Spectra Energy Corp. Q4 2007 Earnings Call Transcript

Feb. 6.08 | About: Spectra Energy (SE)

Spectra Energy Corp. (NYSE:SE)

Q4 2007 Earnings Call

February 6, 2008 10:00 am ET

Executives

John Arensdorf - VP, IR

Fred Fowler - President and CEO

Greg Ebel - CFO

Martha Wyrsch - President and CEO, Spectra Energy Transmission

Analysts

Lasan Johong - RBC Capital Markets

Ross Payne - Wachovia Capital Markets

Faisel Khan - Citigroup

Nathan Judge - Atlantic Equities

Matthew Akman - Macquarie

Scott Engstrom - Blenheim Capital Management

Operator

Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spectra Energy Fourth Quarter Earnings call. (Operator Instructions)

I will now turn the call over to Mr. John Arensdorf, Vice President of Investor Relations. Please go ahead sir.

John Arensdorf

Thank you, Dennis. Good morning everyone and welcome to Spectra Energy's fourth quarter 2007 earnings review. Thank you for joining us today.

We were with many of you recently in New York, providing an overview of our 2008 business and financial plans, and we are pleased to share with you today our very positive fourth quarter and year-end results. Leading our discussion today will be Fred Fowler, our President and Chief Executive Officer and Greg Ebel, our Chief Financial Officer. Also with us and available to take your questions at the end of the call are Martha Wyrsch, President and CEO of Spectra Energy Transmission, and Sabra Harrington, our Vice President and Controller.

Fred, will begin our discussion today by sharing his perspective on our very successful year in 2007. Then Greg will provide detail and context around Spectra Energy's fourth quarter results and provide some details showing how we expect to get from our 2007 earnings per share to our 2008 employee incentive target of $1.56. Of course we will have plenty of time for your questions.

Before we begin, let me take a moment to remind you that some of the things we will discuss today concern future company performance and include forward-looking statements within the meanings of securities laws. Actual results may materially differ from those discussed in these forward-looking statements.

So you should refer to the additional information contained in Spectra Energy's Form 10-K and in our other SEC filings concerning facts that could cause these results to be different from those contemplated in today's discussion.

In addition, today's discussion includes certain non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our investor relations website at www.spectraenergy.com.

With that I will turn the call over to Fred.

Fred Fowler

Thanks, John and good morning everyone. Thanks for joining us today. I am pleased that we have great results to share with you. Spectra Energy has enjoyed an extremely successful first year underscored by strong financial results. You've seen the numbers by now and I hope that you will agree that we delivered all the promises that we made to you when we launched Spectra Energy.

We told you that we would achieve our $1.40 employee incentive target; EPS target. We exceeded that goal by 9%, achieving annual ongoing EPS of $1.53 per share. We enjoyed strong earnings in all of our businesses and delivered an excellent fourth quarter with an ongoing diluted EPS of $0.47.

We told you that we are going to invest in expansion projects to the tune of $1 billion a year between '07 and '09, and we kept that promise. Our actual expansion and capital expenditures for '07 totaled just over $1 billion. We have placed 13 strategic new projects into service during the year with a total capital invested of about $650 million on those projects.

These projects provided about $25 million of EBIT in 2007. We expect an incremental $50 million in 2008 for a total of $75 million of new EBIT. We expect these solid projects to deliver the 10% to 12% returns on capital employed that we set for ourselves.

Our expansion momentum will continue this year, and in a big way. Just yesterday, I think you saw us announce our Phase V capacity addition to the US portion of our Maritimes & Northeast Pipeline.

We have entered into an agreement with EnCana to expand the system, and to provide 170 billion cubic feet per day on a year-round basis with an additional 30 million cubic feet per day during the winter. This contract will provide EnCana with the means to bring its Deep Panuke gas to both the Atlantic Canada and the growing Northeast US markets.

At the same time that we have been invested in growth, we have reduced our corporate and our administrative costs by $20 million during our first year, surpassing our commitment to achieve that level of savings by year-end 2008.

We maintained the strong investment grade balance sheet. We've increased our liquidity by more than $1.2 billion, which will help us execute on our capital expansion plan, as well as take advantage of emerging opportunities.

As we committed to you last year, we successfully launched our master limited partnerships Spectra Energy Partners, which achieved a record yield of 5.45%. Net proceeds to Spectra were $345 million from this partnership.

I am proud of what we've accomplished on behalf of Spectra Energy's investors during this first year. We clearly delivered on our 2007 financial operational and investment commitments, and you could expect us to do the same in 2008. All of our businesses continue to provide strong dependable results.

We remain focused on expanding our footprint of high performing assets, responding to needs and opportunities of the demanding market and continually growing value for the investors and the customers that we serve.

Our shareholders can expect a strong sustained level of earnings growth this year and into the future. Combined with a dividend yield of more than 3.5%, you can expect total shareholder return to be in the 10% range. That's a value proposition I believe our shareholders should find compelling over the long-term.

With that, let me turn things over to Greg. He is going to talk in more detail about the results from each of our business segments.

Greg Ebel

Thanks Fred, and good morning everyone. As I am sure, you saw in our earnings release Spectra Energy reported exceptionally strong fourth quarter results, with a net income of $291 million, or $0.46 per diluted share. After removing the effect of special and extraordinary items and discontinued operations, ongoing earnings were $297 million or $0.47 per diluted share.

Solid results from all of our businesses during the quarter resulted from projects and expansion projects, and a favorable quantity environment. For the year, we delivered ongoing earnings of $969 million or $1.53 per share, reflecting strong revenues at US Transmission and Union Gas. There were Higher NGL gross margins at Western Canada and higher commodity prices at Field Services.

I'd like to review the results for each business segment in a little more detail. Let's start with US Transmission, which reported fourth quarter ongoing EBIT of $221 million, compared with $172 million in the fourth quarter of 2006. Strong revenues from the US pipeline and storage activities, primarily reflecting higher demand for services and increased earnings from expansion projects drove the improvement.

Higher commodity prices for gas processing associated with pipeline operations and lower project development expenses in the fourth quarter of 2007 also contributed to the increase. Year-end ongoing segment EBIT for US Transmission was $894 million, representing a 13% increase over the prior year.

Now let me turn to our Distribution business, Union Gas. Distribution reported fourth quarter 2007 segment EBIT of $84 million, unchanged from the same quarter in 2006. Distribution benefited from increased customer usage due to colder weather as well as additional loads from gas fired power generation, higher rates, and a strong Canadian dollar.

These earnings contributions were offset by higher operating costs, including higher than expected unaccounted for gas, which is the difference between metered gas received on to the systems, metered gas delivered off the system to customers, and billing estimates. These monthly fluctuations typically self-correct over time, but as of the year-end we have not seen the entire amount come back.

Distributions year end segment EBIT increased 22% over the prior year with annual EBIT of $322 million. I would also note that last month the OEB approved a five year incentive rate mechanism for Union Gas. This was a favorable decision for the company and it created a stable operating and regulatory environment to pursue growth and investment opportunities.

Let's now turn to our Western Canadian operations. Western Canada Transmission and Processing enjoyed a strong fourth quarter with ongoing EBIT of $142 million, compared with $76 million in the fourth quarter of 2006, an 87% increase quarter-over-quarter. The increase in the EBIT primarily resulted from stronger NGL prices that benefited our Empress operations, as well as higher segment earnings, due to the strong Canadian dollar in the fourth quarter 2007.

The Empress frac spread averaged approximately $10 during the fourth quarter of 2007, compared with slightly more than $4 for the same quarter in 2006. Year-end ongoing segment EBIT for Western Canada increased 11% over the prior year with an annual EBIT of $366 million.

While some western Canadian regions including the area around our Fort Nelson plant are experiencing volume reductions, we continue to see increased drilling around our Pine River and McMahon facilities. We are also seeing increased volumes as a result of de-bottleneck projects at several of our plants.

Now let me turn to Field Services. Our Field Services segment, which represents Spectra Energy's 50% interest in DCP Midstream, had a strong quarter. It reported ongoing segment EBIT of $194 million, compared with $119 million in the fourth quarter of 2006.

The most significant benefit for the quarter was favorable oil prices, which averaged about $90 per barrel, versus approximately $60 a barrel in 2006. This commodity pricing was partially offset by lower gathering and processing margins, resulting from a change contract mix in 2007 and some lower plant efficiencies. During the quarter, Field Services paid distributions of $260 million to Spectra Energy. Year-end ongoing segment EBIT for Field Services was $549 million.

Now let me turn to Other, which is primarily comprised of our corporate governance costs and captive insurance. For the fourth quarter, Other reported ongoing net costs of $48 million, compared with ongoing earnings of $5 million in the previous year's quarter. Prior year ongoing results for the quarter included $24 million for management fees billed to Duke Energy affiliates during 2006, and market-to-market gains on discontinued hedge contracts.

Excluding these items, net costs were higher in fourth quarter 2007 by $29 million, primarily due to increased corporate costs, including higher employee incentives and benefits costs. 2007 ongoing net costs for Other were $89 million, below the $100 million we expected for our first year of operations.

The next slide shows several important additional items. Interest expense for the quarter was relatively flat compared with fourth quarter 2006 and fourth quarter 2007. Income tax expense from continuing operations was $129 million, compared with $42 million in the fourth quarter 2006.

For the 2007 quarter Spectra Energy's effective tax rate was 31%, compared with 15% in the prior year quarter. The lower tax rate for the prior period was primarily attributable to a tax benefit for the impairment of international investments which are no longer owned by Spectra and an adjustment of US tax on the repatriation of certain Canadian earnings.

As of December 31, 2007 our debt to total capitalization stood at 55%. We fully expect to be able to fund our CapEx program through a combination of internally generated fund and debt, while staying within the 55% to 60% range we have committed to. As of December 31st, we had a total capacity under our credit facilities of $2.7 billion and available liquidity of $1.9 billion.

Finally, the Canadian currency had a positive net after tax effect on earnings for the fourth quarter of about $14 million, compared with the fourth quarter of '06. We've given you an overview of our fourth quarter results, which as you can see we really did have a great quarter and great year.

The next several slides will show you how we get from the dollar $1.53 in 2007 to the $1.56 in 2008. Let's look at how those components for both years stake up. First, you're your reference, here is the slide we showed you in mid-January with side-by-side comparison of 2007 actual ongoing EBIT, and 2008 forecast EBIT for each business segments, which we will break down in more detail on the next two slides.

This slide rolls forward the $1.53 EPS to the $1.56 EPS by major drivers. It begins with the $969 million in ongoing net income for 2007 and reconciles it to our 2008 projected net income of $1 billion. We show major drivers effecting earnings and then show the effective interest and taxes to get to the 2008 net income.

We expect projects placed into service in 2007 to provide incremental 2008 EBIT of about $50 million. And projects placed into service in 2008 to provide about $90 million during the year. So, that accounts for the first buy of $140 million in expansion projects. I will tell you how that splits out among the business units on the next slide.

The next bar shows the effective commodity prices and volumes. The $55 million represent a $95 million increase in Field Services and a $40 million decrease at our Empress facility in Western Canada. With the Field Services increases, it seems we have an average oil price of $83 for 2008, compared with $72 in 2007. The Empress number is based on an average frac spread of $7.25 in 2008.

We are assuming parity of the US dollar and the Canadian dollar in 2008. This compares to an average in 2007 of $1.7 Canadian per US dollar. So we expect to see an EBIT pick up of about $50 million from this more favorable exchange rate. About $30 million of this will happen at Union Gas and about $20 million at our Western Canadian operations.

Next we take a take a look at the items that bring you back to $1 billion in net income for 2008. Firstly, it's important to remember that when we start projects, we expense the costs until we are confident that the project will move forward to successful completion and startup. At that time we'll reverse the expenses and capitalize those development costs. In the long run this results in a timing difference, since the net affect on the income statement should be zero.

In 2007, we capitalized the previously expensed amounts for several projects, which provided a net benefit of about $20 million. In 2008 we expect the net amount to be an expense of about $25 million. So you can see there is $45 million delta year-over-year. While it may show as a year-to-year variance, it really is good news since we are continuing to invest in new projects as we execute on our expansion program.

In 2007, our tax department succeeded in negotiating a number of favorable tax settlements with local and state taxing authorities, and settlements that allowed us to recognize about $30 million in EBIT. The timing of these settlements is always difficult to predict but we've not assumed any settlements for 2008.

Our US Pipelines benefited from additional processing volumes as a result of facilities owned by others continuing to be down. This was due to hurricane damage from the 2005 season, and those affected facilities will be back up in service in early 2008. As a result, even in the strong pricing environment, we expect to see about a $20 million reduction in these processing revenues. The full year minority interest in our MLP will reduce the EBIT by about $10 million. Interest, income taxes and other miscellaneous items balance out to around $1 billion.

Now let's look at the roll forward of EBIT. Starting with our ongoing 2007 EBIT of $2.42 million, we show EBIT change by business segments. The Field Services change of $101 million was substantially due to the $95 million uplift in commodity prices. We told you in January that the sensitivity to a dollar-change in oil would be about $12 million for '08, all other things being equal.

So when you look at the $11 per barrel increase, we assumed in 2008 from the 2007 average. You might expect a commodity increase of about $130 million. But we assumed a lower correlation of NGLs to oil in 2008 at approximately 60% than the average in 2007 which was 64%.

At the Distribution business, $15 million of the increased EBIT is due to pipeline expansion and storage. Growth in the base business and increased rates accounts for $13 million and [$30 million] is the effects.

The US Transmission's EBIT reduction may not be intuitive at first, so let's walk through those components. Starting with the $894 million of ongoing EBIT, we realized in 2007 we would subtract the net project development cost reversals of $20 million. The property tax benefits were $30 million.

High processing results of $20 million, and the incremental effect of a full year's minority interest on the MLP's earnings of about $10 million, come to $814 million. To that amount, you should add about $105 million and EBIT from pipeline and storage expansion projects. When you then take out the $25 million project development costs in '08 and other costs, you come to our projected 2008 ongoing EBIT of $870 million.

Our US Transmission segment is fully benefiting from the CapEx projects placed into service and realizing the 10% to 12% returns on new projects we have discussed. At our Western Canadian operation, the small reduction in EBIT is made up of increased EBIT from expansion projects and FX of about $40 million, which evenly split.

This is offset by the reduction of EBIT at Empress of about $40 million, while the frac spread at Empress is about the same in '07 and '08. We expect to see reduced volumes this year, and that's because we gained some volumes for our account last year. Volumes that a third-party was unable to utilize were due to downstream operational issues on their end, and we don't expect those additional volumes to be available to us in '08.

Our reductions are around the processing operations in our Fort Nelson area, which is experiencing reduced producer activity and additional budgeted turnaround costs. I hope this gives you a better feel for the various components our 2008 plan compared to the 2007 actual results.

And I am going to turn things back over to Fred.

Fred Fowler

Thanks, Greg. Spectra Energy's growth story is pretty simple and it's consistent. We expect to invest about $1 billion a year in CapEx for expansion projects. We will finance this CapEx from cash flow from operations and debt and we will harvest the 10% to 12% EBIT returns from those projects, as we placed them in to service.

We are executing on this plan and fully expect to deliver the 5% to 7% earnings growth that we promised, when we launched our company early in 2007. Our 2008 employee incentive target is at $1.56 a share, and that's an 11% increase over our 2007 target of $1.40.

We've told you that we are committed to growing our dividend as we grow our business. Last month we increased our annual dividend by $0.04, bringing it to $0.92 a share. We'll continue growing our business in 2008 as we execute on the aggressive capital expansion plans that we laid out for you.

In addition to the projects and growth between '08 and '10, we are also looking at longer term opportunities, and we will deliver those that create strong earnings growth and long-term value for our investors. A key component in our 2008 long-term incentive is based on total shareholder return that compares favorably to a group of peer companies, so you can trust that we are dedicated to delivering results.

Again, as we've shown you today, Spectra Energy enjoyed a great quarter and a great first year. We are very excited and ready to deliver on the tremendous promise that we see for '08.

With that let's open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question will come from the line of Lasan Johong with RBC Capital Markets.

Lasan Johong - RBC Capital Markets

Good morning, congratulations on a good quarter and a good year. Couple of quickies, Greg, you had mentioned that CapEx this year is going to be $1 billion-plus, going forward. But it looks that by our estimates, you have about $1.8 billion in operating cash flow. So how much more CapEx spending are you going to do beyond the $1 billion that I am not accounting for, that would get you to borrow money? And how much money are you going to end up borrowing?

Greg Ebel

Well, let me work those in reverse. We are going to borrow approximately $1.4 billion. The total CapEx number that I guess you should be looking at would be about, and this would be an SEP which gets consolidated, Lasan. So maybe that's not where you are picking it up, but…

Lasan Johong - RBC Capital Markets

Okay.

Greg Ebel

It would be about $1.9 billion for expansion, and that includes about $400 at SEP, and then $550 million of maintenance capital.

Lasan Johong - RBC Capital Markets

Okay.

Greg Ebel

So, you are probably not picking up that piece. On January 17th we put out that slide, so that might be helpful to take a peak at actually. It shows projected cash flow and the CapEx and the maintenance and expansion, including SEP.

Lasan Johong - RBC Capital Markets

Okay and then what are your natural gas prices? I mean, your oil price assumptions I thought was 83, and frac spread was about 720?

Greg Ebel

Right.

Lasan Johong - RBC Capital Markets

Was your natural gas price assumption embedded in your business model?

Greg Ebel

It's about $8.

Lasan Johong - RBC Capital Markets

$8, okay so are you expecting some fairly large cost increases?

Greg Ebel

You mean, in terms of the Empress plant?

Lasan Johong - RBC Capital Markets

Yeah, and generally Field Services.

Greg Ebel

Yeah, you do see some higher cost at Empress, that's for sure. As gas prices go up, even though oil is going faster, hence the frac. Your cost of running the Empress plant does go up. That's absolutely correct.

Fred Fowler

The other thing that you are seeing, Lasan, is in this price environment, producers are just demanding that they get more of it. So, we are seeing margin pressure from that direction as well.

Lasan Johong - RBC Capital Markets

So they want to have the upside potential on the frac spreads?

Fred Fowler

They want to share it.

Lasan Johong - RBC Capital Markets

Share it, okay.

Fred Fowler

They want a bigger share than they have gotten in the past, just because of how big the margins have become.

Greg Ebel

And we've taken that into account, looking at 2008.

Lasan Johong - RBC Capital Markets

I got you. Also on the Distribution business, I am assuming part of that upside is FX?

Greg Ebel

The upside between '07 and '08 or you mean...?

Lasan Johong - RBC Capital Markets

Yeah, '07 and '08.

Greg Ebel

That's correct. So there is about a $30 million increase from FX hitting the Distribution business in 2008 versus 2007.

Lasan Johong - RBC Capital Markets

So, it's actually net of FX, something like $28 million bump up in EBIT, possibly?

Greg Ebel

Yeah, correct.

Lasan Johong - RBC Capital Markets

Okay, that's' it from me. Thank you, and congratulations.

Greg Ebel

Thank you.

Fred Fowler

Thanks Lasan.

Operator

Your next question will come from the line of Ross Payne with Wachovia Capital Markets.

Ross Payne - Wachovia Capital Markets

How are you all guys? First question on Field Services, it looks like it's going to be up 18%, year-over-year. Can you speak on volumes as well? I mean, obviously you've given us, kind of, your commodity expectations, but is your volume growth at DCP Midstream?

Fred Fowler

I think, on an overall basis, there's slight volume growth, but it's fairly flat and moves in different areas.

Ross Payne - Wachovia Capital Markets

Okay, as you are going to lose some, I guess, around the hurricane areas and pick up in other areas?

Fred Fowler

Well, this is just a natural decline in the business. As you see, with reservoirs declines, you have a kind of natural decline in the level of business that you have from it, so you have to go out and regenerate new business to replace them.

Ross Payne - Wachovia Capital Markets

Alright.

Greg Ebel

The other thing to think about, Ross, year-over-year is we had a substantial weather impact in 2007. I think it's about $30 million for Spectra's account. So we wouldn't expect, obviously, to see that happen. That's one of the reasons why you get pickup too.

Ross Payne - Wachovia Capital Markets

Okay. Also, you obviously benefited from a stronger Canadian dollar. Is that because of your hedges? Second of all, was that embedded in the Western Canadian numbers as well as distribution?

Fred Fowler

Well, for 2007, we don't hedge the Canadian dollar. Remember we've got a natural hedge, because all of our Canadian businesses are financed in Canadian dollar debt. So, income goes up and so does interest expense. Income goes down as a result of currency, and so does interest expense.

But the real impact in 2007 from FX was mainly in Western Canada and that's because the Canadian dollar really didn't move up until the last half of the year. Union makes most concern of the first quarter. So, the low Canadian dollar, in fact it was below our forecast in the first quarter current union. So, the biggest pick up was really in Western Canada.

I think the total bottom line number would have been about $17 million for the year, after tax net income.

Ross Payne - Wachovia Capital Markets

Okay, great. That's it from me, guys. Thanks.

Operator

Your next question will come from the line of Faisel Khan with Citigroup.

Faisel Khan - Citigroup

Good morning.

Fred Fowler

Hey Faisel.

Faisel Khan - Citigroup

How're you doing?

Fred Fowler

Good.

Faisel Khan - Citigroup

Alright, I know you guys made an acquisition in Field Services, I think with MEG for around $600 million or so. Is there any way to quantify how much that acquisition contributed to your earnings in the fourth quarter?

Fred Fowler

It's not very much. The bigger part of that acquisition was the Barnett Shale piece. It's somewhat of a hockey stick to the one that we firmly believed in, because of the acreage that we have under contract there. It is primarily ELG, and we are a believer in their story, because we are in the opinion, and the ConocoPhillips group has supported us and helped us on this, that ELG is the producer that's really figured out how to produce the Barnett Shale.

Faisel Khan - Citigroup

Okay.

Fred Fowler

So early on, that's got a lot of impact. It comes on, really year three is when you start seeing good impact from it.

Faisel Khan - Citigroup

Okay, so when I look at the volumes, you are reporting that Field Services is not much of a contribution from those.

Fred Fowler

Right.

Faisel Khan - Citigroup

Okay, so is that something you'll deliver in the future, as Barnett production kind of ramps up?

Fred Fowler

Yes.

Faisel Khan - Citigroup

Okay, got you. If I'm looking at this, if I am taking a step back and looking at overall liquids production at your Canadian processing business and your US processing business, what are you seeing from customers that are consuming those liquids? Is demand still in fairly stable form, I guess with your chemicals and your refineries, or is there any softness, given the economic slowdown that we're seeing right now?

Fred Fowler

Yeah, we haven't seen it yet.

Faisel Khan - Citigroup

Okay and why do you think we haven't seen it yet?

Fred Fowler

I would say that most of the stuff ends up in world markets, and I think we just haven't seen the slowdown in the world markets yet, and I think that's probably the big unknown. I think there are probably two unanswered questions. Number one, how tough is the period that we are going into in the US? Number two, how is that depending on what that is how will that impact the overall world economy? While we're not a big part of the growth in the world economy, we are still one of the larger markets in the world economy.

Faisel Khan - Citigroup

Fair enough.

Fred Fowler

So if you saw a very severe recession in the US, I think it would probably have to leak over into the world economy soon.

Faisel Khan - Citigroup

Okay, and on the US Transmission side. In your press release you talked about how higher commodity prices for gas processing helped the pipeline operation. Is that significant at all? Generally, I don't associate commodity prices with US Transmission operation, so maybe I'm…

Fred Fowler

Yeah, there are a couple of plants that we have that are in the old regulated portion of our business. A certain amount of gas has to get processed so that it meets pipeline quality.

Faisel Khan - Citigroup

I got you.

Fred Fowler

And so there are two plants that we still have in the regulated part of our business.

Faisel Khan - Citigroup

Okay.

Greg Ebel

You know the quarter, we probably think that there is $12 million to $15 millions, versus '06.

Faisel Khan - Citigroup

Okay, got you. And then in terms of the distributions that are paid out for Field Services, you said $260 million in the quarter. On average, is it fair to assume there will be $0.5 billion a year in distributions in that business, or what's the run-rate?

Greg Ebel

Well, I think 90% of net income is the way to look at that.

Faisel Khan - Citigroup

Okay, got you. And then in term of the interest expense number that you drew up on your slide, slide 12 of $60 million, the incremental interest expense, what's driving that large increase?

Fred Fowler

It's funding the expansion on gas transmission. If you realize the way I kind of think about it, is to go over to the first line and look at that 140.

Faisel Khan - Citigroup

Yeah.

Fred Fowler

That's what it's costing us to finance that 140 of expansion projects.

Faisel Khan - Citigroup

Okay, I got you. I take it that you are assuming a kind of 50-50 capitalization of those new projects?

Greg Ebel

Well no. We are actually financing. Remember, we retain about 40% of our net income, right? 60% is paid out in dividends.

Faisel Khan - Citigroup

Sure.

Greg Ebel

And then the remainder that we need, we are actually borrowing externally. So that's why you can see the large borrowing. You do see debt up year-over-year. So that's driving as Fred said, as we put the capital working you'll see same thing. We'll borrow $1.4 in 2008 and hence you are going to see that change of about $60 million in interest expense. It's a good thing.

Faisel Khan - Citigroup

Yeah. I hear it. So you are funding expansion projects with retained earnings and then the rest is being financed with that which makes this …?

Fred Fowler

Correct.

Greg Ebel

Correct. It's the combination of the two.

Faisel Khan - Citigroup

Got you, okay. Great, thanks for the time guys.

Greg Ebel

Thank you.

Operator

Your next question will come from the line of Nathan Judge with Atlantic Equities.

Greg Ebel

Hi Nathan.

Nathan Judge - Atlantic Equities

I just have one question; you said that your assumption for the relationship to oil prices was going to be 60%. I think historically you have been at about 66%, or so. Is there a breakdown of that relationship, or is that just conservative?

Fred Fowler

I think it's just a fact that we felt the actual commodity price at the time was fairly high. Typically when you see oil, particularly when its oil driven, there is a tendency for the relationship to reduce. In times, what I am trying to say is in times of very high oil prices, you will typically see a disconnect between gas liquids and crude.

Nathan Judge - Atlantic Equities

Okay. What would be your earnings sensitivity and a dramatic slowdown, possibly a deep recession in the United States?

Greg Ebel

Well, I think that the real sensitivity we would see is really if you believed that it had an impact on commodity prices. Remember, most of our pipelines in the US are long-term contracts, and the same, you know the distribution business is if you thought people would dramatically reduce their heat intake. But in the short term it's not dramatic on those two businesses.

So, you've got to make an assumption whether that moves commodity prices down. Commodity prices have stayed pretty strong. You also must remember that commodity prices generally trade in US dollars, so if you believe the US dollar is going to remain weak, maybe that keeps the commodity price strong. But from our base, the SET business that Martha runs that would not see a dramatic move in the short term.

Fred Fowler

Probably the impact there would be that it would slow our growth rate in the future, but as far as growing any short term and earnings impact it should be fairly negligible.

Nathan Judge - Atlantic Equities

Fine and then just kind of an associated question along with LNG question earlier. I think one of the expectations that I have had is about new storage expansions really ramping up. How is that progressing, and from your point of view, looking forward, in interest from suppliers? Are you seeing an increased interest in storage and where are we in that part of the cycle?

Fred Fowler

Yes, we do continue see it. I think when it will really hit big-time, Nathan, will be when LNG starts really coming in at larger volumes, which in our opinion looks like it's probably going to be in the 2011, '12 range. I think that's when the market is going to fully appreciate the need and the value of storage. Its one of the reasons that we continue to be very bullish on storage, but at the same time trying to timber how much of risk we're willing to take to build it.

Nathan Judge - Atlantic Equities

Fair enough. And then just finally, as you look across the market, there are quite a few new entrants into the gas transmission business. Spectra is obviously one of the larger companies out there. What's your view on consolidation and your portfolio of assets and how do you see that perhaps in the next several years?

Fred Fowler

If you think about our business, Nathan, it's really two businesses. It's our gas transmission business that is 100% up, and then it's our gathering and processing joint venture with ConocoPhillips. The gas transmission sector in the US is a fairly consolidated business. I think there could be opportunities that arise, going forward, but I think there will be a greater number of opportunities, probably over in the gathering and processing part of the business.

I think we made it fairly clear from our belief in recent times, because of the markets and what they were allowing people to do, so we created a tremendous amount of master limited partnerships. In our opinion there are more of them, and there really are assets to grow them. And we think that there will probably be a consolidation coming in that sector fairly soon, because a lot of these newer MLPs have been backed by private equity and those guys are typically pretty smart and savvy in knowing when it's time to harvest.

Nathan Judge - Atlantic Equities

Is that comment somewhat related to the number of deals that have been coming to you or is it hedge, just a general comment about the overall market?

Fred Fowler

I think probably little of both.

Nathan Judge - Atlantic Equities

Thank you very much.

Greg Ebel

Thanks Nathan.

Operator

Your next question will come from the line of Matthew Akman with Macquarie.

Matthew Akman - Macquarie

Thanks very much. A question on your Western Canadian business; we haven't seen drilling really pick up in Western Canada. Overall, what's your view on '08 and what's kind of in your guidance in terms of volumes on your system, because obviously we've seen that while the basin, overall, is kind of stagnating, the northeast BC region, where you guys pick up volume, still remains fairly strong. But what's in your guidance, what's your view on that?

Fred Fowler

You'll take that one.

John Arensdorf

Yes Matthew, do you want to say anything.

Martha Wyrsch

Nathan, I'm sorry, it's Mathew. We have seen continued strong drilling up in the Grizzly Valley, around the Pine River facilities, as you know. And so we don't see any decline in throughputs in the plants, and we actually saw an up-tick last year in those facilities. The same has been true at McMahon. Now with Fort Nelson, we continue to be pretty flat and we don't see an up-tick in drilling there.

Greg Ebel

Yes, I think you see that in the forecast. But that roll-forward chart; the decline is really the one plant where we see the reductions. As Martha said, with the other two areas we see continued strong growth.

Fred Fowler

And actually we have some expansion projects in other two areas.

Greg Ebel

Yeah we do.

Fred Fowler

But I think, kind of a net-net overall we see that it is fairly flat.

Matthew Akman - Macquarie

Okay.

Fred Fowler

Two areas that are improving one area, the largest one though flat or actually declining, that kind of overall is flat there.

Greg Ebel

It's a good thing to be in northeast British Columbia, as opposed to perhaps on the other side of the border right now.

Matthew Akman - Macquarie

What is your view on the demand-pull in terms of lots of proposals for LNG coming on around the packed northwest? Is your view that it will come on, or do you think you'll be okay there?

Martha Wyrsch

We've seen very strong continued usage. In fact, an up-tick with usage on the pipeline mainline system, and right now those LNG projects don't seem to have enough true reality to them, that they are impacting our throughput at all.

Matthew Akman - Macquarie

Okay, and I guess just last on Canada overall. Canadian energy infrastructure assets seem to be trading at a pretty big premium to your stock, and even your income fund seems to be trading at a premium to the corporation. Is this a challenge or an opportunity? And if it's an opportunity, how could you, maybe, capitalize on it?

Greg Ebel

Well, I think it's definitely a challenge and I would suggest that there is a huge opportunity for our investors. I don't think there is any reason why there should be that delta in value. I think we need to spend more time with folks up there. I think we need to spend more time with, obviously, investors to explain the good quality business we have.

Fred Fowler

From an income fund perspective it's a relatively small element of the business. I am not sure of the income fund elemental as a driver.

Matthew Akman – Macquarie

Okay. Thanks for answering my questions.

Fred Fowler

Thanks Matt.

Operator

(Operator Instructions). Your next question will come from the line of Scott Engstrom with Blenheim Capital Management.

Scott Engstrom - Blenheim Capital Management

Good morning.

Fred Fowler

Good morning.

Scott Engstrom - Blenheim Capital Management

Greg, did you mention, when you are going through the quantity, what your actual realized spread was at Empress frac spread in '07?

Greg Ebel

I think $7.15 would have been the frac.

Scott Engstrom - Blenheim Capital Management

Okay. So, in the '08 guidance it's essentially flat. It's 725 versus the 715, is that right?

Greg Ebel

Correct. But as we indicated, we have received some volumes that we realized in '07 that we won't realize in 2008. We don't have all the capacity in our plants. So, we will lose some of that, which is why you see it coming down.

Scott Engstrom - Blenheim Capital Management

Just following up on the previous question, and more looking beyond the temporal issues at Empress; between picking up some volumes last year that due to a competitor and losing some maintenance this year, is there a way to think about that if volumes are beyond sort of last year and this year? What should we be thinking about in terms of volumes in the long term?

Greg Ebel

Well, just to be clear, we are seeing good volumes at the plant. In fact the increase, as you went through that the back half of the year; it's just that we don't own the full capacity at the plant. So, the plant at 100%, if you will, saw good volumes. And we expect to see those volumes stay up, keeping in fact grow a little bit. It's just that we won't be able to realize 100% of the plant. We'll just get a proportion of capacity from the plant.

Scott Engstrom - Blenheim Capital Management

Okay, question on the other line. It looks like maybe the fourth quarter you had kind of a high class problem. If I look at it quarter-by-quarter, rather the first quarter was a drag of $12 million and $19 million and $10 million. The fourth quarter jumps up to $48 million drag. You mentioned incentive payments. Can you break that down a little bit? Have we seen or is there any reason to think that's jumped between the third quarter and the fourth quarter, on an ongoing basis?

Fred Fowler

No, as you know, you plan and your incentive payments, I think about our target of about 40 as the year accelerates. And you see where things end up, and obviously in the fourth quarter we had a very strong year. So, you then accrue for how the year is coming out, but you don't do that obviously early in the year thinking much as you see something dramatic that would suggest you are going do so much better. But I think there is more a timing issue there than anything.

Scott Engstrom - Blenheim Capital Management

Okay. So the first three quarters of the year are more or like your kind of ongoing rate. I know you're guiding for $85 million drag for the year, but does that all still hold?

Fred Fowler

That would be correct.

Scott Engstrom - Blenheim Capital Management

Okay. You on the, your 50% of management bonus for your peer group comparison, do you have off the top of your head who your peer group actually is?

Greg Ebel

Well, for 2007, it was a smaller group that I think had Enbridge, TransCanada, Southern Union, but going forward it's got about 19 companies, a bunch of them that would be in the utility index say about half and then the folks directly in our sector would be folks like El Paso and Enbridge, Equitable, ONEOK, Sempra, Southern Union and Williams. So you've got a good mix there.

Scott Engstrom - Blenheim Capital Management

Thank you. Lastly, just going back to the big picture question about hedging, it just seems to me that one of the lessons of last year is that there is a little bit of asymmetric payoff for you guys with respect to commodity prices meeting, as prices have gone up here favorably for the company and for shareholders. Producers, as you've mentioned many times, have been asking for more of those margins. My sense is that if it goes the other way, producers are not going to be so quick to want to share the margins on the downside. So I'm just wondering if the experience of oil running up into the high 90s and 100s has changed the way you are thinking about hedging, given that asymmetric payoff for shareholders?

Fred Fowler

No, it is something that we continued to evaluate, but we still believe that not hedging is the way to go.

Scott Engstrom - Blenheim Capital Management

Okay, thanks very much.

Fred Fowler

Thank you.

Operator

(Operator Instructions). Your next question is a follow-up question from the line of Ross Payne with Wachovia Capital Markets.

Ross Payne - Wachovia Capital Markets

Greg a bookkeeping item here, what is the depreciation for 2008?

Greg Ebel

The total depreciation number for 2008 is going to run around $600 million. Give me a second; I can probably dig up the exact amount. It's not. We'll get it to you, but it should be around $600 million, Ross.

Ross Payne - Wachovia Capital Markets

Okay, that's great. Else is good to the EBITDA, thanks.

Greg Ebel

Yeah.

Operator

And your next question is also a follow-up question from the line of Faisel Khan with Citigroup.

Faisel Khan - Citigroup

Hey guys, sorry, just one more question. On your current processing infrastructure in the US, you mentioned in the past that those processing plants are less efficient than some of new plants that are up and running. Do the economics make sense to retrofit or refurbish those old vintage plants?

Fred Fowler

That's part of our ongoing business plan every year, and we have done some of that virtually every year.

Faisel Khan - Citigroup

Okay. Fair enough. Thanks.

Fred Fowler

That and not only a lot, and the other thing that we've done a lot recently is just redirecting gas from less efficient plants to more efficient plants.

Faisel Khan - Citigroup

Okay.

Fred Fowler

It's because we have done some capacity additions in the past.

Faisel Khan - Citigroup

Okay, and then when you've talked about in the past about how there is change in your contracts mix a little bit. It's not moving POP to sea-based, it's moving peephole to sea-based, right?

Fred Fowler

Yes.

Faisel Khan - Citigroup

Okay, got you, thanks.

Fred Fowler

Peephole to POP.

Operator

(Operator Instructions)

John Arensdorf

Dennis, it appears there are no more questions.

Operator

Yes sir. That is correct.

John Arensdorf

Okay. Well thank you everyone for joining us on the call today. As always, if you have any additional questions feel free to give me a call or Patty, that's Patrick. We will be happy to help you. And I just want to remind you that Thursday of next week we're going to be in New York for breakfast and in Boston for lunch. There you'll have an opportunity to ask additional questions you might have. We'd be very happy to see you there and if you haven't already signed up, if you'd let us know that you are going to attend, we'd appreciate it. So, hope to see you in New York or Boston next week and with that we'll end the call.

Operator

Ladies and gentlemen this concludes the Spectra Energy's fourth quarter earnings call. You may now disconnect.

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