Dominion Resources Inc Q4 2005 Earnings Conference Call Transcript (D)

Dominion Resources Inc (D)
Q4 2005 Earnings Conference Call
January 26th 2006, 10:00 AM.

Executives:

Thomas F. Farrell, President and Chief Executive Officer
Thomas N. Chewning Executive Vice President and Chief Financial Officer
Duane C. Radtke EVP and EVP, Consolidated Natural Gas Company

Analysts:

Greg Gordon
Faisel Kahn
Steven Fleishman, Merrill Lynch
Dan Eggers, Credit Suisse First Boston
Paul Fremont, Jefferies
David Schanzer, Janney Montgomery Scott

Presentation

Operator

Good morning ladies and gentlemen, and welcome to Dominion Fourth Quarter Earnings Conference Call. We now have Mr. Tom Chewning Dominion Executive Vice President and Chief Financial Officer in conference. Please be aware that each of your line is in listen only mode. At the conclusion of Mr. Chewning’s presentation, we will open the floor for question. At that time instructions will be given as procedure to follow, if you would like ask a question. I’ll now turn the conference over to you Mr. Tom Chewning, sir you may begin.

Thomas N. Chewning, Executive Vice President and Chief Financial Officer

Good morning and welcome to Dominion fourth quarter 2005, earnings call. Joining me this morning are Tom Farrell our President and CEO and other members of our management team. This morning I’ll first review actual fourth quarter and full 2005 earnings. Tom Farrell will give his review of 2005 operations, as well as offer his perspective on Dominion's focus for 2006. Following Tom's remarks, I will provide 2006 earnings guidance and reconcile the 24 month period from January 1st, 2005, to December 31st, 2006, to the outlook we had discussed during our last call with you on November 3rd, 2005. Before answering your questions, we will offer our current perspective on the drivers that will create a significant uplift in Dominion's earnings in 2007 and beyond.

Concurrent with our earnings announcement this morning, we've published several supplemental schedules on our website. We ask that you refer to those exhibits for certain historical quantitative results as well as earnings guidance detail. From time to time during this call we will refer to certain schedules included in our quarterly earnings release or to pages from our 2006 earnings guidance kit, both of which were posted this morning to Dominion's website. That website address is www.dom.com/investors

Let me start by providing the usual cautionary language. The earnings release and other matters that may be discussed on the call today contain forward- looking statements and estimates that are subject to various risks and uncertainties. Please refer to our SEC filings, including our most recent annual report on Form 10K and quarterly report on Form 10Q, for discussion of factors that may cause results to differ from management's projections, forecasts, estimates, and expectations. Also on this call, we will discuss the measures about our company's performance that differs from those recognized by GAAP. You can find a reconciliation of these non-GAAP measures to GAAP on our Investor Relations website under "GAAP Reconciliation."

We're very pleased with our fourth quarter operating earnings of $1.02 per share. This compares to our fourth quarter operating earnings guidance of $0.60 to $0.70 per share. Exceeding our quarterly guidance is directly related to the earlier than expected resumption of hurricane delayed gas and oil production in the Gulf of Mexico. This early return of production resulted in $0.38 per share benefit to earnings. Following the hurricanes, we forecasted fourth quarter production delay totaling 66 Bcf equivalent.
About 23 Bcf equivalent was resumed ahead of our initial projections resulting in a fourth quarter delay of 43 Bcf equivalent. In addition to the early return to production, we recorded a $0.23 per share non-cash market to market gain on hedges that would be designated in Q3 due to the hurricanes. The positive mark is due to lower 2006 gas and oil prices as of December 31st compared to those prices on September 30th. These positives were offset by lower than expected natural gas prices and increased locational basis differentials net of basis hedges. This reduced potential income by $0.17 per share.

GAAP earnings for fourth quarter were $0.74 per share. The difference in the quarter between GAAP and operating earnings is primarily attributable to a 51mm dollar impairment of a note receivable related to the 1998 sale of merchant generation facilities to Calpine and $14mm book loss primarily from the sale of the company's equity interest in certain non-core merchant facilities. Full year operating earnings of $4.53 per share exceeded our updated guidance of $4.11 to $4.21 per share provided in November. The difference between actual and guidance is explained by the same factors that reconcile our Q4 actual to guidance. GAAP earnings for 2005 were $3 per share. In addition to Q4 items excluded from operating earnings, the primary difference between GAAP and operating earnings is attributable to the effects of Hurricanes Katrina and Rita discussed on our November call. A reconciliation between quarterly and annual GAAP and operating earnings can be found in Schedule 2 of this morning's earnings release

For the 12 months ended December 31st, 2005, funds from operations to interest coverage was 3.7 times. At December 31st, adjusted debt to total cap ratio was 58.1% compared to 59.5% at the end of third quarter. Our available liquidity was $2.2 billion. Now I’ll turn the call over to Tom Farrell for his comments. Tom?

Thomas Farrell, President and Chief Executive Officer

Thanks Tom, and good morning everyone. 2005 operations and results met or exceeded the goals we established at the beginning of the year, except for oil and gas production delays resulting directly from hurricanes Katrina and Rita. During 2005 we successfully integrated an additional 3,300 megawatts into our generation fleet, an increase of 13%. This includes Dominion New England with units at Brighton, Manchester, and Salem, as well as the Kewaunee nuclear plant in Wisconsin. It made us the largest generator of electricity in New England. Our nuclear fleet had an outstanding year in 2005, achieving a capacity factor above 92%. In Virginia we achieved record nuclear generating performance of 28.6 million MWh compared to the previous record of 28.3 million MWh accomplished five years ago. All of our merchant nuclear plants exceeded expectations

Our fossil units performed extremely well during our first year in PJM, achieving a peak season equivalent availability of 96%, the highest since 2002. At Energy, we successfully integrated into PJM effective May 1st, and met 15 new peak days without any operational incidents. We received approval for new rate structure at Dominion Transmission for a five year period, and mitigated the financial impact through operational efforts, including producer services and near record results in the gathering and by products businesses.

The Delivery business in 2005 connected over 75,000 new electric and gas customers, set four new electric load peaks on its system, and saw its four year average annual growth in electric demand increase to almost 4.7%. Virginia continues to have a thriving economy. While meeting this increase in demand we were also able to improve our electric service reliability by 8%.

Turning now to our E&P business. During Q4 we were able to restore Gulf of Mexico production from a pre-hurricane level of 435 million cubic feet equivalent per day to over 500 million a day yesterday, utilizing both permanent and temporary repairs. This still leaves about 80 million a day unavailable because of third party infrastructure, but we expect those repairs to be completed by the end of second quarter. We expect additional volumes to come in over the course of the next two quarters and reach a peak rate of about 550 a day by the end of June. During 2005, we had a reserve replacement ratio of 200% at a finding and development cost of $2 in Mcfe. That brings our total reserves at year end to 6.3 Tcfe compared to 5.9 Tcfe at the end of 2004. These reserve levels have been fully reviewed by Ryder Scott, which is the independent auditor for our entire E&P program.

During 2005 we drilled 955 net wells in the United States, a new record for Dominion. In 2004 we were the nation's leader in drilling activity. During late 2005 and early this year we have added discoveries for extended new production wells at a variety of locations. Some of the highlights include, Spiderman Well No. 3, our discovery at Q, West Cameron 130, West Cameron 100, Devils Tower is now producing greater than 37,500 barrels of oil equivalent per day net to Dominion. And we have had multiple discoveries in the deep Anadarko Basin in Western Oklahoma.

Our plans for 2006 remain unchanged from what we have said on our last three quarterly calls. We will continue to concentrate on operations, particularly fuel management, as well as oil and gas production. We are setting our E&P production guidance for 2006 in a range of 445 to 455 Bcfe, which compares to 383 Bcfe produced in 2005. The 2005 figure was obviously affected by hurricanes Ivan, Katrina and Rita. There are several factors that keep 2006 forecasted production growth from being even higher. These issues other than perhaps royalty relief will be resolved this year and will not carryover to 2007.

They include as I said a moment ago Rita and Katrina, third party infrastructure issues reduce our daily Gulf of Mexico production by about 80 million a day for a total of 10 Bcfe during 2006. All of which we believe is covered by business interruption insurance. Based on the December 31, 2005 strips, we expect to lose about nine Bcfe from our own account because higher prices are causing a phase out of US Government royalty relief. In other words, the oil and gas will be produced, but nine more Bcfe must be credited to Uncle Sam's account to satisfy our royalty obligations. The reduced royalty set aside we enjoyed at lower prices disappears at current price curves. One remaining issue from Ivan will cost us about 4 Bcfe. The main pass oil pipeline will not be finally restored to service until the end of February.

Oil performance at the Front Runner wells net of improved production from our onshore gas factories is causing us to reduce our original plan by about 9 Bcfe. As we told you in November, the shape of the Front Runner production has flattened from our initial forecast resulting in lower 2006 results, but increasing our 2007 and 2008 projections. In other words, while less oil will be produced by Front Runner 2006, more will be produced in 2007 and 2008 than we had planned.

Tom Chewning mentioned the financial impact on our 2005 results of the basis differentials being experienced by the entire E&P industry. 2005 hurricane season caused the greatest amount of damage to supporting infrastructure in transportation in the history of the Gulf of Mexico. That infrastructure has still not fully recovered. The loss of the infrastructure has caused very significant discounting across a variety of basins as producers compete for limited transportation capacity by reducing their pricing. The differentials cost us about $0.40 in fourth quarter 2005. And the issue is lingering into 2006. Sitting here today, we see as much as $0.30 to $0.40 impact over the course of the entire year. The $0.40 in quarter four of 2005 and maybe as much as $0.40 over the course of all of 2006. The differentials, though, are reverting to the norms we have seen for many years as infrastructure in the Gulf is returned to service. We're confident that the regional pricing differences will be eliminated by year-end.

Because of our unique set of assets, we have been able to make up some ground in first quarter 2006 at Dominion Energy through optimization through our storage and pipeline assets and capacity position, in other words being on the other side of some of this discounting. I'd like to turn to 2007, 2008 and 2009. For those years all of the structural drivers we have discussed over the course of 2005 remain unchanged. I want to review several of the most important that will occur as the calendar turns in 11 months.

First, our oil and gas production will grow five to 6% annually on average from 2006 through at least 2008. The growth in 2007 over 2006 will exceed that average at a pace of over 10%. The growth drivers are in place and include the expiration of the three volumetric production payment agreements we executed in 2003, 2004 and 2005, returning a total of 43 Bcfe to our own account by the end of 2008. Schedule showing that detail is on our website. But for order of reference, 8 Bs will come back to us in 2006 and 23 Bs will come back to us in 2007. Front Runner and Devils Tower will achieve peak production during the 2006-2008 periods. While Front Runner has cost us some production in 2006, as I said because of the flattening of the curve, we will have a higher production than expected from those eight wells in 2007 and 2008. The 2005 hurricanes have also impacted the service industry in the Gulf. Delays in rig and completion equipment will result in less growth in 2006, but more in 2007 and 2008 than originally planned.

The Eastern Gulf of Mexico wells we have previously announced, including Spiderman, San Jacinto, and Q, will come on line during 2007. These wells and their related infrastructure are on their original schedules. Thunder Hawk will come on line in late 2008 or early 2009. We will, of course, have continued onshore expansion. Because of all of this activity, we forecast that our production in 2007 will be in a range of 500 to 515 Bcfe and 520 to 535 Bcfe in 2008. We have taken Uncle Sam's increased royalty set aside caused by present pricing into account in estimating these ranges. So E&P's production potential remains unchanged from earlier forecasts. Second, along with the continued production growth, we will have much higher price realization in 2007, 2008 and beyond.

As shown on page 9 of the 2006 earnings guidance kit, our average realized price for hedge volumes grows from, $4.65 per Mcfe in 2006 to $5.60 in 2007 and to $7.11 in 2008. The un-hedged volumes grow from about 145 Bcfe in 2006 to over 440 Bcfe in 2008. The December 30, 2005, calendar strips for gas were $10.75 per Mcf in 2006, $10.26 in 2007, and $9.37 in 2008. Now, if you compare the December 30, 2005, oil and gas strips for 2007 and 2008 to yesterday's closing strips for the same periods, you'll see that gas is down slightly in 2007, but up slightly in 2008. Oil is actually up significantly in 2007 from what was $64 a barrel at year-end to $68 a barrel on yesterday's 2007 strip, and up from $62.73 for 2008 at year-end to $66.40 on yesterdays forward strip. While 2006 has seen more downward movement, it makes little difference to Dominion because of our hedge positions. So, despite recent movements in the forward curves, all of the E&P growth revenue factors remain unchanged. Third, the average realized price for New England generation will show significant growth over the period. As shown on page ten of the guidance kit, our average pricing at Millstone for the 93% which is hedged in 2006, grows to $55.13 on average a megawatt hour compared to the $40.87 we received on average in 2005.

We continue to see a higher price curve for Millstone and our other New England assets in 2007 and 2008. The December 30, 2005, forward curve in NEPOOL for 2007 was $91.83 a megawatt hour and $83.53 in 2008. Also, in New England we expect a significant lift from LICAP in 2007 and beyond. We should be able to give details on LICAP during our May analyst meeting in Boston. In short, the generation revenue growth factors remain unchanged. Fourth, we will reset our fuel recovery factor effective July 1st, 2007. We will enjoy one half year benefit that year with a full year in 2008 and beyond. I would note that last Friday the Virginia State Corporation Commission awarded ADP 100% of its fuel rate increase. The increase in their factor was from $1.42 to $1.785 per kilowatt hour resulting in over a 6% increase in the overall average monthly residential bill. We have no reason to believe that we will be treated any differently. As we've said before, the Virginia Commission has over 30 years of fuel case precedent. These precedents were applied to AEP, and they will be applied to us. The fuel reset growth driver remains unchanged.

Finally, in 2008 we should see uplift from at least one half year of the Cove Point expansion with a full year impact in 2009, while the timing of each factor may vary from one quarter to another depending upon when each element occurs. It is highly likely that Dominion's earnings will grow at a very accelerated double digit rate in 2007 over 2006 and beyond. We are confident not only in growth and EPS, but also in cash flow. As a result, the board voted this week to increase our quarterly dividend to $0.69 per share effective this quarter bringing our annual rate to $2.76. This of course is my First Call as Dominion's CEO. While I'm new to the job title, I'm not new to Dominion, its asset base or its business plan. Our strategy, diversifying across geographic regions and the energy chain, was conceived and implemented by our entire senior leadership team. We are pleased with where we are, while recognizing that we can continue to improve. We are making some internal changes that will not be visible to the investment community, but will help us manage our asset base more effectively. You should not expect any dramatic change in Dominion's plans in the near or medium term future. You should expect us to continue to complete our review of our existing assets to ensure that we're delivering premium returns on your invested capital. You should also expect us to continue to achieve best in class or near best in class operational performance. We are intent on delivering earnings and cash flow growth in 2006 and perhaps more importantly 2007, 2008 and 2009. We look forward to working with all of you over the years ahead. Now I will turn the call back over to Tom, who will discuss specifics of our 2006 earnings guidance.

Thomas N. Chewning, Executive Vice President and Chief Financial Officer

Thanks Tom. Our guidance for 2006 is $5.05 to $5.25 per share. When added to the $4.53 per share of actual earnings in 2005, the total 24 months operating earnings for 2005 and 2006 will be $9.58 to $9.78 per share. Page 4 of our 2006 earnings guidance kit reconciles this range to our 24 months outlook discussed during our last call with you on November the 3rd, 2005, which was based on our May 2005 assumptions. The projected total operating earnings of $10 to $10.35 per share less the lost income experience during our business interruption insurance deductible periods. Implicit in our projection is the assumption that other than the deductible periods, earnings related to our pre-hurricane gas and oil production forecast will be recognized either through physical production or through business interruption insurance. We now calculate that the lost income during the deductible periods was $0.25 per share. You can see that we have benefited from higher commodity prices and realizing market prices on volumes of oil and gas de-designated as a result of Hurricanes Katrina and Rita. Offsetting much of this gain have been large increases in vocational basis differentials.

As Tom Farrell mentioned earlier, the potential oil and gas production for 2006 has been reduced by phase out of royalty relief, a longer decline curve for the production at Front Runner, and continued delayed production as a result of Hurricanes Katrina and Rita. Business interruption insurance costs have grown as a result of the loss experience of our offshore underwriters. The company has lowered the discount rate used in our pension and benefit calculations, which causes an increase in this expense.

Finally, please recall that our original 2006 guidance range incorporated upside potential from three drivers integration into PJM, the benefit of the establishment of a LICAP market in New England, and the potential swap of deep water offshore reserves in exchange for onshore natural gas reserves. We integrated into PJM effective May the 1st, so that remains in our 24 month outlook. We've calculated the impact of the delay of LICAP implementation in New England from our previous assumption until October of this year. And we've not been successful in negotiating a swap of offshore reserves for onshore reserves. Practically speaking, we're not pursuing this option any longer. Due to the uncertainty of the receipts and recognition of business interruption proceeds and the quarterly mark-to-market of de-designated hedge volumes, we're not offering quarterly earnings guidance, we will however provide quarterly earnings drivers, you can find these in the 2006 earnings guidance kit on page 7, as we said several times in 2005, Dominion's 2006 would not be a year of earnings growth due to the constraints of legacy hedges and our fixed fuel factor in Virginia.

On May 22nd when we share our initial guidance for 2007, you'll see that the company's future earnings power is indeed very strong. Certainly there's been more concentration on 2007 and beyond in the investor community as we get closer in time to those years. Although we normally steer clear of commenting on particular analyst views or market speculation, today we offer Dominion's perspective on a few items of interest. First, in developing our five year financial plan, we have included substantial increases in operating costs for our oil and gas production. To exclude a rising cost structure for E&P, would be to ignore recent experience as well as evidence that links rising prices received with both variable and fixed price increases. We will supply you with our specific assumptions for E&P price increases for 2007 in our May 22nd meeting.

For 2006 earnings guidance, we've included increased lifting costs of 20% over those experienced in 2005. Further, we have included a 15% increase over 2005 in finding and development costs for 2006. The market rumors have it that we are selling assets and that we are doing so to avoid selling equity. It is our continued practice to not address specific market rumors, nor to discuss either the sale or purchase of assets except at the point when an agreement has been finalized by all parties. We will continue to purchase assets when our expected return criteria are met, the financial metrics of the investment meet rating agency ratios for the perceived risk, and the resulting income is accretive to our earnings. On the other hand, we will seek to sell assets when we feel that the resulting after-tax proceeds would be sufficient to maintain or improve our financial metrics and result in earnings accretion when compared to future earnings forecast.

The company stated recently that we have no intention of issuing additional equity in a response to a recent downgrade of our securities by one rating agency. However, it is not correct to link any potential asset sales to this statement. We have no commitments to any rating agency to issue equity or to reduce debt by any specific date. Whether the company sells assets or not in 2006, we will not sell additional equity to support our 2006 planned CapEx and dividend requirements. Of course if we do acquire incremental assets outside of our present portfolio, we model these purchases with appropriate additional equity. This concludes our prepared remarks and we will happy to undertake your questions.

Questions & Answers

Operator

At this time we will open the call for questions. If you would like to ask a question please press the “*