc., Research Division

Okay. Perfect. And should I just assume that, really, the overall cost relative to when the pipeline was included is generally the same in the case of Resthaven in that additional $35 million?

Peter D. Robertson

Yes, that's correct.

David Noseworthy - CIBC World Markets Inc., Research Division

Okay. And have the owners approve that scope change?

Robert B. Michaleski

We're in discussions currently with them, David. So they haven't as yet given the blessing. But we think we have a strong case for justifying an increase in the capital fee.

Michael H. Dilger

Yes, they have approved the scope changes for the increased liquids, but some of the design changes are still under review. So some of that has been approved.

David Noseworthy - CIBC World Markets Inc., Research Division

Okay. So part 1, yes; part 2 still to go?

Robert B. Michaleski

Right.

Michael H. Dilger

Yes.

David Noseworthy - CIBC World Markets Inc., Research Division

Got it. And in terms of -- one of your creditors, I guess, TransCanada, recently announced Hartland Pipeline and terminal facility. It seems like kind of the project that's ideally suited for Pembina's asset suite. Do you see more demand for that kind of service offering or does the lack of an international export pipeline limit Pembina's ability to secure this kind of service offering?

Robert B. Michaleski

Well, we view any takeaway capacity from the basin as positive no matter whether it's gas, NGL, the stuff we're working on with propane or crude, so any of those kinds of developments are positive. With the expansion plans we've announced so far, we believe there's enough takeaway capacity in industry. But beyond that, for our open season, it remains to be seen how large that will be and if there's sufficient takeaway capacity. So certainly, any announcements for other takeaway projects would be viewed positively by Pembina.

David Noseworthy - CIBC World Markets Inc., Research Division

Right. Sorry, I mean, what I kind of meant more was like do you see an opportunity to build out when you start doing this oil -- crude rail oil to build out more terminals in the Hartland and pipeline connected into either Edmonton or Hardesty, that's similar as to what TransCanada announced?

Robert B. Michaleski

Yes, we do.

David Noseworthy - CIBC World Markets Inc., Research Division

Okay. Fair enough. And then just one last question with regards to Younger and that tie-in that you completed. What kind of volumes do you expect related to that tie-in?

Robert B. Michaleski

I think it's about under $100 million a day. So it's not massive in the scope of Younger's nameplate but it's certainly helpful. The volumes there are building and we build -- optimistically, we hope that can continue but we'll see.

David Noseworthy - CIBC World Markets Inc., Research Division

And will the economics around those volumes be similar to the rest of volumes going through Younger?

Robert B. Michaleski

Yes.

Operator

[Operator Instructions] And with no further questions, I'll turn the call back over to our presenters.

Robert B. Michaleski

All right. Well, thanks for those who participated on the call this morning. And for those of you who are in Calgary, we'd love to see you at our AGM this afternoon and we can carry on this conversation further. So again, thanks for participating and we look forward to speaking to you again soon.

Operator

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

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