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Executives

Bob Hess – Director-Investor Relations

Gregg S. Kantor – President and Chief Executive Officer

Steve P. Feltz – Senior Vice President & Chief Financial Officer

Analysts

Daniel M. Fidell – U.S. Capital Advisors LLC

Northwest Natural Gas Company (NWN) Q2 2013 Earnings Conference Call August 7, 2013 11:00 AM ET

Operator

Good morning and welcome to the Northwest Natural Gas Company Second Quarter Teleconference and Webcast. All participants will be in a listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Bob Hess, Director of Investor Relations. Please go ahead sir.

Bob Hess

Yes. Thank you, Dennis. Good morning everybody and welcome to our second quarter earnings call for 2013. As a reminder, some of the things that will be said this morning contain forward-looking statements. They are based on management’s assumptions, which may or may not come true, and you should refer to the language at the end of our press release for the appropriate cautionary statements and also our SEC filings for additional information. We do expect to file our 10-Q later today.

As previously mentioned, this teleconference is being recorded and will be available on our website following the call. Please note that these conference calls are designed for financial community. If you’re an individual investor and have questions, please contact me directly at area code 503-220-2388, media should contact Kim Heiting directly at area code 503-220-2366.

Speaking this morning are Gregg Kantor, President and Chief Executive Officer, and Steve Feltz, Senior Vice President and Chief Financial Officer. Gregg and Steve have some opening remarks and then will be available to answer your questions. Also joining us today are other members of our executive team, are available to help answer any questions you may have.

With that, let me turn you over to Gregg. Gregg?

Gregg S. Kantor

Good morning, everyone. Thanks for joining us for our second quarter earnings call. I’m going to start with a brief overview of the period and turn it over to Steve to cover the financial details before I wrap up for the look forward. Performance in the second quarter was on target, a $900,000 increase in net income quarter-over-quarter, was primarily due to an increase in utility margins from two changes coming out of last year’s rate case; one relating to our decoupling adjustment and the other an increase to our fixed monthly customer charge. Those changes to base rates smooth out the seasonality of our earnings, and we will continue to see positive variances on these items during the warmer months ahead.

In the second quarter, customer growth held steady at about 1% with housing starts continuing to show solid improvement. For example, in June, Oregon housing permits were up nearly 50% over 2012 levels, Portland home sales are up about 16%, and home prices are up about 14% year-over-year. Unemployment in the metro area inched down to 7.3% in June and the local construction industry added 2,500 jobs twice as many as expected and really another good indication that things are moving in the right direction.

In the period, we also saw modest gains from our gas reserves investment and gas storage operations, which Steve will touch on in a moment, but clearly, the big news since our last earnings call, was the annoucment of two All-Party regulatory settlements that addressed important issues carried over from last year’s rate case.

In November, when the Oregon Commission approved our environmental cost recovery mechanism, they also directed a new docket to be open to address several implementation issues. Those issues included a prudency review of remediation expenses to date as well as the creation of an earnings test to determine amounts that would be collected from customers based on the company’s earnings. Under the settlement, approximately $97.6 million in remediation expenses and associated carrying costs incurred through last year were deemed prudent.

Parties also agreed that past insurance settlements of approximately $40.7 million are prudently executed. Part of the settlement, we agreed not to seek recovery of $7 million of PASS cards, which if approved by the Commission will result in a one-time after-tax charge of $3.4 million. Going forward, remediation expenses will be subject to an annual prudence review and earnings test. That test sets an earnings range below and above our authorized return on equity in Oregon. Within that range, the company will share a portion of its earnings to cover remediation costs. As an example, assuming our Oregon rate base remains unchanged and we earn our authorized ROE, currently 9.5%, under the annual earnings test, we would contribute approximately $600,000 of our earnings to the net environmental expenditures deferred for that year.

Settlement also states that any insurance proceeds recovered after 2012 would be applied against approved expenses in equal amounts over a 10-year period following receipt of the funds. And finally, the settlement allows Northwest Natural to put into rate base, the costs associated with the construction of a water treatment station at the site of our historic manufacturing gas plant.

That station is currently under construction and is expected to be in service in the third quarter of 2013, with costs estimated at $20 million to $25 million. After its completion, Northwest Natural can include those costs for rate recovery in our 2013-2014 PGA filings with the approved investment costs being added to rate base and recovered over approximately 30 years.

The other recently announced settlement addressed the amount Northwest Natural should recover for working gas inventory carrying costs. All parties agreed the company should collect $4.5 million in deferred carrying costs on working gas inventory for the current PGA year. Going forward, $4.5 million in annual carrying costs will also be added to base rates in the next PGA year starting this November. As in the past, the amount included in the rates will only be adjusted in a future rate proceeding. This approach is consistent with how carrying costs on working gas inventory have been historically treated and we believe it’s an appropriate resolution.

Resolving these outstanding regulatory items provides certainty moving forward and we believe both settlements offer a fair outcome for customers and the companies. The next step is Commission review and we anticipate a decision in the next few months.

In the meantime, we continue to work toward resolution of the two remaining issues from last year’s rate case, which are the recovery of carrying costs related to prepaid pension assets and incentive sharing percentages related to the interstate storage and asset optimization activities. We expect decisions on these two dockets later in 2013 or early 2014. This working year, I’m pleased with the progress we’ve made, we’re executing well in the utility and we made great strides towards resolving several important regulatory items.

With that, let me turn it over to Steve for the financial details.

Steve P. Feltz

Thank you, Gregg, and good morning, everyone. As we discuss the results for the quarter, please remember that a significant portion of our business is seasonal and therefore results are lower in the second and third quarters of the year due to the warmer weather impact on customer use for natural gas heating. For the second quarter of 2013, consolidated net income was $2.1 million or $0.08 per share, compared to net income of $1.2 million or $0.05 per share last year. As Gregg mentioned, earnings were in line with the company’s expectation, including an increase in utility results from timing differences that were driven by changes from the 2012 Oregon rate case.

As you may recall, these rate case changes relating to fixed monthly charges and average monthly usage resulted in margin decreases in both the fourth quarter of 2012 and the first quarter of 2013. This quarter, margins increased by $3 million or $0.07 a share. Overall, these rate changes were designed to more appropriately recover the utilities annual fixed costs from customers, with the result being a more even distribution of revenues and earnings throughout the year. Again, these are timing differences only and are not expected to impact annual earnings after the first full-year following the rate case.

Turning now to a more complete discussion of the second quarter results, the utility contributed $650,000 to net income this quarter, up from $100,000 last year, primarily reflecting a $3.4 million increase in margin revenues, which were partly offset by a $1.6 million increase in O&M expenses and an $800,000 increase in depreciation expenses.

As noted previously, the utility benefited from $3 million of margin timing differences in the quarter. The remaining increase was attributable to $1.4 million from customer growth and gas reserve investment, partly offset by a $900,000 decrease in gas cost savings and $400,000 decrease from our lower regulated return on equity. Total gas deliveries in the second quarter were down 3% compared to a year ago with gas sales to residential and commercial customers totaling 103 million therms or 4% below last year. The volume decrease was largely due to warm weather in the quarter partly offset by volume increase from customer growth.

Customer adds, as Gregg mentioned, were up slightly over a year ago with a 1% growth rate for the 12 months ended June 30, compared to 0.9% in the prior year. Margin from residential and commercial customers is up $4 million from a year ago, reflecting a combination of the timing differences, customer growth and gas reserves, discussed earlier.

With respect to industrial customers, gas deliveries decreased 2% to 109 million therms this quarter, reflecting a decrease in demand from customers in the pulp and paper sector and some seasonal shutdown for plant and maintenance. Meanwhile margin from industrial customers was down $200,000 from last year.

Despite the volume declines, we still see positive signs of customer growth from large commercial and industrial sectors, but while we see pockets of improvements, we also realize there maybe periods of uneven volumes and margin due to seasonality and economic conditions as evidenced by the lower volume this quarter. As for the gas storage segment, we reported net income of $1.5 million in the quarter or an increase of $300,000 over last year. The increase reflected lower expenses at Gill Ranch and higher revenues from third-party asset management services.

Moving onto operating expenses, for the quarter, we reported consolidated operations and maintenance expenses of $33.2 million, which was 3% higher than a year ago. The increase was mostly due to higher utility payroll costs as well as increases in system maintenance and safety costs.

Turning now to year-to-date financial results, for the six months ended June 30, net income was $40 million or $1.47 per share. This compared to net income of $42 million or $1.54 per share in 2012. Decrease was largely driven by lower utility results, which contributed $37 million this year, down from $40 million last year. More specifically, utility margin decreased year-to-date by $2.5 million with decreases coming from timing differences, lower gas cost incentive sharing gains and lower authorized return on equity, partly offset by margin increases from customer growth and gas reserve investments.

Since 2011, we’ve invested $142 million in gas reserves including $34 million so far this year. Net rate base grew from $49 million a year ago to $89 million currently. We are now over halfway to our expected $250 million five-year investment. On a year-to-date basis, total gas deliveries were down 2% compared to a year ago. Sales to residential and commercial customers were 372 million therms or 3% below last year. The volume decrease was largely due to weather, which was 6% warmer than a year ago, partly offset by additional volumes and customer growth. Meanwhile, utility margin from residential and commercial customers was relatively flat compared to last year, despite the decline in sales volume and negative timing differences.

Our weather normalization mechanism adjusted margins down by $4 million for the six months ended June 30, while the decoupling mechanism adjusted margins up by $3.9 million. With respect to the industrial sector, gas deliveries and margins were also relatively flat year-over-year with 240 million therms delivered and $14.2 million of margin contribution this year. In the gas storage segment, year-to-date net income was $3.1 million, up from $1.9 million a year ago. The increase reflects lower power costs and property tax expense at Gill Ranch, as well as higher revenues increases from additional contracted capacity in the first quarter.

Our revenues from third-party asset management services also contributed to the storage segment increase. Year-to-date consolidated operations and maintenance expenses were $67 million or 1% higher than a year ago, accounting for the increase for higher utility payroll costs plus system maintenance and safety costs. Those cost increases were largely offset by decrease in utility bad debt expense.

Cash flow provided by consolidated operating activities for the first six months of 2013 was $160 million compared to $175 million for the same period last year. The variance primarily reflects changes in working capital balances related to receivable and payable accounts.

Cash used for investing activities year-to-date was $81 million down from $89 million last year, reflecting lower capital expenditures on facilities projects plus proceeds received from an asset sale partly, offset by increased investment in gas reserves. A highlight for us this quarter as Gregg mentioned, was filing the Environmental Settlement Agreement, which if the agreements are approved would resolve the implementation issues for the environmental cost recovery mechanism and set the recovery of carrying costs in our working gas inventory balances.

If approved, we will take a one-time after-tax charge of $3.4 million, which equates to approximately $0.13 per share. Besides the initial charge, there are few key things to remember going forward. First, the earnings test established by the environmental settlement relates only to utility earnings with the test applying to the amount of environmental expenditures deferred each year, net of the allocated insurance recovery. Second, the earnings test is based on a sliding scale, which starts at 75 basis points below our authorized return on equity and results in a reduction of environmental costs recovered through the mechanism.

As Gregg explained, if we earned at our authorized return, which is currently at 9.5%, the company would reduce the net amount deferred for the current year by approximately $600,000. Third, under the working gas inventory settlement, we will recover $4.5 million annually in carrying costs on approximately $40 million of inventory included in rate base going forward.

Finally, with respect to 2013 earnings guidance, we are reaffirming the guidance range we announced in July, with earnings per share expected to be in the range of $2.02 to $2.22 per share. This guidance assumes a continued slow economic recovery and customer growth, normal weather conditions, and no significant changes in prevailing legislative and regulatory policies or outcomes.

With that, I will turn it back over to Gregg.

Gregg S. Kantor

Thanks, Steve. While a write-off of any size is disappointing, moving toward closure on these regulatory matters is an important and positive step forward. The costs associated with state and federally mandate environmental clean up activities can be significant, but we believe the settlement provides a reasonable outcome to a complex and difficult issue.

Also in the quarter, we made progress on one other regulatory item. We filed a tariff with the Oregon commission to provide high pressure gas service for CNG vehicle refueling. If approved, the tariff allows us to provide this service to fleet owners interested in the cost and environmental benefits of natural gas, benefits that aren’t accessible today due to a lack of refueling infrastructure.

Last week, it was a workshop at the Oregon commission to discuss the tariff and we felt it was a constructive and useful meeting. Incidentally, last week Ford, actually announced that in 2014 it will be rolling out its best selling F-150 truck with a CNG option. Going forward, they expect to offer seven other commercial vehicles with a CNG option next year. Really a great sign of the momentum, we are seeing around CNG vehicles and the market’s growing interest, but vehicle choices without refueling infrastructure addresses, only half the problem.

The fact is our CNG tariff provides local businesses, the option of using natural gas for fleets that’s just isn’t available in our market today. For that reason, we are hoping for OPUC approval in the near future. From our perspective, the CNG tariff and the adoption of cleaner transportation alternatives is a tangible way to advance Oregon’s greenhouse gas reduction goals and the governor’s tenure energy plan that was released last year. In that plan, the governor calls out the beneficial role of natural gas that it can play in driving Oregon to a cleaner energy future.

And I’m pleased to also report that a new law was passed in this recent legislative session that conferred to that goal. With the support from the Governor’s Office, the Oregon Commission, Senator Lee Beyer and the Oregon Trucking Association, Senate Bill 844 was passed to allow OPUC to establish a voluntary greenhouse gas reduction program to incent natural gas utilities to invest in projects that reduce emissions.

We believe this first of its kind bill provides a new proactive way for Northwest Natural to invest in projects that have quantifiable environmental benefits for customers, projects that would otherwise not move forward.

The bill takes effect in January and the interim, the OPUC will be opening a lawmaking docket to establish project and investment criteria. But at this point, we have the framework, but there is a great deal that still must be done on the details. In my view, this bill represents Oregon’s creative approach to environmental policy and I believe it provides a potential for a good deal of innovation going forward. We’ll keep you posted as the process advances.

Finally, this morning, let me give you a quick update on our Mist storage expansion to support PGE’s gas fired plants at Port Westward. Since our last call, we’ve continued the initial work on several components of the project. We are finalizing a request to the Oregon PUC for regulatory approval on the rate structure, for the storage services associated with this potential expansion. And as I’ve mentioned before, the project would require the development of new storage wells, a compressor station and additional pipeline facilities.

We are now in the process of completing detailed budget estimates to review with PGE to determine whether to proceed with the project. And we expect that decision to be made in the coming months. So halfway into the year, we’ve advanced a number of our key policies, but as always, there is a great deal left to do.

The months ahead, our focus will be on working through the remaining rate case items, continuing to execute on our utility business plans, making progress on our growth initiatives.

With that, I’ll open it up for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) We have a question from Dan Fidell from U.S. Capital Advisors. Please go ahead, sir.

Daniel M. Fidell – U.S. Capital Advisors LLC

Good morning, everyone.

Gregg S. Kantor

Good morning, Dan.

Daniel M. Fidell – U.S. Capital Advisors LLC

Just a couple of questions on the regulatory side, I guess the first one, would you expect any tweaking to the settlements you’ve got in place by Oregon regulators ultimately or do you think that’s going to be a fairly smooth approval process. and then secondarily, a separate question, can you give us a little bit of color on the remaining issues, lingering from the 12-K, so the recovery of pension carrying costs and the storage sharing items, anything you can provide there in terms of sort of where that lies and what you’re hoping for ultimately, that would be very helpful? Thanks.

Gregg S. Kantor

Yeah. On the, do we expect any tweaking, generally, you file all-party settlements; you don’t end up with tweaking going on. this is a pretty complex settlement on a big issue for customers. So it is possible, I think it’s a low probability, but there is, you got to, on this one say, there is some probability that it could be tweaked. We’re hopeful that it won’t be, and again, I think it’s very complex, a settlement, and I think when you begin to pull on one piece of it, other pieces of it begin to get more complex.

So again, I think there’s some small probability, but we’re hopeful that it won’t be. and then the color on the other part of the question, yeah, the pension docket is really taking a long time. We had kind of a long discussion about schedules and how the docket would proceed. That’s now completed and the first milestone on the schedule is our filing in late September. and that’s really the only milestone that we’ve got on the docket so far.

So this is the one where I expect it to go into 2014, probably at least the first quarter of 2014. again, this is also pension’s as you know, very complex issue. We’ve got two other utilities or three other utilities, basically, all the utilities we stayed involved in it, which I think can also work to extend that that the timeline on that.

So it’s going to take a while. On the interstate storage sharing docket, we’re getting started right now. This is one that it’s not quite as complex; I think we could probably get to a decision by the end of the year on it. and our hope is that we can really help people understand, how this is benefitting customers, the incentive mechanisms and that tinkering with it, it’s been very successful for customers.

Customers have benefitted in very, very big ways and our belief is that it is delivering what’s expected for customers and really it shouldn’t be offered. But again, we’ve got some education work to do, and on both sides, we’ll be sitting down, listening to customer advocates as well to their issues. and again, I think this is one that we can hopefully resolve before the end of the year. That helps, Dan?

Daniel M. Fidell – U.S. Capital Advisors LLC

Yeah, very helpful. Thank you on that color. Just one other quick question from me, and I’ll step back and let someone else to have some questions. but on Senate Bill 844, can you just sort of talk a little bit about the growth opportunities after the first for the year. Are those environmental related projects? Is that kind of renewable focused, just any kind of color you can give in terms of what kind of a future growth opportunity that might present for you? Thanks.

Gregg S. Kantor

Yeah. Thanks for the question actually. this was a bill that was really proposed by one of our commissioners and the governors. So, John Savage, he was very interested in this issue and it got passed. I think the opportunities here are pretty broad and what we’re expecting to do is to produce some brainstorming around what are the range of investments we might make, that would help through our using natural gas to reduce carbon emissions, and there’s lots of opportunities, ranging from enhanced CNG or LNG vehicle infrastructure, which reduces greenhouse gas emissions by 30% over gasoline and diesel, it could relate, we’ve talked in the past about programs that would help eliminate old furnaces that are out there and particularly, in low income homes that we would subsidize those through investments that would go into rate base.

So that’s kind of the range, but just about anything you can think of, that would have a significant and cost-effective carbon emission reduction, I think will be on the table as I say, we’re right now internal to the company going through kind of a brainstorming process about programs, and initiatives that might provide some greenhouse gas emissions might be interesting. and we’re going to present those two to commission, again, Biogas is another option, we have done some investment in Biogas through our Smart Energy program and there maybe some ways to enhance that as well.

So it’s really kind of an exciting bill from my perspective, it really allows us to do some great brainstorming and offer up some programs that the governor and I think the commission will be interested in.

Daniel M. Fidell – U.S. Capital Advisors LLC

Very interesting, thanks for the color, Gregg.

Gregg S. Kantor

Sure.

Steve P. Feltz

Thanks, Dan.

Operator

(Operator Instructions)

Gregg S. Kantor

We don’t have any other questions. Everybody probably wants to get out and enjoy the summer. have a great rest of the summer and we’ll talk to you in the fall. Thanks for coming.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.

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