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Enbridge, Inc. (ENB)

Q3 2007 Earnings Call

November 7, 2007, 9:00 AM ET

Executives

Vern Yu - VP, IR & Enterprise Risk

Patrick D. Daniel - President and CEO

Stephen J. Wuori - EVP, CFO & Corporate Development

Colin Gruending - VP and Controller

J. Richard Bird - EVP, Liquids Pipelines

Analysts

Robert Hastings - Canaccord Adams

Karen Taylor - BMO Capital Markets

Matthew Akman - CIBC World Markets

Linda Ezergailis - TD Newcrest

Andrew Kuske - Credit Suisse

Robert Kwan - RBC Capital Markets

Daniel Shteyn - Desjardins Securities

Ross Payne - Wachovia Capital Markets

Presentation

Operator

Good morning ladies and gentlemen, and welcome to the Enbridge Incorporated Third Quarter 2007 Financial Results Conference Call. I would now like to turn the meeting over to, Mr. Vern Yu. Please proceed.

Vern Yu - Vice President, Investor Relations & Enterprise Risk

Thank you. Good morning and welcome to the Enbridge, Inc. third quarter 2007 earnings call. With me this morning are Pat Daniel, President and Chief Executive Officer; Steve Wuori, Executive Vice President, Chief Financial Officer and Corporate Development; Richard Bird, Executive Vice President, Liquids Pipelines; and Colin Gruending, Vice President and Controller.

During this call, we may refer to or speak to certain forward-looking information. Statements made with respect to forward-looking information are subject to a variety of risks and uncertainties pertaining to operating performance, regulatory parameters, weather, economic conditions and commodity prices. A more fulsome discussion of these risks are included in our securities filings, which are publicly available on both SEDAR and EDGAR.

I would also note that our supplementary financial information package for the period of 2002-2006 is now complete and is available on our website under Financial Information Additional Resources.

This call is webcast and I encourage those listening on the phone lines to view the supporting slides which are available on our website at www.enbridge.com/investor. A replay of the call will be available later today and the transcript will be posted to our website shortly thereafter.

The Q&A format will be the same as the Q2 call. The initial Q&A session is restricted to the analyst community. When we have concluded Q&A for the analyst community, we would invite the media on the call for further Q&A. For both Q&A sessions, we ask you to limit your questions to one follow-up and rejoin the queue. I would also remind you that Colin, Anu and I will be available after the call for any detailed follow-up questions you may have.

And at this point I would like to turnover the call for Pat.

Patrick D. Daniel - President and Chief Executive Officer

Great, thanks Vern. Good morning everyone and thank you all for taking the time to join us. As you know, earlier today we reported year-to-date adjusted earnings of $438 million, which is a 4% increase over last year. The third quarter adjusted earnings were 14% lower than last year's third quarter and this is primarily because we have employed more conservative risk management practices at Aux Sable this year, which has decreased the earnings contribution in 2007. And of course the rapid increase in the value of the Canadian dollar has negatively impacted the earnings contribution from our US operations.

Despite these factors, we are still on track to meet our $1.75 to $1.85 EPS guidance range, albeit at the lower end of that range. Steve Wouri will provide a full review of the financials results after my remarks. So what I'd like to do now is just move on to a strategic update and of course we recently completed our annual investor conferences in Toronto and New York where we provided you with a very comprehensive review of our growth initiatives and the financing plans associated with those. And for anyone who was not able to attend the sessions, they are available on our website under the Investor Relations tab.

So what I would like to do now is just take a few moments to update you on the development since investor days and to provide the current status of the growth initiatives that we have underway. The biggest news of course since Enbridge Day is the Fort Hills pipeline project. At a forecast cost of about $2 billion for the first days of the project and a 2011 in service date, this project represents the first in that second wave of growth opportunities that we identified at Enbridge Day. Most of the capital was provided for in the risked component of the first wave of development, but part of it represents the first commercially secured portion of the second wave. So we are very pleased with that.

It will contribute to continued growth in earnings in the next decade and the details of course of the agreement are confidential and will remain so for competitive reasons. However, I think it's fair to say that on the strength of our operating and construction capabilities, we are able to achieve an attractive risk return package, similar to that of other large projects that we have discussed with you in the past. Similar returns, basically low teens returns, a flat return profile, no throughput risk, and a carefully structured capital cost risk management and sharing agreement.

The Fort Hills system will be our third regional system serving the Athabasca oil sands and will further reinforce the scale and efficiency of our regional asset base. And for those that were with us and following us at the time that we embarked on the Athabasca pipeline, I think you can see the wisdom of that investment and the risks we took at the time.

Turning to other projects, we remain on schedule to complete all of our secured liquids projects for their planned in service dates. Let's start first of all with the regional pipeline developments. Enhancements to the Athabasca pipeline have been completed along with the associated pipeline modules that serve the Long Lake and Surmont Oil Sands projects. The Surmont facilities are in service and we expect Long Lake to be in service later this year. Construction continues on Waupisoo pipeline and that project remains on track to be completed by the end of the second quarter of 2008.

Our mainline capacity expansions also remain on schedule. Phases 1 and 2 of Southern Access are both expected to meet their respective service dates of early 2008 and early 2009. As you are aware, commercial terms related to Albert Clipper have been finalized for some time and an application for the Canadian portion has been filed with the NEB. Enbridge Energy Partners, our US affiliate, will file its application with FERC in 2008. And Alberta Clipper is still scheduled to be in service in mid-2010.

On the regulatory front, a revised tolling agreement for the Southern Access Extension in Patoka was filed with FERC on October 18th of 2007 and it's still our expectation that we will have regulatory approval in time to commence construction in 2008, and to be in service in 2009 with that extension.

Staying on schedule continues to be a challenge and it is coming at a cost. The hard reality is that it's costing us more than we would have liked to meet our expected in service dates. The increased capital costs have stemmed primarily from higher than anticipated contractor and labor costs. Those have been the prime driver. And as you will have noticed in our MD&A, three of our projects, Southern Access, Southern Lights and Waupisoo, have experienced significant cost increases.

While these cost increases are disappointing, I should note that we are still happy with the returns of the overall portfolio and recognize the overruns will actually increase the aggregate earnings that we derive from these projects. The estimated capital cost for the US portion of Southern Access has increased from $1.8 billion to $2.1 billion. The vast majority of the overrun will be recovered in a higher toll and will not have an official impact on the return on that particular project.

Our Southern Lights project, we now expect the total capital cost to be in the order of US $2.2 billion and that's up from $1.5 billion. The project is tolled on a cost of service basis and we will recover all of our capital costs. This cost overrun does lower the project's equity return to the lower the end of that 10% to 12 % range that we discussed at Enbridge Day. Now we have the ability to increase our return depending on the extent to which throughput on the line exceeds 90% of capacity, which could increase our returns by about 2% to roughly 12%.

Finally, we now expect the capital cost of the Waupisoo project to increase by roughly $100 million to $0.6 billion and this is inclusive of IDC by the way. Our contract with Waupisoo shippers allows for a portion on these costs overruns to be shared with the shippers. These cost overruns will not materially impact our return on the project and that return will remain in the mid teens.

As we discussed at Enbridge Day, Enbridge's overall portfolio risk to cost overruns has been largely mitigated on a contractual basis and the portfolio-wide cost overrun of 50%, which still only result in a portfolio return reduction of roughly 2% in terms of return on equity.

Enbridge Energy Partners announced, as I am sure most of you are aware, an annualized $0.10 per unit distribution increase last week. This distribution increase signals that EEP's base business has improved and that it is on track with its growth projects. On an annualized basis, the distribution increase will add roughly $2 million in incentive earnings to Enbridge, Inc. and sitting at $3.80 per unit that brings it closer to the high general partner distribution splits of $3.96, known as the high splits. So we are moving in the right direction.

Turning to the gas side of the business, we are very encouraged with the recent developments at our gas distribution business. We have reviewed many of those with you at Enbridge Day. Some increased equity techniques [ph] in going to from 35% to 36%, along with the implementation of incentive regulation is good news when taken in the context of already strong organic growth in the core business augmented by a growing non-regulated slate of business opportunities that Al Monaco reviewed with you. So we look for good things coming out of gas distribution over the next five years.

Staying in Ontario, we have received final regulatory clearance to construct our 182 megawatt wind project in Bruce County. Construction has begun on that project and we expect the facilities to be in service in the latter half of 2008.

Our Rabaska LNG project received Quebec cabinet approval on October 26th, which represented the last regulatory hurdle in the province for that project. We also expect final federal regulatory approval in the near future. And as you know, we continue to work on securing long-term supply contracts for the project.

In Texas, Enbridge Energy Partners continues to move forward with its $635 million US Project Clarity to transport the growing production out of East Texas. Stage 2 facilities are now complete and the third stage is scheduled for completion in early 2008. Current throughput approximately 200 million cubic feet per day, building towards 700 million per day when fully complete in 2008. So the system is partially operational already.

So that's a quick run through on major projects and concludes my remarks. I am going to now turn it over to Steve and I will come back and do a very quick wrap up. Steve, could you go ahead with the financial and operating highlights?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Okay. Thanks very much Pat and good morning everyone. I thought what I would do is start with the financing strategy first, particularly in light of the Fort Hills pipeline project announcement last week, and the capital cost revisions that Pat referred to earlier. We continue to follow the financing plan I laid out at Enbridge Day and we remain confident that we will be able to finance our projects on attractive terms. I'd like to briefly walk you through an update of the financing flowchart that I presented at Enbridge Day for the base case or first wave of projects, and update it to where we are today.

In addition to the cost revisions that Pat described earlier, we've now included the Fort Hills project and we have also adjusted our Canadian to US dollar exchange rate assumption from CAN$1.15 to US$1 to CAN$1.05 to US$1 and we have had to start talking here as to which is the big dollar and which is the small dollar as we do these exchange rates. But we are talking about adjusting it for a CAN$0.95 versus the dollar yesterday to $1.10 this morning. Given that the Canadian dollar is trading at around that, the total capital costs actually are going down the higher the Canadian dollar goes because a lot of these are US dollar costs. And so the estimate that I am giving here is probably a little bit conservative from a capital perspective, especially at a 95 cent dollar.

As a result of the updates, our total cost estimates have increased by about $1.7 billion to just under $14 billion, and that's $13.9 billion you see at the at top of the chart. You should note that a portion of Fort Hills' capital costs were in the first wave capital figures presented at Enbridge Day and they were in on a probability-weighted basis. Removing that probability-weighting for Ford Hills or making it 100%, the additional funding requirement for this project is now on the order of $0.7 billion higher than what was presented at Enbridge Day. So, it's important to note that a large portion of this was notionally in the figures already. This still leaves about $1 billion of probability-weighted liquids pipelines projects that are in the development stage still included in the first wave.

Turning to the financing chart then and starting with the revised $13.9 billion, deducting free cash flow of $5.7 billion over the period of 2007 to 2011 leave us a net funding requirement of $8.3 billion. Separating that into average capital structure of debt and equity results in a total requirement of $5.8 billion of debt and $2.5 billion of equity. Looking first at the left hand debt column, we have already raised $1.2 billion in 2007. This leaves $4.6 billion of debt yet to be funded over the next four years. That's a change from $3.6 billion previously. And also a reminder that project financing will be used for the Southern Lights project.

Moving over to the equity column, after deducting new equity from our dividend reinvestment and stock option plans, and the $600 million raised in early 2007, the net equity requirement to be funded over the next several years is $1.6 billion; that was $0.9 billion on the chart at Enbridge Day. As I indicated before, this can be met with any or a combination of asset monetizations, common equity or hybrid securities. Our equity requirement could decline if the Canadian dollar remains strong and if some of the projects in development do not come to fruition.

I think it's worth noting that the $2 billion in capital cost for Fort Hills is concentrated in the 2010-2011 period. So it's a really good fit for the rest of the wave one capital, which has a larger period of spend in 2008 and 2009, and as such Enbridge's equity requirements in the near term will not be impacted meaningfully by the Fort Hills project.

It's also worth reiterating here that all of the projects are underpinned by strong commercial arrangements and are very credit supported... supportive. So while we are talking fairly large numbers, when you break the financing plan down into its components, it remains very much manageable. We also continue to be well positioned from a liquidity perspective. We currently have about $4.4 billion of standby credit facilities, of which about $2.4 billion is available and undrawn net of the amounts that are backstopping our commercial paper programs.

We intend to further increase our credit lines by year-end or very shortly thereafter to ensure that there is sufficient available liquidity to fund Enbridge's capital program and to manage through adverse market conditions or for an unanticipated expenditures.

I'll now move to the quarterly financial results. Reported net income in the third quarter was $78 million or $0.22 a share compared to $95 million or $0.28 a share in 2006. The results are relatively clean from an accounting standpoint with only modest adjustments for non-operating factors given that weather impacts were minimal in both 2006 and 2007. Adjusting for non-operating items, third quarter earnings were $79 million or $0.22 per share, down from third quarter '06 earnings of $92 million or $0.27 per share. On a year-to-date basis, adjusted operating earnings of $1.23 per share are generally in line with the prior year period.

I'll now walk you through our key challenges in the quarter and then I am going to finish with the description of the strongest areas of the business this quarter. First of all, foreign exchange. Virtually every Canadian company is going to be talking about this and we may as well. Our earnings were adversely impacted by the dramatic appreciation of the Canadian dollar against the US dollar over the last quarter. Overall, there was a negative foreign exchange impact on earnings of about $5 million in the quarter. This will be a challenge for us in the remainder of 2007 and beyond from an earnings perspective. And just a reminder of the sensitivity that a $0.01 change in the US-Canadian dollar exchange rate results in an after-tax earnings impact of about $1.8 million.

I should also note that we have cash hedges in place to protect foreign currency denominated investments and their associated cash flows. Over the first nine months of the year, we have received $12.5 million in after-tax cash flows from these hedges. The payments that we received under these have been booked to the balance sheet and are included in the cash flow statement, but they do not flow to the income statement and that makes me mad.

If the dollar remains about where it is and who can tell where it is right now, but about a $0.03 drag on EPS for the full year can be expected if things remain through the rest of the fourth quarter as they stand today.

Turning to Aux Sable, the adjusted earnings from Aux Sable are down $9 million compared to last year, mainly due to realized hedge loses. Given our large capital expenditure program in other areas of the business, our goal is to preserve cash flows from the assets that tend to exhibit more volatility of earnings and cash flow than the comfort level that we have. And therefore Enbridge entered into transactions earlier this year to hedge an approximately $10 million in upside earnings for the full year while 2006 of course was unhedged, that being the first year of that agreement. Looking forward, we've taken advantage of the record high forward fractionation curve and we have locked in Aux Sable earnings in the order of about $20 million for 2008.

I will now talk about the Enbridge Offshore System. Earnings were down modestly compared to the third quarter last year, mainly due to lower deliveries on the Offshore System pipelines. Lower offshore volumes were expected given the continued natural production declines in the area. And the start-up of gas production from new deepwater development projects continues to be delayed from the aftereffects of the hurricanes in 2005. Earnings were also affected by higher operating costs and continuing 2005 hurricane inspections costs, as we do the final inspections in the systems.

So while this quarter's offshore performance is weak, mostly due to factors beyond our control, we do expect that it is going to steadily get better from here. We have several new projects that will start to generate earnings as they come on stream, and they include the Neptune oil and gas project by early 2008 and I should note that we are already booking standby fees on the Neptune system in the fourth quarter of 2007. Atlantis, we expect in late 07', Thunder Horse in late 2008, and Shenzi in mid-2009 as a rough timeline of when these new developments will come on.

Turning to Liquids Pipelines, earnings from the Enbridge Mainline system and Athabasca are down compared to the third quarter of 2006, primarily due to increased operating costs, which continues the trend from the first two quarter of this year. As well, Enbridge System earnings were impacted by higher taxes in the Terrace segment of Liquids Pipelines.

Earnings from Customer Works were also down over the prior year quarter. As you know, Customer Works has been an excellent investment, but pursuant to an OEB recommendation, it did lose its major client, Enbridge Gas Distribution. Customer Works

Customer works will retain its other clients and will look to add new customers.

Although we have encountered the challenges that I have just described, we are fortunate to have a diversified assets portfolio and there were assets that frankly rocked in the quarter. It's hard not to be excited, first of all, about EEP's outlook. EEP's increased earnings were driven primarily by Enbridge's higher ownership interest and improved financial performance at Enbridge Energy Partners from both the liquids and gas businesses of the partnership. As Pat mentioned earlier, we believe that the partnership's recent increase in its distribution is a strong signal of its continued growth profile and we expect further growth in its earnings and distribution as it completes its slate of expansion projects.

Enbridge Gas Distribution experienced its usual seasonality in the quarter, but it's having a very good year, primarily as a result of continued customer growth and higher average usage by utility customers. International segment just continues to deliver strong performance. Third quarter earnings were up slightly over 2006, mostly due to higher earnings from CLH, which were positively impacted by a 2.6% increase in volumes, higher average transportation tariffs, and also the impact of a stronger euro.

And finally in the Corporate segment, our third quarter costs were lower by about $4 million compared to 2006, primarily due to lower interest expense as we use the proceeds of the February equity issuance to pay down debt.

So those are my remarks on the financing plans in the quarter, Pat. And I will turn it back over to you.

Patrick D. Daniel - President and Chief Executive Officer

Great, Steve, thanks. Just a little reminder that CFOs are supposed to be emotionless, you are not allowed to get mad about the accounting rules certainly. Thanks Steve. So we continue to execute on our existing crude oil expansion projects and now been able to secure this first project in this second wave growth opportunity with the agreement on Fort Hills.

While these projects will contribute modestly to near-term earnings and cash flow, our earnings and cash flow will ramp up steeply in 2009 and thereafter as a result of the significant series of projects coming on stream. Supporting this of course is a very diversified business platform that continues to deliver strong operating and financial results.

So in closing, as we build and grow our business for the long term, we will continue to employ best construction practices, we will consult closely with stakeholders and work very closely with the regulators to complete this significant expansion program.

So on that note, I think we can now move to the Q&A Vern.

Vern Yu - Vice President, Investor Relations & Enterprise Risk

Okay. We will very happy to take questions at this point.

Question And Answer

Operator

Thank you. [Operator Instructions]. Your first question comes from the line of Bob Hastings with Canaccord. Please proceed.

Robert Hastings - Canaccord Adams

Hi. Yes, I share Steve's concern on the hedging. Just to clarify that, the impact of the Canadian dollar you said was $5 million, it's about 6.4% of the earnings. What would that have been had that been booked the way it used to be booked?

Patrick D. Daniel - President and Chief Executive Officer

Yes, $12.5 million would have flowed to income.

Robert Hastings - Canaccord Adams

In the quarter?

Patrick D. Daniel - President and Chief Executive Officer

That's for 9 months.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Yes, 9 months ended... so we would have had $12.5 million booked to income under the old Canadian hedge accounting rules for the 9 months ended September 30.

Robert Hastings - Canaccord Adams

And the third quarter?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Third quarter was approximately $3.5 million.

Robert Hastings - Canaccord Adams

$3.5 million? By the way, it would be nice in the MD&A if the explanations of changes could relate more to the third quarter because that's sort of what we're focusing on on the... because we've seen the previous part of the year.

The other question I had really is stemmed around Aux Sable, and Aux Sable is... I heard you say, Steve, that there is $10 million sort of hedged into the earnings. Does that mean that that's what you expect to earn for the year and it's all locked in at this point or you've done that portion of the earnings and again this year we'd expect to see a big fourth quarter contribution coming through?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Yes, I think about $10 million is what we'll expect from the asset for the year, the way it looks right now, yes. That's what we've hedged in and that's pretty much where it's going to land barring anything unforeseen.

Patrick D. Daniel - President and Chief Executive Officer

And as you know, Bob, we did that intentionally in order to lock in what we thought was a very favorable position on Aux Sable, as it turns out, crude oil prices continue to rise, cash price softens. So, playing the market would have turned out to be better, but that's not what Enbridge is about. We locked in what we thought was very solid operation there.

Robert Hastings - Canaccord Adams

Okay.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Oil gas fractionation ratios were about 6 to 1. They are about 12 to 1 today. So it's a really... it's a very strange time that we're in quite frankly. And as I said, we have taken advantage of that for 2008 because our objective really is to stabilize what comes out of Aux Sable.

Robert Hastings - Canaccord Adams

Well, do you feel that your hedging program has effectively locked in no matter what happens, sort of $20 million of earnings next year, a step up of 10 million bucks?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

It's a little bit more than that, but we have locked that in thus far. We have not locked in the full year, but there is a little bit of upside left there.

Robert Hastings - Canaccord Adams

Okay. And does that have any impact sort of as we see the year progresses, coming in in one particular quarter where the hedging works or --?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Well, I guess if... an ideal scenario would of course in this situation be that the frac ratio would collapse, we would wind up the hedges and reload, but that's not what we are planning for. We have locked in the earnings and I think we are comfortable with that level of performance for sure.

Robert Hastings - Canaccord Adams

All right, okay, thanks. Thank you very much.

Colin Gruending - Vice President and Controller

Bob, it's Colin here. Just to may be give you a little bit more quarterly color on what we have to expect '08 to come in and as you know, this is the hedge of our upside sharing agreement that is contingent upside. So we are still following generally the contingent kind of gain accounting where you will see the income likely fall into the final quarters of the year. You will also see mark-to-market hedge gains or losses relative to our hedge position on the market value of those spreads. So, there will be some mark-to-market always [ph] along the way here, which will always [ph] low risk. We do not get hedge accounting on this.

Robert Hastings - Canaccord Adams

Okay. So again the noise along the way, but by the end of year, you should be up to above that $10 million that you've blocked in.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

For '07, yes.

Robert Hastings - Canaccord Adams

So $10 million, $20 million for next year. Okay, thank you very much.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Thanks Bob.

Patrick D. Daniel - President and Chief Executive Officer

Thanks Bob.

Operator

Your next question comes from the line Karen Taylor with BMO Capital Markets. Please proceed.

Karen Taylor - BMO Capital Markets

Just I guess a question for Steve. Steve, at Enbridge Day, you said that you were going to work hard to eliminate the equity requirement for 2008. And so given that the capital expenditure profile for Fort Hills is skewed towards the 2010 period, is that still one of Enbridge's goals to avoid issuing equity in 2008 and doing instead asset divestures and monetizations?

Karen Taylor - BMO Capital Markets

Well, I think what I said at Enbridge Day, Karen, is that the base case assumption should still assume an equity issuance roughly the size range that we did in 2007. But we did introduce the willingness to consider asset monetizations and quite honestly, we do continue to pursue that. And so I think I do not want to flip over and make the base case into an asset monetization because then we start running down the trail of what asset, when, how, and so on. But I think that I would just reiterate that we are very much looking at that as a way of frankly avoiding issuing the common equity, but we are willing to do that and it will be a... the calculus will be what is the more dilutive or accretive move to make at the time.

Patrick D. Daniel - President and Chief Executive Officer

So that strategy as laid out at Enbridge Day is very much intact, Karen.

Karen Taylor - BMO Capital Markets

Okay. And I don't know if this is a question for Richard, but perhaps you could just talk about the cost escalation on the Enbridge System itself and on the Liquids portion of course in Canada, and just talk about where that's coming from? Is it under control now going into the fourth quarter? And how does it look I guess for next year as well?

Patrick D. Daniel - President and Chief Executive Officer

Karen, are you referring to the existing mainline operating costs?

Karen Taylor - BMO Capital Markets

Yes.

Patrick D. Daniel - President and Chief Executive Officer

Cost escalation?

Karen Taylor - BMO Capital Markets

Yes.

Patrick D. Daniel - President and Chief Executive Officer

Okay. Richard?

J. Richard Bird - Executive Vice President, Liquids Pipelines

Sure. Yes, I can tackle that. So if you are looking at the mean... or if you are looking at the Enbridge System, in about a $9 million year-over-year unfavorable variance, the three big components there are tax effects from Terrace, double taxation effect that we mentioned in the past is starting to catch us. That would be the biggest component of that. Higher O&A related to higher compensation costs would be the next biggest component and that's not really driven by increasing headcounts although our headcount increases have been significant as move into execution of these projects. For the most part, that's all being capitalized. Most of it is frankly just due to the environment in Alberta and in the Northern US, and the fact that we are offering significantly higher compensation benefits and have to do so to attract and retain people.

And then the final component of that would be on the integrity side where we have had some integrity incidents this year and as a result, we had to ramp up our integrity programs. And so under the incentive tolling settlement, we are still taking up some incentive gains on that integrity program, but not as big as in the prior year. I think we are going to continue to see that cost impact on staff costs, will go on [ph] into the future. That's not going to go away. I think we are likely going to see the integrity thing go back to a more normal level as we move into the future. And of course, that Terrace tax effect thing, as we've talked about, is something that we will have to reckon within the future.

Karen Taylor - BMO Capital Markets

Can you... of the $9 million year-over-year variance, can you attribute it to the three different categories being the taxation, higher O&A for comp, and integrity and then do so for the quarter as well?

J. Richard Bird - Executive Vice President, Liquids Pipelines

I can do it for you in rough terms. Say, a little over half is Terrace tax effects and the balance is roughly evenly split between the higher compensation and the integrity.

Karen Taylor - BMO Capital Markets

So that assume 60% for the... I am sorry, repeat that.

J. Richard Bird - Executive Vice President, Liquids Pipelines

A little over half of it is the tax effects on Terrace and the other two factors would be roughly equal.

Patrick D. Daniel - President and Chief Executive Officer

[multiple speakers] taxes to do comp and integrity.

Karen Taylor - BMO Capital Markets

And is that the same in the quarter?

J. Richard Bird - Executive Vice President, Liquids Pipelines

The quarter would be a little higher skewed on the tax effect side. Started to hit us more significantly in the third quarter and I don't have specifics in front of me on that, but that's the direction.

Karen Taylor - BMO Capital Markets

Okay, thank you.

Patrick D. Daniel - President and Chief Executive Officer

Thanks.

Operator

Your next question comes from the line of Matthew Akman with CIBC World Markets, please proceed.

Matthew Akman - CIBC World Markets

Thanks very much. I wanted to explore the impact of the cost increase, especially around Southern Access, it's pretty large from $1.3 billion, I guess, to $2.2 billion. How do you guys look at that because on one hand the ROE is lower, I guess, from base case 12% down to 10%, but on the other hand it's a bigger investment opportunity. So I guess it's 10% base case on $660 million of equity now versus before 12% base case on $390 million of equity and though at a 10% ROE that's is an accretive investment. So is this really... I mean, how do you look at that? Is this a good thing or a bad thing?

Patrick D. Daniel - President and Chief Executive Officer

Well, I think you have... yes, first of all, you said Southern Access, but you meant Southern Lights, Matthew, right?

Matthew Akman - CIBC World Markets

Correct.

Patrick D. Daniel - President and Chief Executive Officer

I think you have analyzed it correctly. It does have a negative impact on ROE. It can have a positive impact on EPS growth.

Matthew Akman - CIBC World Markets

So on a net basis this isn't necessarily a negative development for the company.

Patrick D. Daniel - President and Chief Executive Officer

Well, we consider it a negative development because we want to bring these projects in at as higher return as we can and we want to be able to offer as lower toll as we possibly can to our customers. So we're not happy at all, Matthew, and we would trade the EPS accretion for higher return and lower toll.

Matthew Akman - CIBC World Markets

Okay, Maybe I can move to another project that seems to be a little bit delayed, which around Athabasca, the earnings were a little bit lower. Is Long Lake going to contribute earnings to the Athabasca pipeline in the next year as the pumping comes into service even though Long Lake might not be producing until, what is it, 2009?

Patrick D. Daniel - President and Chief Executive Officer

Richard, can you comment on timing on --

J. Richard Bird - Executive Vice President, Liquids Pipelines

Yes, we should begin to see bitumen flows on both the laterals and the Athabasca line in 2008. So it will begin to ramp up and make a contribution in 2008.

Matthew Akman - CIBC World Markets

But do they pay you only when the production starts to come on or do they pay you when the capital comes online?

J. Richard Bird - Executive Vice President, Liquids Pipelines

There is a standby fee on the laterals whether they are flowing or not, it's not as remunerative as when they are actually flowing, and of course we don't get any revenue on the Athabasca pipeline on the mainline until they start flowing.

Matthew Akman - CIBC World Markets

Okay. Thanks for that clarification, that's all I have.

Patrick D. Daniel - President and Chief Executive Officer

Okay. Thanks Matthew.

Operator

Your next question comes from the line of Linda Ezergailis with TD Newcrest. Please proceed.

Linda Ezergailis - TD Newcrest

Thank you. When we look at your long list of pipeline projects, I guess notionally I have been assuming that the further out the project be less accurate or from the cost estimate. But can you give us a sense maybe of a refined sense of constant levels in your various cost estimates and which ones might be subject to further revisions?

Patrick D. Daniel - President and Chief Executive Officer

Sure, and I will maybe ask Richard to do that using our methodology of a certain class of estimate, which implies a level of accuracy recognizing that in the rapidly escalating environment that we are in, it has been difficult to forecast that. Then, Richard, could you maybe just run through on the cost estimates that we have on the projects underway?

J. Richard Bird - Executive Vice President, Liquids Pipelines

Yes, sure. So, maybe just for context, we have been through a very extensive reexamination of the cost on all these projects and that's why you see new numbers or will see them in the MD&A and Pat's just referred to the major adjustments. That reflects the fact that on a number of these projects we are now well along in construction and so we can see what costs actually are, and further projects we... which aren't in construction, we now have proposals from contractors. So we've got I think a much better handle on costs at this point in time. And unfortunately as a result of that we have increased our forecast. All of the projects at this point will be operating off of a forecast, which is either at a class three level, which typically carries a plus or minus 20% level of accuracy in this world, or better than that in cases where we have actually moved into construction. I think our latest cost estimates reflect an element of conservativeness in them having been once off the mark. The organization is generally focused on trying to make sure we have got it right this time. But in the current environment, there still does remain an element of uncertainty associated with those costs.

Linda Ezergailis - TD Newcrest

And so the Fort Hills will be a class three as well?

J. Richard Bird - Executive Vice President, Liquids Pipelines

No, sorry, Fort Hills is... the Fort Hills cost estimate will go through a pretty extension process over the next two years really of finalization of scope and refinement of costs estimates. So it's a conceptual estimate, it's a place keeper for the time being until the customers finalize scope and then we go through very detailed engineering process, and we won't put the pin on the cost for that until we have basically completed the engineering and bid the project out.

Linda Ezergailis - TD Newcrest

So is that a class four plus or minus 50% or there no class either to --

J. Richard Bird - Executive Vice President, Liquids Pipelines

It's not really a classified estimate.

Linda Ezergailis - TD Newcrest

Okay, alright.

J. Richard Bird - Executive Vice President, Liquids Pipelines

You can't do a classified estimate with the scope as open ended as it remains at the moment.

Linda Ezergailis - TD Newcrest

Yes, great. Okay. This is a follow-up question, how much interest and how many... how much other in terms of operating expenses has been capitalized in the quarter and year-to-date?

Patrick D. Daniel - President and Chief Executive Officer

Colin?

Colin Gruending - Vice President and Controller

Yes, Linda. It's Colin here. For the year-to-date, and I will speak to interest primarily, Richard alluded to capitalizing costs for construction, but interest is on... there's a number of projects here, almost a dozen, capitalized for $39 million of interest. I think this is pre-tax and for quarter, about $17 million. That compares with about $40 million and $6 million from the corresponding periods in 2006. So you are seeing a three-fold increase in that area; and that's as expected in that standard gas and we are in the construction mode so [ph].

Patrick D. Daniel - President and Chief Executive Officer

Does that answer your question, Linda?

Linda Ezergailis - TD Newcrest

On the interest side, but can we get any more clarity on the operating expense side?

Colin Gruending - Vice President and Controller

No, it's very comprehensive. We don't have that with us, Linda.

Linda Ezergailis - TD Newcrest

Okay, thanks Colin.

Colin Gruending - Vice President and Controller

Thank you.

Operator

Your next question comes from the line of Andrew Kuske with Credit Suisse. Please proceed.

Andrew Kuske - Credit Suisse

Thank you, good morning. Now, labor productivity has been a big issue in Alberta and you are feeling a bit of the brunt of that. And I am just curious when you look at the tradeoff and you mentioned a little bit of this early on, on staying on schedule on some of these projects versus cost increases to keep the project on schedule. How do you deal with that tradeoff? And then realize a follow-up to that question, how are you compensated at the end of the day because if you wind up strong more bodies at a project you get it done on time, and you suffer cost escalation. How do you actually get compensated from the shipper and I know it's going to vary from pipeline to pipeline, but if you could give us some color on that that will be greatly appreciated.

Patrick D. Daniel - President and Chief Executive Officer

Sure. Well, I'll let Richard respond to that Andrew. But you have put your finger on a very important issue and that is the one of productivity because we've seen a very significant escalation in cost, but we've seen a significant reduction in productivity. And the two in combination has resulted in the challenges that are described in the MD&A. But, Richard, could you try to provide a little more of a quantification around that?

J. Richard Bird - Executive Vice President, Liquids Pipelines

Sure. Well, it is the combination of labor cost escalation and labor cost productivity that is by far and away the single largest factor accounting for the variance here in fact. The reality is our steel costs have been locked in on all these projects. So you are seeing significant cost increases expressed as a percentage of the entire project, but really they are occurring on a... both two-thirds of the cost base of the project and on that two-thirds, they are even more significant on a percentage basis. So it's those two factors in combination with the fact that the contracting environment is really such that you can't get contractors to accept any of that risk. You can't get fixed price contracts or if you do, you find yourself renegotiating those part way through or running the risk that you won't have people to complete the job if you don't. So that is the environment.

How are we compensated for it? Well, a number of the projects, as we have indicated, are basically cost pass throughs. So what our customers are telling us, we have got to have that project and we have got to have it on time, which for the most part is what they are telling us. They are absorbing the risk associated with that in the form of a cost pass through and that's generally, I guess, how we are compensating for is our risk... our capital cost risk management structures on these various projects are designed to absorb us of a significant portion of the cost associated with meeting the schedule through passing that through to tolls.

Andrew Kuske - Credit Suisse

So most of the pass throughs that occur, effectively it's going to wind up in sort of a notional type rate base and you are going to receive that special cost over or under higher costs over a period of time as opposed to being compensated in a more immediate and direct fashion?

J. Richard Bird - Executive Vice President, Liquids Pipelines

We will be compensated in the form of higher earnings post completion, yes.

Andrew Kuske - Credit Suisse

Okay. And then if I may ask just a slightly different question or quite a different question, just on FX hedging, with the dollar where it is right now, how do you look at your FX hedging program on a forward basis?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Yes, it's a good question. I would tempting to unwind it and take several hundred million dollar gain from the hedge portfolio, but we have a policy of being 50% to 70% hedged on our foreign dollar denominated cash flows and investments, and we are at the lower end of that range right now, and I think we are comfortable there. I think we are going to continue to evaluate now as we and everybody else try to see where the Canadian dollar is going to go. But I think the stability is what we really look for and predictability, and don't see us abandoning that strategy just because of a move in the Canadian dollar, particularly a one or two-month move.

Colin Gruending - Vice President and Controller

And offsetting that exposure over long Canadian dollars were also... long US dollars were also short US dollars as we construct things. And a lot of our purchasing is done in US dollars. So, that's going to help us hopefully lower our overall aggregate capital costs on those projects, but there is an offset, Andrew.

Andrew Kuske - Credit Suisse

Great, thank you.

Patrick D. Daniel - President and Chief Executive Officer

Thanks Andrew.

Operator

[Operator Instructions] Your next question is from the line Robert Kwan with RBC Capital Markets. Please proceed.

Robert Kwan - RBC Capital Markets

Thank you. If I can just revisit the equity funding gaps and what you have there. So, Steve, you mentioned... so you are at $1.6 billion now, but there is a couple of things that can move that number around, whether it's in the... the Canadian dollar sticking in where we are or even strengthening in addition to, I guess, projects not coming through. Is there any way you can kind of quantify those two impacts and what that could do to the $1.6 billion?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Well, I think that as I said, the $1.6 billion is predicated on a CAN$0.95. So it's already conservative based on where the dollar is today. Capital costs will go down if the Canadian dollar remains as high as it is, as we have talked about before. I think per what Richard said with the thorough scrub that's been down on capital cost that we've now brought forward for today, we don't see that moving around a lot from here. But certainly if there are any upward adjustments that could drive the numbers slightly the other way, although I think the impact is quite muted from the top line to the bottom equity line through that. So, there is not a lot that's moving that... that's out to move that number around at this point. And we have done it for all of the years, so that goes right up to the end of 2011 and includes all of Fort Hills. So that's quite a span of time and I guess what we are trying to convey is that the top line number when broken down becomes very manageable.

Robert Kwan - RBC Capital Markets

[indiscernible] I was just I guess thinking a little bit more about your comment about that you risk adjusted certain projects that have not been announced yet?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

For sure, yes, thanks. I mentioned that about $1 billion of this $13.9 billion is projects that are in development that we have assigned a probability weighting to. If they don't come, let's say that none of them came to fruition, you could take $1 billion off the top line if that was where you were headed. We always have a risk probability or a probability weighting on the projects that we have in development so that we can keep a good grip on that from a financing perspective. So about $1 billion of that is in development. I think we would say fairy likely to proceed, but we do have our internal risks or probability weighting assigned to them.

Robert Kwan - RBC Capital Markets

Okay. And so just kind of to get a sense if in the unlikely case that you have got none of the billion dollars just based on the equity component that you might reduce your equity funding by about $400 million or so?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Pretty close, yes.

Patrick D. Daniel - President and Chief Executive Officer

Yes.

Robert Kwan - RBC Capital Markets

And then just the last thing on that, do you have some thoughts as to the timing of your equity funding gap? I know you have given some color around what you think you might need to do in'08, any kind of thoughts through the remainder of the year as how the remaining kind of how the $1 billion breaks down?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Yes, I think it's going to be a continual iterative process of looking at the actual funding needs, liquidity needs, and also our FFO credit metrics and other metrics that the rating agencies watch. So that's what we will be watching pretty closely. I think we have tried to be pretty clear about what we think in 2008 and we are going to assess from '09 and beyond, but certainly one of the fulcrums around which this turns is our credit concerns as well.

Robert Kwan - RBC Capital Markets

Okay, thanks Steve.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Yes, thank.

Patrick D. Daniel - President and Chief Executive Officer

Thanks Robert.

Operator

Your next question is from the line Daniel Shteyn with Desjardins, please proceed.

Daniel Shteyn - Desjardins Securities

Yes, good morning everyone. I have... my first question is with regards to Albert Clipper. Now there has been some headlines, I guess, over the last couple days about the fact that First Nations Community is asking for compensation on from the Alberta Clipper project. I am just wandering if this particular announcement was already factored into your timeline and cost estimates?

Patrick D. Daniel - President and Chief Executive Officer

Yes, I think it's fair to say that it is, Daniel, and we work very closely with First Nations people along all the right ways, including Clipper, but very much so we've been very much aware of the issue and it has been factored in.

Daniel Shteyn - Desjardins Securities

Okay. Now to borrow the famous words of someone, are there any other known unknowns with regards to First Nations claims on your [indiscernible] pipeline project and by that what I mean is are you anticipating any other challenges or demands for compensation with any one of the projects that you have in the going that could be material

Patrick D. Daniel - President and Chief Executive Officer

Well, you maybe caught me up with your last word on material, but we definitely anticipate that in this day and age of growing stakeholder challenges around gaining right away an access to land that there will be challenges. With regard specific issues that we're aware of, no, but we have factored into all of our projects the expectations that landowner negotiations, rent way [ph] costs and First Nations challenges, often as a result of land claim issues with the federal government are part of doing business today. So we certainly have factored the expectation of those challenges in.

Daniel Shteyn - Desjardins Securities

Very good. And going back to the revised funding requirement slide, the $13.9 million... billion, I should say. Are there any other probability weighted projects from the second wave and the funding requirement much like Fort Hills?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

I think so. Fort Hills was about the only one. We had regional pipeline development projects probability weighted, of which Fort Hills is a large part of that.

Daniel Shteyn - Desjardins Securities

Okay. And the $1 billion that you mentioned that was the probability adjusted firstly wave projects that were in there, do you mind specifying which ones those are again?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Yes, I actually do mind, Daniel. And I don't mean to be glib, but I think it's probably not. I think that what I would say is that when you think of the presentations Richard has made with regard to extension to the US Gulf Coast, Eastern PAD II, other regional development projects between the oil sands and Edmonton, Hardisty, I think those are the key areas that we would consider. And then of course also in wave two could be Gateway Pipeline. And so that's probably as close as we can come just because there is a number of project discussions underway and possibilities, and I don't think it would be too helpful right now to try to get more specific.

Daniel Shteyn - Desjardins Securities

Okay. That's fine, I understand. What about the expansion of Alberta Clipper? Would that be considered more as a first wave or a second wave project?

Patrick D. Daniel - President and Chief Executive Officer

It's second wave.

Daniel Shteyn - Desjardins Securities

Second wave, got it Okay, thanks very much.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Thanks.

Operator

Your next question is from the line of Ross Payne with Wachovia Capital Markets. Please proceed.

Ross Payne - Wachovia Capital Markets

Hello guys. You mentioned monetization is one form of generating cash for some of these CapEx programs. What are thoughts there in terms of drop down... potential dropdowns to EEP for some of your US assets? And secondarily, does the change in currencies impact that decision making? Thanks.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Okay. I think that all is a possibility just structurally between corporate assets and EEP. I think the way we look at it right now though is that EEP has such a strong growth profile and list of projects ahead of it that there really isn't an imperative to try to do dropdowns at this point. There are candidates among our US assets that would probably be logical fits in the MLP, but we are not really focused on that in the near term. We will always look at that as a possibility, but I don't think we are really focused on that right now.

Patrick D. Daniel - President and Chief Executive Officer

Yes, I think Steve's point is bang on with regard to the near term. I think that as we work our way through the capital programs that is certainly is one of the potentials when you take a look at the long term financing needs that it's a potential monetization for Enbridge in the longer term, but certainly not in the near-term for the reasons he's indicated.

Ross Payne - Wachovia Capital Markets

Okay, thank you.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Thanks.

Operator

And your next question is a follow-up from the line of Bob Hastings with Canaccord. Please proceed.

Robert Hastings - Canaccord Adams

Yes, just to get a clarification on the EGD's rate case. You mentioned they had one that's retroacted at the beginning of the year. Just wondered how you booked it? Whether you've booked it already and if so, how much was applicable... how much was it and what was applicable to previous quarters?

Patrick D. Daniel - President and Chief Executive Officer

Colin?

Colin Gruending - Vice President and Controller

We don't have that for you today, Bob.

Patrick D. Daniel - President and Chief Executive Officer

He may get back to you on that.

Robert Hastings - Canaccord Adams

Sure. But was it... is it in the numbers?

Patrick D. Daniel - President and Chief Executive Officer

Very tough one. Yes, Colin is hesitating here.

Colin Gruending - Vice President and Controller

Yes, there is not much in the quarter, the quarter is pretty weak, as you know, seasonally. So --

Robert Hastings - Canaccord Adams

Okay. You can get back to me when you --

Patrick D. Daniel - President and Chief Executive Officer

Yes, we'd have to get back to you on that one, Bob.

Robert Hastings - Canaccord Adams

Okay, thanks a lot.

Operator

Next question is a follow-up from the line of Linda Ezergailis with TD Newcrest. Please proceed.

Linda Ezergailis - TD Newcrest

Thanks. Just going back to your $13.9 billion number, the $1 billion risk adjusted number, assuming all of those projects were to go ahead, what would that $1 billion number grow to?

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

You might have to give us a minute to look through that Linda. We might have to get back to you, I don't know that we can just... there is quite a list of different projects with probabilities. And so it would take us a little time to force those all to 100% and assess whether we believe that's the right approach or not. So, I think we should get back to you on that one.

Patrick D. Daniel - President and Chief Executive Officer

Yes, and the numbers that we've used in there, Linda, are quite conceptual and because the projects have not been fully scoped out, so it's difficult to know what the capital would look like on each of them. But we can maybe work up a ballpark number and get back to you.

Linda Ezergailis - TD Newcrest

Okay. And just to get a better understanding of your probability risk adjusting, that's just a simple linear 50% probability or 75%?

Patrick D. Daniel - President and Chief Executive Officer

Right.

Linda Ezergailis - TD Newcrest

Okay.

Patrick D. Daniel - President and Chief Executive Officer

Yes.

Stephen J. Wuori - Executive Vice President, Chief Financial Officer & Corporate Development

Yes, it's a probability of proceeding and then a forecast percentage of ownership. In most cases, it's 100, but there are some projects where we may have equity partners. And so, I guess, notionally when Richard talked about the wave two potential at Enbridge Day, you could kind of look to that as being one of saying if you put it 100% the risk weighting or probability waiting of all the projects, you start moving towards wave two capital.

J. Richard Bird - Executive Vice President, Liquids Pipelines

Yes. I think that's right and also for classification, I am not sure whether this was the impression that we gave, but not all... we don't apply a 50% probability weighting to all projects. Some of them are lesser than that, some of them like Fort Hills would have been embedded in the prior numbers at a significantly higher probability than that because at the time that plan was put together, which was back last spring, we also... we were already beginning to get relatively confident that Fort Hills would fall into place.

Linda Ezergailis - TD Newcrest

Okay. So then all of your wave two projects in some form of risk adjustment are in that $1 billion number?

J. Richard Bird - Executive Vice President, Liquids Pipelines

No, the wave two projects were the $14 billion potential over and above wave one.

Patrick D. Daniel - President and Chief Executive Officer

Yes.

Linda Ezergailis - TD Newcrest

Okay. So other than Fort Hills, there is no wave two in there?

Patrick D. Daniel - President and Chief Executive Officer

I think there were small amount, as Steve indicated, all the way from may a portion of Gulf Coast to some regional infrastructure to some tankage that was included in that as well, Linda.

Linda Ezergailis - TD Newcrest

Okay. Okay, thank you.

Patrick D. Daniel - President and Chief Executive Officer

Thanks.

Operator

And the next question is from the line of Karen Taylor with BMO Capital Markets. Please proceed.

Karen Taylor - BMO Capital Markets

Thanks. If you could get back to me as well with the Linda's number on the rehearsed risk weighting for the $1 billion please, and also on the Enbridge Gas Distribution, how much of the rate case reflected in this quarter, if any. And also, is the rate case available, the one that was filed on October the 18th for Enbridge Gas? If someone likes to email me a link, I'd appreciate it.

Patrick D. Daniel - President and Chief Executive Officer

The filing?

Karen Taylor - BMO Capital Markets

Yes.

Patrick D. Daniel - President and Chief Executive Officer

Okay.

Karen Taylor - BMO Capital Markets

Those were my questions.

Patrick D. Daniel - President and Chief Executive Officer

We will do that. Thanks Karen.

Karen Taylor - BMO Capital Markets

Thank you.

Operator

And there are no other questions in the queue at this time. I'd like to turn the call over to Mr. Vern Yu for closing remarks.

Vern Yu - Vice President, Investor Relations & Enterprise Risk

Well, thank you. I'd like to thank everyone for their interest in Enbridge this morning and would like to remind everybody that Anu, Colin, and I are available after this call and for the rest of the morning to take any more detailed questions. And with that, I'd like to thank everyone and wish you a good day.

Operator

Thank you all for your participation in today's conference. This concludes the presentation; you may now disconnect and have a great day.

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Source: Enbridge, Inc. Q3 2007 Earnings Call Transcript
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