AGL Resources (ATG) 2008 Update Call April 2, 2008 8:30 AM ET
John W. Somerhalder – Chairman, Chief Executive Officer, and President
Hank Linginfelter – Executive Vice President, Utility Operations
Michael A. Braswell – CEO, SouthStar Energy Services
Douglas N. Schantz – President, Sequent Energy Management
Dana A. Grams – President, Pivotal Energy Development
Andrew W. Evans – Executive Vice President, Chief Financial Officer
Steve Cave – Managing Director of Investor Relations
Good morning everyone. We want to thank you for coming out and joining us. We want to welcome you to the 2008 AGL Resources Analyst Meeting. I’m Steve Cave; I’m the Managing Director of Investor Relations. We also want to welcome those who are joining us on the webcast. We have placed a copy of the slide on our website. We’ve also filed a Form 8-K this morning with the slide. For those in the room, we have a copy of the presentation in front of you. We also have, just for your information, we have a copy of our 2007 annual report which is hot off the press release just a couple of weeks ago; so you can take a look at that as well. I did want to just mention, in terms of the format today, John Somerhalder, our Chairman, CEO, and President is going to make some opening remarks. We’d like to go through all the presentations today before we get to the Q&A. Obviously, as each of the business unit leaders go through their presentation; if you have a question, feel free to stop and ask it, but we would just ask that we get through some of the business presentations in a timely manner.
Let me just get a couple of housekeeping items out of the way; we go to the forward-looking statements. As you know, when we go through the presentations today, we will be making some forward-looking statements and our actual results could differ materially from those statements. The factors that could cause those results to differ are detailed in our SEC filings including our 10-K just filed about a month ago; and in describing our business, we also use some non-GAAP measures such as EBIT, earnings before interest and taxes and operating margin, and you can find reconciliations to the GAAP measures on our website and in our SEC filings as well.
Let me just quickly run through the agenda. John, as I said, is going to make a few opening remarks, then we’ll turn it over to Hank Linginfelter, who is our Executive Vice President of the Utility Operations, and he will talk through the 2008 utility plan. We’ll then turn it over to Mike Braswell, who is the CEO of the SouthStar Energy Services business. We’ll take a break at 10 o’clock until 10:15. We will then take it up with Sequent Energy, Douglas Schantz, who is the President of that business, who will talk through our plan for that business for 2008 and beyond. At 10:45, Dana Grams is here to talk about our storage projects. Dana, as most of you know, is the President of our Pivotal Energy Development business. And then at 11:15, Andrew Evans, our Executive Vice President and CFO will wrap it up with a financial overview before John gives a few closing remarks and we go to Q&A. So, one other housekeeping item, if you could just make sure you have your Blackberrys and your phones turned on silent throughout the presentation because it can interfere with the webcast, and with that I’d like to turn it over to John Somerhalder.
John W. Somerhalder
Thank you Steve and good morning. Thank you for joining us today, those of you that are here and those of you on the webcast. As Steve indicated, I’m going to start out with kind of a summary of what your going to hear today with the key points that I take away from the business unit presentations and where the business is today. The first one I think you’ll see ends up being throughout all of the business units as we see very favorable and in fact improving natural gas industry fundamentals, and the key driver is one we all know about, and that is for the last 10 years, about all of the electric generation that has been installed has been natural gas. And if you look at efficiency and environmental drivers moving forward, it appears that most of the electric generation that will be installed for at least the next decade will be natural gas fired. All you have to do is look at, as an example coal fire plants that were announced and were on a schedule to move forward; a year ago about half of those had been canceled in states like Kansas, it’s very clear that 80% plus of the new generation will be natural gas. What that will do is drive the need for natural gas infrastructure and natural gas services like our wholesale services and that positions us very well for growth. But it’s not only on the electric generation side; if you look at direct use of natural gas, that’s the most efficient use of natural gas or any fossil fuel; because of the environmental benefits of natural gas, it’s the most favored fuel from that standpoint as well. What we see is improving fundamentals around the direct use of natural gas which will also drive our distribution operation statements. So, we see very favorable conditions in the natural gas business to drive business opportunities and in fact those are improving because of efficiency and environmental benefits. At the same time, we see a challenging current economic set of conditions, and you all know what those challenges are, I don’t need to go through that list, but what I can tell you is what we see directly. If you look as for example, in Georgia, our major market, and this pretty well applies to other markets; if we talk to whether it’s the cable company or the electric company or to realtors, almost everyone is seeing new housing sales and starts down about 40%. That’s the number you hear quoted most often. In fact if we look at the statistics, it’s probably more in line with things that are running at half the pace they were over the last several years; so basically, new housing starts and new connects which drives a lot of our growth cut about in half because of the economic conditions that we see.
What I’d like to do now is kind of walk you through a summary of what you’ll hear from each one of the business leaders, and the first thing we need to make sure is that we can take advantage of the opportunities in natural gas business is to make sure that we focus on our core business and we have a strong foundation to do that. We’ve had great success this year from the standpoint of making sure our foundation is strong. In distribution operations, we have focused on growth and attrition. On growth, we focused on a number of ways to continue to grow outside of just connecting your homes, those are things like vertical mains where new condominiums within the past – high-rise condominiums that would have been all electric – now they have an opportunity to go natural gas; we’ve had great success with that – Hank will talk a little bit about that – things like backup generators in places like Florida converting from oil to gas, obviously we have a big advantage now with the oil prices; we focused on those and those programs have been very successful. On attrition, we’ve had the most success. There we focused on marketing the advantages of natural gas, the benefits of natural gas, as well as providing some rebates to makes sure people don’t convert to other sources of heat for the space heating and water heating like electricity and we’ve had great success there. If you look at the rate of attrition that we saw historically especially coming out of the hurricanes, attrition today is running at about half the pace it was through those time periods. So, we’ve had great success with some growth initiatives where we targeted and we’ve had the most success with attrition. What that translates into is if you go back to 1996 coming out of the hurricane, we actually – before we targeted attrition and growth initiatives – by the middle of 2006 our year-over-year growth was at zero. Because we focused on this we were able to still achieve about 0.5% growth in customer count in that year because of successes on attrition. Last year, in 2007, we had about a 0.9% growth year over year. Had we not focused on attrition because what we saw is the start of the housing market slow down, had we not had the reduction in attrition, we would have had very close to zero growth in 2007. Because of the success with these programs, we still have close to 1% growth. Unfortunately, this year even though we still have success on the growth initiatives and attrition, because the housing market has slowed down so much, we expect that the growth would be more in the range – and Hank will talk about the numbers – but the nominal number we’re looking at now is probably around 0.5%. What that does is that because of the success of those programs, that positions us very well when we return to more normal economic conditions to have growth that’s higher than we’ve had historically, and on top of that, because of the environmental and efficiency benefits in natural gas, we think there’s even further upside long term to grow in our distribution operations business.
We always talk about a strong cost discipline around all of our businesses, especially distribution operations – and Hank will talk about the successes we’ve had today – and I can tell you we’re still focused on making sure that we’re a leader in the area of costs. The real foundation of our distribution operations business is our regulatory and legislative successes, and we’ve had – really and I’m impressed with that at end of the year this year as far as successes in that area – everything from successes around, asset management agreements with Sequent, extending those agreements in a number of jurisdictions; that not only benefits Sequent, but because Sequent so effectively managed that capacity and brings value but share back with our customers, it helps our customers as well. We have had success in several areas on stabilizing our margin. As you know, in our major jurisdiction, Georgia, we’re essentially straight fixed variable, but in Virginia and New Jersey, we’re a little more susceptible to volume throughput, whether it’s because of weather or because of conservation. Even though we had weather normalization, we continued to make progress there. We successfully got commercial WNA in Virginia which further helped and legislation in Virginia that will make de-coupling more probable there. We also had some financial successes from a regulatory and legislative standpoint as an example making sure we got AFEDC on the pipeline we’re building in Virginia and making sure we can include the purchase acquisition training in Florida for calculated return which helps us financially. So, a very strong foundation has been established through distribution operations.
SouthStar last year saw a very stable year from the standpoint of retail business, number of customers, the retail margins in the Georgia market, as well as having successes in Ohio. They continue to manage the cost and bad debt very effectively and those are very important parts of their profitability, and in 2007 – Mike Braswell will talk about the fact that very strong results from the commercial value; when they get a group of customers, they also get their assets – the pipeline transportation and storage of those along with that – very effective and very profitable management of those activities in 2007; not something we see repeating every year, but in 2007 they’ve really executed on that very well. Sequent had very stable 2007 results, but it was a return to much more normal conditions, and there were no surprises about the performance from our standpoint that we had in 2007. That was very normal performance, in fact very much in line with what we told you historically will be the normal type earnings from Sequent and under normal conditions. We were surprised with how quickly we went from the 18 months following the hurricanes with a lot of volatility, a lot of summer/winter shred value, and a lot of pipeline transportation bases to much more normal conditions. That happened very quickly. We are very well positioned, we believe, under normal conditions to make solid earnings and then to have upside from there.
Also, in 2007, we had challenges from the standpoint of making sure our organization stayed stable and solid. That was because the number of banks and others were getting into the business, and even though our attrition was a higher number than present, the attrition was higher in 2007, that fact that it moved to a little over 20% from historically around 10%, Doug and the group were able to bring very good people, and in fact, we feel very good about that organization. Today, we feel like we have the strongest organization ever and ready to move forward, and as always we are very much focused on arresting credit and managing those issues and a very good performance last year.
Pivotal, we saw extremely strong performance of Jefferson Island – actual physical operations, improvements there, everything from compression, dehydration, the ability to cycle that facility, improvements in all those areas, and very good commercial success there; not only on transportation, but when we re-contracted, we saw very good rates. A big part of our fundamental business at Pivotal is developing new projects, and as you all saw, we stuck to our schedule and made great progress on GTS, Golden Triangle, received the FERC certificate late last year, and we’re completely on schedule to move the construction next month; so very positive results there. And we’re now at a point where we’re taking significant steps to get Jefferson Island expansion back on track. And I had a question earlier – does that mean that settlement discussions are going nowhere – and that’s not the answer. We actually have had discussions in Louisiana with DNR, The Department of Natural Resources, and with the Governor’s office. We actually believe now is the right time for settlement, but we think the right way to do that is to very much make sure we protect all of our interest and keep pressure on those issues. We think that will result in the most timely and most favorable settlement. So we still are very optimistic about settlement. If that’s not achieved, we’ve got the litigation teed up and we plan to pursue this to make sure we have the best chance to get that expansion back on track.
We got great successes from the standpoint of growth and great opportunities in that area. The distribution operation is just a fundamental business, whether it’s growth or pipeline integrity or making sure systems are updated. We are very well positioned to continue to prudently invest capital in that business, and because we’re going through accelerated cycles – and Hank will talk about that – we’re well set up to make sure we get good recovery on that rate base investment. We got great success on two pipeline projects – Hampton Roads Crossing and Magnolia pipeline project. Hampton Roads is up in Virginia, it’s about a little over $100 million project. About 60% of that project is for the benefit of our existing customers. That will go on rate base. Because of a favorable treatment on AFEDC and the timing of that project in service and putting that on a rate base, we’ll earn a good regulated return on that piece of the asset. About 40% of that project will go then for third parties, for Columbia and Dominion. They will charge incremental rates and earn a good regular and late return off of that project from incremental revenues from two other companies; very good project. Magnolia Pipeline Project is a project to move gas from Elba Island into our Georgian market up into the Macon and ultimately up into the Atlanta area. That project we were successful on another regulatory proceeding and it passed the supply plan in Georgia, we’re getting approval to include that in the supply mix where as soon as that project goes into service, that will be included in the cost of gas through the retail marketers to the customers and we’ll start earning a good return on that project. It’s a little smaller, it’s in the $40 to $45 million range.
SouthStar had success in Ohio and are having success in Florida. We continue to look in those areas, those are evolving markets; we think we have opportunity there, and we’ll look at other places like New York. Sequent has had successful expansions of its business to the west and into Canada and also looking at some of the new salt dome storage that other people are developing. They are very aggressive in making sure they can get good deals on that, and Doug will talk about the startup effort we’ve had in acquisition in the commercial and industrial area and we’ve had success with that today. Doug will just summarize what I talked about before, but success with Golden Triangle, moving forward to get Jefferson Island back on track, and then we’ll talk today about another storage project; it’s a very similar project to Golden Triangle, similar sized production area, Gulf Coast facility; it’s actually on a virgin salt dump, so has a little bit longer development schedule than Golden Triangle, but it’s a project that we’re starting a little more than a year behind where Golden Triangle was probably a year and three or four months behind where we started that, but because of the extra development scheduling time on that project and in order to prioritize our resources since we’re working on these other projects, we expect construction start on that facility about 2 years behind when we start construction on Golden Triangle, and Dana will talk to you in more detail about that.
As you all know, we’ve been an aggressive inquirer related to acquisitions, but we’ve been very disciplined in that. We really have not missed any opportunities over the last two years, but one thing we do is that we take these very seriously. We’ve got a very good team that goes in and fully evaluates and makes sure that we don’t overpay for the facility, and even though we’ve been aggressive and made sure we were there at the table, we’ve come up short with deals that have been done are just not deals that would have made economic sense for us, and that’s more important, the discipline side of that is much more important to us. You can count on us to continue to be aggressive, and we think the industry needs consolidation, but we’re going to make sure we do not do a deal that does not work for us. Everything you’ve heard about to this point is what we’re really focused on, but we’ve been very good at developing new business opportunities that are closely related to our business, and we are focused on four other areas that we think will have opportunity in the future. We’re focused on these in a way that won’t detract from the other things we’re doing since these ultimately will be complementary, and I’m going to talk a lot about these today, but know that we have opportunities in these four areas moving forward and we are heavily investigating what our opportunities are. The first one is pretty straight forward. Most of these are driven out of the fundamentals I talked about on slide one and a lot of them out of the environmental benefits of natural gas. The first one is it tends to go through cycles but production area storage has been very important. We think as we go back and rationalize the portfolio that market area peaking in storage will be important and we’re very well positioned for that with facilities we operate, LNG peaking facilities in a number of jurisdictions. We’re very well positioned with our skill set, market area peaking facilities, and that would be almost all of our jurisdictions that we look to do that. Because some of the fundamentals we talked about earlier, energy efficiency is going to be important, there are a number of natural gas appliances; whether that’s natural gas heat pumps, combined heat and power distributed, generation, natural gas vehicles, a number of things that we think the environmental benefits are going to push through the need for those, that can help us grow our distribution operations or it may give us other opportunities to invest, so we’re heavily looking into opportunities around high-efficiency natural gas appliances and vehicles.
Renewable gas is another area we’re looking at just like the electrics have looked at renewable power and that’s primarily been in the wind area as you know and solar. We have a unique opportunity to take renewable gas into our distribution system instead of inefficiently converting that to electrons, take that to the end-use where it can most efficiently be used, that’s everything from land-filled gas to agricultural by-product gas that you can get, and we see a real opportunity to start investing in that area over the next several years as global climate change becomes a larger driving factor. You not only get the benefits of that gas in your distribution system where you can efficiently use it, but you say in many cases methane emissions, as most of you know methane emissions are even more powerful than CO2 emissions. So, you’re not only getting environmental drivers that provide good economics, you get additional environmental benefit out of that type of project.
The last thing we’re looking at – and this is a little long term – on probably sequestration, there could be some opportunities there since we understand pipelines, because we understand storage, could be opportunities ultimately with carbon capture and storage, but probably in the near term some opportunities around carbon trading as the carbon allowance programs put in place Sequent is very well positioned for that. We’re going to look at those types of opportunities. So, we have these four areas are not areas that you hear a lot about today, but know that there are other areas that we think we’re very well positioned to start executing around and adding even further benefit to our business.
The bottom line, is what you’ll heard from Drew, is with financial performance and metrics that we see that can support all of these plans, we anticipate – as we told you many times – medium to long-term earnings growth in the 4% to 6% on a compounded annual basis, and we expect if you look out 4, 5, 6, or 7 years that we can achieve not only in that range but at the high end of that range, especially with the type of growth projects we have with pipelines and with the storage projects, but the shape of that curve really is influenced by the fact that right now we have an economic slow-down, right now we’re spending a lot of money on development and we’re in the construction phase of a lot of these projects, and over the next several years, we’re going to the right places in distribution operation. So, we still get to the same point that we do see the slope of the curve is a little flatter to start out with because of the fact that I talked about, a little steeper as these projects commercially kick in and as we come out of some of the rate cases. One thing we should notice – and Drew will focus on this – is we have a very strong portfolio and a very balanced portfolio diversified. Last year distribution operations contributed to about 72% of our EBIT and this year we anticipate pretty close to the same number. We’ve had very strong dividend growth consistently over the last 5 years and we have a very competitive yield – and Drew will focus on that – an extremely strong balance sheet and financial flexibility to execute around this plan. So, we feel very good about the industry, we feel very good about the foundation and the core of our business, we had a lot of success on those areas especially positioning for growth, and we’re going to move forward on that basis. With that, I’m going to turn it over to Hank Linginfelter.
Thanks John. Good morning everyone. It’s a pleasure to be here. I appreciate all the folks joining us. I’m especially thankful for the opportunity to share with you a few minutes about what’s going on in the distribution business. Sometimes, John refers to me as the new old guy at the conference because I’m in a relatively new position, but I’ve got 25 years with the company this month, almost exclusively in the Utilities, having been with Atlanta Gas Light for many years before it bought VNG, moved to Virginia as part of that, inherited New Jersey and Maryland out of the NUI property acquisition, and I’m back in Atlanta now, head of all the utilities, and I’ve got to tell you, I think in the 25 years of my career, I don’t think natural gas has ever been more critical to the energy economy than it is right now, and I think our company is as well positioned as it’s ever been given the challenges and opportunities in the market place. So, very thankful also that utilities are a big player in that, and want to give you – this is kind of a map of our territory. We’re really an Eastern Seaboard Utility company; you can see the customer count numbers there, Atlanta Gas Light by far the largest, but really a well diversified mix of utilities across the Eastern Seaboard, and we thought we’d also share with you just a little bit about our mix. We have a high percentage of fixed charges generally covered in the way our rates are set. As you know, Atlanta Gas Light is straight fixed variables, so it’s 100% recover fixed charge margin recovery business. The others you can see the numbers there. We do have rate cases almost everywhere coming up over the next few years. We’re in the middle of one right now, and Elfin which is our smallest operation in Maryland, we have reached terms with a settlement with the parties, but the commission still has to rule on the settlement and they could change what the settlement is, but we think it’s a good one, it’s a modest increase in rates in Maryland, but gives us some other flexibility and a little more security around the margin opportunities in that business. So we have WNAs in three jurisdictions and I’ll talk about those and more in a couple of minutes; 2.3 million customers and 2.3 billion in rate base.
I think I’m going to give you today some of our priorities for 2008, but these are really sort of – not only 2008 but they are generally the priorities we have in our business overall. Customer growth and attrition, John talked a little bit about that, I’ll cover it some more. We really are working to make sure these utilities have earning stability and that we can continue our cost control as an organization. We centralized some functions and activities and I’ll share those with you, and that’s really under the determination to make this business very receptive to acquisitions, and we’ve done those well so far but we sure would like to do some more. Rate case planning and timing, I’ll talk about that. Some of the growth projects diversify supply and the excitement we have over those, and I’ll wrap up with just a little bit of a discussion about our overall plan for the reputation and brand value of our utility. Now you can see we are in kind of a high expectations environment, have been for a number of years, we want to grow, we want to make sure we are marketing our products, and that we reduce the attrition return we have, but at the same time we have these difficult economic conditions. The way we run a business of course is to add customers, add meters, retain them, that gives us margin growth, but also to sell more services with the existing customer base and so we have really worked hard to continue to improve our attrition numbers and also to look for plenty of opportunities in the market place. Economic conditions are very tough. Although you may have seen, if you’re paying attention to some of our territory, Metropolitan Atlanta actually was the second fastest growing city in America last year, second only to Dallas, and that’s exciting. We hope to get a lot of growth out of that opportunity. In fact, the census forecast says Georgia for example will add 4 million people between now and the year 2030, and that’s the bedrock of our business of course. Other states we serve will grow I think as well, but with that one thing you don’t hear much about is where Atlanta stands, for example in the foreclosure business, and we’re the sixth highest number for closures in the country in Atlanta; so as much as we see a lot of population growth, it doesn’t necessarily turn into a lot of housing growth that ends up in gas meters for AGL, although it certainly does result in growth and we’re excited about it.
In the short run, we have a lot of inventory in our metropolitan markets of housing stock. So, some of those houses are already connected to our system. They are using gas modestly but they are not really using at that traditional levels. Ultimately, the market will absorb that inventory and we’ll see a return to growth over the next couple of years we believe. Now we’re going to continue the focus on growth in our business and I wanted to share with you a little bit about that attrition stuff that John referred to. We’re still seeing new leaders, which is a good thing, we’re seeing them across our footprints. New Jersey and Virginia are particularly good, a little over 1.5% growth I think in those markets typically. The attrition is a little over there. Atlanta had good growth, but we still had some serious attrition, but what’s great about our efforts is we’ve seen the attrition drop dramatically from our messaging, our informational advertising, and the rebate programs that we put in place in the markets where we have competition, and you can see the yellow is the attrition number and that has dropped dramatically from the historic levels. Now, this year we’ll see slower new growth and a continued challenge with attrition; so, as John mentioned we’ll see Atlanta Gas Light be fairly flat on growth and the entire distribution ops group we think will grow at something around 0.5% – maybe a little more – maybe a little less – depending on market conditions, but I’m really pleased we got our growth to almost 1% last year given the challenges we’ve had historically on the churn issue of the attrition. We are trying to capitalize on new opportunities in the marketplace and I’m going to share with you some of the things that are going on there. One of the more visible ones, and I think we talked just briefly about this last year to you, is something called Vertical Main. We serve a lot of urban areas; Atlanta, Miami, New Jersey, and the South Eastern part of Virginia for example, and we do see a return to live-in quarters more inside cities, traffic is becoming more difficult, the cost of gasoline, people are returning to in-town living, and what we’re seeing is still fairly robust market in high-rise apartments and condos, and in particularly, in downtown Atlanta. Vertical Main is a technology that allows us to actually own the pipe that goes through a building going up to the top and so we build the trunk line and the developer then taps into that and individually meters apartments or condos, and we’ve found that to be a pretty effective tool. We learned about it from another gas company in Florida, and they’ve been successful with it. So, we have a 20-storey tower in Buckhead that will have gas cooking for example and it got a lot of exposure in the Atlanta paper just a few weeks ago. So, it’s an exciting opportunity, we’re working about 18 of these right now, to try to get gas into high-rises. That is where the market is headed for a lot of our territory. We’ve historically not been competitive there because of the technology gap to get infrastructure in. Some other things I want to share with you that are going on inside the utilities around growing the core business, adding loads. Anybody who is paying attention over the last couple of years recognizes the dramatic trend toward the greening of businesses of industry of society, and we’re no different. We think gas has been green forever. We believe it’s the greenest fuel you can use and we really love the direct use of natural gas for appliances in our territories and throughout the country, but we think we’ve never really captured the messaging right for that, that natural gas is a real solution to the carbon challenge of America and of the world, but we’re really working on that much harder now, I’m very proud to tell you that last year we formed our working group of other South Eastern LDCs to talk about collaborating, getting better strategies, better marketing programs, better messaging, pooling resources for advertising for example around why natural gas is a green choice, and we led that last year with 5 LDCs including AGL. We had TECO Peoples, Piedmont, we had Alabama Gas, and Mobile Gas. And that five utilities started talking last year has now turned into 22 states. Donna Peeples, our Vice President of Marketing and Sales, is the chairperson of the green team of 22 states with gas companies all at the table, and in some cases combo companies, all talking about how we can collaborate, get our message out, let’s get a methodology for determining how you count carbon, for example, American Gas Association has joined in, Southern Gas, and some other trade associations are participating. This is an area where we are a leader, we’re very proud of that, but it also has to turn into something commercial, and I want to share with you just the first outgrowth of some of that is a landfill project in Metropolitan Atlanta called Live Oak. This is a project being developed for a landfill recovery of methane that we’re going to build a tap station, connect a pipe to that facility, we’ll monitor the gas quality, and we’ll take it into our system. We believe the volume of gas that is there will fuel about 15,000 homes a year for the next 20 years. That’s a source of supply that’s right in our backyard. It’s the use of kind of a green concept to bring new supplies to the market place. We think there are many other opportunities in the landfill as necessary inside our service territory all across our footprint. And so, this is a learning opportunity to add this service to Georgia. We’ll post the volumes on our electronic bulletin board. The marketers can then re-market that gas as a green fuel and we believe it’s the beginning of a real opportunity for us.
In addition to that, we’re going to continue to grow our service territory where we can extend service, where we can convert people from other fuels to natural gas, and that sometimes involves new technologies, things like combined heating power which John mentioned, fuel cell technologies, we’re seeing a lot of activity here, we’ve been working about 14 large projects for combined heat and power across our system, and those are generally large power generation projects. We have about 1500 MW right now on the company’s system for combined heat and power. We think there’s more opportunity for that as well. Fuel cell technologies, European and Asian markets are really moving faster than America is on taking these technologies down to a residential application, but they are moving very fast. We’re studying those opportunities to see how fast we can bring them to the state and add that level of sales opportunity to our utilities.
And finally, there’s something called a desiccant in the new technologies; you’ve all heard the saying, “it’s not the heat, it’s the humidity.” A desiccant system is a natural gas fired dehumidification system for buildings, and it dramatically reduces the amount of electricity required to cool a building. That’s going to grow as a technology. We’re right there with it and we’ll continue to sell it where it fits in the right application. Finally, there are a few other applications we’re working on. We have some area wide agreements for government contracting under our status as a regulated utility. We now are serving the Norfolk Naval Base on a project and Fort Gordon in Georgia, and those are projects where we can improve their efficiency and also make some non-gas revenue, and we’ll continue to work on those.
Now, I want to switch – while we’re working hard to sell like crazy every day, we’re still trying to make sure we’re protecting our margins, and one of the things that has helped us with margins is the fact that we have weather normalization adjustments in three of our jurisdictions. Atlanta’s straight fixed variable doesn’t need a weather mechanism, but our Elizabethtown gas in New Jersey and Virginia Natural in Chattanooga all have mechanisms. Now, they have helped us with margin; they are not truly perfect mechanisms, but I just want to share with you the size of the value of those things; a couple of years ago, we had colder than normal weather, we discounted bills, but the last couple of years have been warmer than normal, so we surcharged bills in those jurisdictions, and while it’s not a perfect fit for the margin expectation we would have in the business, it is a very big help to us to smooth out year-over-year changes in weather and you can see just from those numbers that we have normalized several million dollars in the last couple years. So, with that I want to just let you know that we’ll continue to work on these mechanisms. I think the way regulation is progressing in our state, normalization may not be the fix we’ll have. There may be some other mechanisms as some states are embracing de-coupling and so forth, but we’ll keep you abreast of what’s going on there.
I want to share another stand on the WNA issue and that is if you look at this chart, the first couple of bars share with you what our 30-year and 10-year normal expectations would be in a normal year. Because WNAs are not perfect, what happens when it’s warmer than normal, consumption patterns change a lot with consumers. If it’s warm during the day but cold at night, that latent heat preserves inside a building and they don’t need as much heat at nighttime even though we get heating degree-days, the consumption just doesn’t show up because of the way the calculations are done, and so our trackers that calculate weather normalization don’t accommodate the fact that people may use less per degree-day, and I believe that if you just put 2006 weather on our normal assumptions – and that’s what the third bar is, the 2006 assumptions – we feel like for New Jersey we would probably be about $5.7 million short if we had a 2006 winter this year versus what we would normally expect, and in Virginia about $4.7 million. It’s just not a perfect mechanism. We really are thankful we have them because they still make up a lot of the gap but they are not perfect by any means.
Well, while we’re protecting margins and selling gas like crazy, we’re also making sure that we’re keeping our cost under control, and many of you are aware of some business process improvement initiatives we’ve done over the last few years. I’m going to chat about those for just a few minutes. We’ve been on fairly long journey on outsourcing. Many many years ago at Atlanta Gas Light, we outsourced almost all of our pipeline construction work. We used contractors for that. There are other things we’ve done in operations to outsource work where it’s more efficient to use contracting. We’ve taken those to our new acquisitions over the years, and taken advantage of those benefits, but more recently over the last couple of years, 2-1/2 years ago, we started outsourcing some of our IT support, our application support, and our project support have both been outsourced, in fact off-shored to primarily India for the last 2-1/2 years, and the value of that has been substantial for us. We see great quality access to labor and a reduction in cost. Those are more traditional uses of off-shoring, but you may be aware about a little over a year ago we did something I’d call fairly non-traditional for a gas utility and that is we moved a large percentage of our call center operations to off-shore – to India – and we had fairly rigorous training effort to get that effort going, it has resulted in a substantial increase in the speed of how we answer our phones, we save a lot of money, and I’m pleased to tell you we’ve taken over 1.3 million calls in the last year in India. We saw complaints drive up pretty early on for the first few months last year. We were converting systems, we were moving our calls to India, we were creating some angst for customers and we saw pretty big spike in customer complaints, but I’m very pleased that our complaints for the last few months are at near historic level lows. We’ve seen customers generally satisfied with the level of service they’re getting in the field from our company on the phones and online, and in fact, we will continue to work on that and make sure that we’re delivering good quality service, but I do want to share since we started the off-shoring initiative a few years ago, our realized savings today is $12 million and our run rate savings now is at about $6.5 million a year for doing off-shoring. So, this has been, while a challenge to make it happen, has been a dramatic success and a cost containment for us.
While I’m talking about systems, let me just share with you some real progress we’ve made also in the utilities over the last few years. This is a diagram of our systems in 2005. It’s primarily our operating systems. You can see the names of the systems on the chart, but what this chart shows you is by utility, we had a pretty wide discrete set of systems as we acquired utilities we just inherited old systems and kept them running, but we decided after the NUI acquisition – and this is the chart that’s just right after that – that it would really be good for us to get as many things on common platform as possible and that we would realize a lot of benefits from that, and so we took an aggressive plan to integrate our despaired systems over the last few years and the next chart shows you where we are on the progress for that. This shows that almost all of our major systems now are on common platform and utilities are all using the same set of tools and they are using the technology consistently across utilities.
We still have some work to do. There are still some things we need to integrate, but this is a real success story. Our CIO, Kristin Kirkconnell, and her teams of IT folks and business people inside the business are working very hard to make this happen. You get great value out of having common platform. The one system that you won’t see on here is the CIS, that’s our customer information system, and you all follow the utilities businesses, you know that a CIS is a pretty tough system to deal with. We still know that at some point we’ve got to modernize our CIS. Some companies who have undertaken that initiative have found it to be very daunting, very expensive. We really think as we’re developing our planning and we’re working on it right now, we have the makings of a pretty good transition to a new CIS that will be smooth and hopefully very cost competitive, but I’m very proud of the track record so far on these other systems and it just shows that we have I think the potential to continue to integrate other utilities because we can build a common platform.
Now, I’m going to one of the indicators of how well your business is doing is how safely you’re operating it. We’ve spent, thanks to John’s leadership and the senior leadership of the company, we really put a lot of focus on safety overall in our business; that is, customer and public safety, employee safety, vehicle safety, and I’m very thankful that we’ve had dramatic turnaround, for example, this is our on-the-job injuries, and it shows that we’ve cut it more than half in the last few years. We also are in the top quartile now on OJI’s and an AGA peer group of companies and we think we may be in the top 2 or 3 gap companies in America around this one metric. The reason I show you this slide as not only so that you’ll be appreciative, we try to work safely every day, but also that this is something if you focus on appropriately, there’s a lot of benefit, so you have reduced liability, you have increased reputation value, you have employees who are at work, you have fewer claims, and you’re also more productive, so you get some gain out of that as well. We’re very pleased with the results we’ve seen in our on the job injuries. We studied it very closely, for example, we know that in the workday, we have 20% of our on the job injuries between the hours of 10 and 11 in the morning, so we’re trying to figure out why is that, we know it’s a lot of types of things, but about 45% of our injuries are back strain; so we’re studying all these things very carefully to make sure that our folks work safely and that we continue to improve on this metric and operate our business better.
Well, John mentioned the regulatory challenges and time lines of the company. We do have major rate cases in our biggest jurisdictions over the next few years. I mentioned we’re settling one right now with Elkton Gas, the smallest rate case, but this timeline shows that in the next 3 years we’ll complete rate cases at Elizabethtown, Atlanta Gas, Virginia Natural, and Chattanooga, and the cycle begins this year with Elizabethtown. We’re now as of yesterday officially in a test year for Elizabethtown’s rate case. April 1 was the beginning of the test year for the Elizabethtown gas rate case. We expect to file that case March of ’09, and rates will be effective January of 2010. Atlanta Gas Light is next in line with an expected filing date of November 2009, and that would result in a test year beginning December of that same year and rates effective May 2010. Virginia Natural is next, and we would file that rate case in February 2010 with the test year beginning August 2010 and new rates effective, we believe, August 2011, and finally Chattanooga we are filing May 2010 and future test year would begin January 2011 for rates effective January 2011. So you can see our regulatory staff will be very busy over the next few years. I believe there are many things to distinguish our company, but I think regulatory intensity, regulatory focus, and regulatory success is one that really is one of the things that AGL is distinctive with.
I want to share with you where we are on our authorized returns and what we’re achieving at the moment, and you can see these, I won’t read them all, but you can see in some jurisdictions we have a little bit of headroom to achieve better results, in other we’re just at dancing around the authorized returns. With those cases pending, we believe many of them will be just restatements of just existing rates, maybe a little increase, maybe a little better than a little increase depending on the jurisdiction, but we believe we have good case to file in ever jurisdiction, and we will work that one very hard to get the right outcomes. In some cases, we may want a little bit different structure of rates. For example, it could be valuable to us and our customers, and we will work with each commission and each jurisdiction to get the best outcome we can for the company, for the customer, and for the regulators too.
I do want to share with you some of the regulatory successes we’ve had. I mentioned all the rate cases, but if you just take a quick hindsight view, we’ve had quite a few things that happened, and John mentioned some of them. Getting our capacity supply plan approved in Georgia for example was a really big achievement because it requires a lot of people to agree. We have many deregulated marketers in Georgia. Getting the right lead on what the amount of capacity we’ll need over the next few years is a big deal, but that supply plan I think was a raving success for our customers, for the company, for the marketers to have the right set of assets for supplying Georgia. It’s our biggest market, and one of the things that came out of that thankfully is a new source of supply. We are working with Southern Natural Gas on the Elba to Atlanta project which John mentioned. It’s an investment pipeline of $47 million that we are waiting for further approval to move forward on, but it would be the first time we’ve gotten LNG from Elba into the metropolitan Atlanta market. It’s a great additional source of supply with competitive pricing, increasing reliability and so forth, but as well as that, we’ve also had asset management extensions granted in Georgia for 2012, New Jersey and Tennessee just granted extensions of Sequent’s Asset Management Services for the utilities. We know that in Virginia, we got approval of a commercial weather normalization adjustment. We didn’t have commercial until last year; now we do, and John mentioned this, with the approval of acquisition premium treatment in Florida for the premium we paid for the Florida assets by the Florida Commission. It was a real big achievement that was the result of Florida recognizing that it’s a good thing to have good companies like AGL come and invest in the state of Florida, and run the company really well.
In addition to that, we’ve had some legislative successes throughout. The funny thing about legislation is most of the time if nothing bad happens, that’s a homerun when legislatures meet, and pretty much in most of our territories, in fact in all of them, we really had no adverse outcomes legislatively, and some are still in session, but so far we’ve done really well. We had two really good ones that were visionary for the Commonwealth of Virginia, and the first one is that they approved a decoupling plant in Virginia, and in fact decoupling in Virginia got the support of the environmental community as well as regulators and legislators, and I believe we have an option to enter into decoupling at some future date in Virginia with our B&G assets. The next one allows for major projects in Virginia for infrastructure and natural gas, accounting treatment for funds used during construction, and we think that is very important for us for the investment we are making in the Hampton Roads Pipeline in Virginia.
Let me share with you a little bit about capital deployment. This is more than we normally share in our 10-K, but it's a breakdown of our capital plan year by year. The legend is small. I hope you can see it on your handout, but it shows where we'll spend the money, and just to give you some insight to that, for example, some of the discretionary spend are things like technology, fleet, and our buildings. They are only discretionary in the sense that we can do them this year or maybe next. We can't really delay some of those things, but most of other things you see on our capital spending plan are things that we really have to do just to run our business. Pipeline replacement program in Georgia. We have one similar in New Jersey. Our Hampton Roads project is the blue box there, and you can see for 2 years we will spend quite a bit of capital there. Magnolia comes in 2010, and the other spending is typical--our manufacturing gas plants, our new business, and so forth, but you can see the breakdown. So we kind of peak on the capital side in 2009 as we finish up Hampton Roads and continue some of the other work that we're doing, and you can see that ultimately the requirements of capital drop off a little bit over the next two years beyond 2010.
Finally, I'll talk just a little bit more about the two project that we talked a little bit already, and that is the Hampton Roads Crossing. This is a huge project for Virginia. In fact, in the Virginia Energy Plan, the Governor considers this the #1 gas infrastructure project in the state, and the state has been very supportive of this. For the first time, we will tie two separate distinct parts of our system together, and it brings us new sources reliable inexpensive supply from the dominion system that allows us to increase our volumes, not only for ourselves, but I am really pleased to tell you that and John mentioned this, we have presently agreements now signed from Columbia Gas of Virginia, VNG, and Dominion Virginia Power for power gen that they are going to do, and since we plan to have the project completed by the end of 2009/first of 2010, those will actually generate positive EBIT we believe in 2010 in advance of when we have a rate case, so I think we have some upside in the Virginia franchise for EBIT that is unassociated with the rest of the business, and just as one of those things when you start doing things, opportunities grow, and the expansion of this service brought in two anchor tenants to this business, and we're very thankful for that. We got our permit from the state. We are waiting for our permit from the Army Corps of Engineers for that project.
The other one was Magnolia, which brings the Elba gas from the coast up to the metropolitan Atlanta area. It's about $47-million investment. Also has very good EBIT uptick for Atlanta Gas Light or AGL Resources, and that project will be online in 2010. Very exciting project for us. I've just shown you a little over $150 million worth of utility investment that is a little bit non-traditional for us with these types, but it's a different character of service and has real time uptick in EBIT outside of generate rate cases, so a very good opportunity for those.
The last slide is one of my talking point slides. One of the things I've tried to do with our utilities is really reframe our core business, and that is if we can do so many things right in that core business, everything else inside AGL Resources seems to work really well. My vision is that we really try to become the creators of our own destiny in utilities. That involves brand quality. It involves relationships in the community with our customers and the public. It requires dialogue and positive working relationships with regulators, and it requires our company to be involved in the right initiatives, the right organizations, the right messaging. I really want our company to be a very strong advocate for its own needs but also for the needs of our industry, and in my experiences as I ran the Virginia and New Jersey operations, we found this to be a very doable model, and we executed on it. And I would tell you today I think those franchises are in great shape just as the others are but I really want to spread this across our footprint. Ultimately, our employees have to be real believers in our product. We want to make every employee an ambassador for natural gas, they need to be involved in their communities and well known. We want to take publics positions that are recognized and appreciated be a thought-leader in the industry. So, we leave the legacy of a very vibrant company for many years to come. We are a 150-year-old business and wish we’d like to be here for another 150. We appreciate your paying attention to our business and we’ll have time for questions after this but thank you for your attention.
Now I’ll ask Mike Braswell to come up here and talk to us about his operation. Mike?
Michael A. Braswell
Thank you, Hank. Just to start out on what Hank said, he was the new-old guy. So I guess that makes me the old, old guy. I’ve been at SouthStar for almost 10 years now and if you go back to my utility experience I’ve been here almost 20 years. So, I’m an old guy, I’ve been here for a long time, lot of history with the company and a good foundation of how SouthStar as a deregulated company, also in respect with the utility which is a regulated industry and as you know, we also have some pieces of our business that look a little bit like Sequent from the standpoint of assets that come with our customers. So, we feel we have a good footprint in terms of understanding all the facets of our business, all the way from the customers to assets.
Now in terms of who we are and a little bit of background, and I think most of you know who SouthStar is but I’ll cover it very quickly. It’s a partnership between AGL and Piedmont and right now it’s an ownership structure of about 70% owned by AGL and about 30% by Piedmont. We’re one of the largest deregulated retail natural gas companies in America and we feel very good about that and positioned for growth. In terms of customer count, it’s about 530,000 customers in Georgia but we also have some supplier relationships in Ohio and Florida. In Ohio, we have some customer equivalents there, of about 30,000 customers that we provide supply to in Ohio. And then behind Florida, we have about 7000 customer equivalents there. So, again, we have a good base of customers in Georgia as well as the supply arrangement at Ohio as well as in Florida. In terms of large C&I customers, about 300 throughout the Southeast and we’re continuing to look to constantly grow that base as well and leverage our assets.
Again on the asset side, whenever we get a retail customer in Georgia as well as the supply trench in Ohio, we get assets with those customers and with supply arrangements. So, we’re constantly managing those assets similar to way Sequent does and what we go out there and do to capture spreads from a storage standpoint as well as leverage long-haul capacity that we have. So, in terms of our business you can that say there is the retail aspect to our business, that looks a lot like the utility and we have a commercial aspect for our business that looks a little bit like Sequent.
Now in terms of the employes that support that, we have about 85 full time FTE equivalent employees at our corporate office and we also have over 200 employees with our BPO provider which is currently 80th. So, if you look at the business overall, we have about 300 FTEs that support our business and manage our assets, customers and all of those things.
Now in terms of earnings and key drivers. If you look at the earnings from 2001, you can see significant growth from 2001 to about 2005 and then from 2005 to 2007 you see a good core of earnings of about $90 million and then in 2007 what you saw was a significant increase and that was primarily due to a lot of commercial drivers. Very favorable market conditions that allowed us to capture spreads and storage, to maintain our price effectuation and release capacity to the market and again make very favorable contributions kind of above those core earnings of 90. As we’re going into 2008, what we’ve seen is some reduction initially and what we’re seeing in terms of commercial drives. So that has moved that back to I would say little more the core of 90 with some upside from some of our commercial drivers and again, what we understand now is what was accomplished through the first quarter on storage, again fourth quarter has not occurred yet so again, we’re looking for some upside from storage potentially as well as from Ohio and Florida as we go into those markets. But again, the key drivers there we feel very good about, customer count and market share in Georgia, that’s been stable over the past few years, we feel very good about that. The portfolio mix of customers, we’ve been very good at managing our customer portfolio to profitability. We feel we understand who the high value customers are and acquire those and manage those customers.
On the commercial side, we’ve been very good at 2 things that they do. They manage risk as well as capture value out in the market. So, in terms of the risk management aspect, you will see price effectuation and weather throughput risk. The utilities, well I can’t talk about have W&A. We use weather derivatives to manage our weather risk, and we think we’ve done a very good job of flattening out that weather exposure and making sure year over year we get much more consistent earnings as opposed to having a lot of throughout risk solely due to weather. So, we’ve managed that exposure very well. Price effectuation is somewhat of a unique risk in our retail market in Georgia. We understand that risk well, we actively manage it and we feel overtime we have the ability to minimize that exposure and compare to potentially other marketers.
In terms of the commercial capture side, again storage and long haul capacity, actively manage that and actively try to get all the value we can out of those assets.
In terms of other contributions, what we’re looking at for the future is to grow in other markets, Ohio is probably the best market we have out there. Florida is a good market, a little more, I would say a million, maybe the 2 million kind of contribution overtime. Ohio, we view as a more sizable contribution. We spend a lot of time there trying to develop that market. We actually have a new executive at SouthStar, Robert Kambi and we brought him in for a lot of market development-type activity and he has done a great job working in Ohio and getting that model to where we like it and where it fits our business model and again we think good growth opportunities there. So, if you look to the future and you are thinking about growth, we’re looking at -- again, if you look at the past 3 years, a good quarter of about $90 million and looking for maybe 4 to 6% in the future and we view a lot of our opportunities in terms of other states Ohio, Florida that are enabling us to do that.
Interest income expense, because we reflect out earnings in terms of EDP, that does impact us year over year, that’s managed through the AGL resources cash pool. In terms of capital and operating expenses, the primary expenses there and we will talk about them a little later, primary expenses are bad debt and pay role as well as customer care, what we call BPO meter to cash. And so, customer care and billings are our largest expense and we certainly focus on that, control that cost and we actually signed an agreement with a new BPO provider and we are transitioning to that provider this year and we are looking for reduced expenses for the future there.
Now in terms of ’07 keep accomplishments, again I talked a little bit about ’07 being a record year. Again, we have about 90 million of core earnings over the past 3 years, but in ’07 we had some additional upside due to some commercial drivers as well as customer acquisition we had from Commerce Energy and again that provided a lot of upside for our business.
One of the key things for the future in terms of managing cost, maintaining it, and improving it, as our 10 year agreement with Vertex North America, and again we are transitioning from Alliance Data Services to Vertex this year. Don’t expect to see any savings this year and we expect to see the savings again to materialize in 2009. Also like Kevin mentioned, one of our key successes was the supply agreement, the capacity supply plan this year that we worked for the Atlanta Gas Light Company arm as well as the other marketers, very successful. I think it was “the” most successful capacity supply plan to date. We have a great array of assets from the low to the customers as well as assets signed to marketers, again that we leverage and create value from as well as supply diversification. So, we thought it was an excellent capacity supply plan. I thought the entire market worked very, very well together from all the marketers to Atlanta Gas Light Company to the regulators as well. Again, it was a great model of success of how everybody can work collaboratively and it’s truly a win, win, win for everybody. We are very happy with that outcome.
Now in terms of growth states, we had talked about Ohio and Florida. In Ohio, what we’ve worked on this year is primarily to create a model of success for the future. We actually won a tranche in Ohio in 2006 and that’s been very successful for us. We were awarded one tranche of business, about 5 BCF of throughput a year and last year in 2007 made about $3 million of margin off of that business. So, again very successful and what we’re trying to do is take that model for the next step and create very robust retail competition.
We wanted to get in as a supplier, understand that market, understand the assets and begin to advocate for a model moving ahead, I feel pretty good about that. Veteran is another utility in Ohio, we’ve worked with them as well. Our goal with the Veteran is to have the same model as BEO and once you put those two utilities together, those utilities are about the size of Atlanta Gas Light Company. So, what we’re hoping for in Ohio over the next couple of years to have an opportunity from a customer count standpoint, is about the same size of Atlanta Gas Light in Georgia and then in the future, Columbia in 2010 which on their own is about the same size of Atlanta Gas Light Company, owns around 1.5 million customers. That could be another opportunity going up for 2010 out of additional supply arrangements and then getting in for their retail market as well. So, again Ohio we view there is some short-term, medium term opportunities as well as longer term as we continue to get in that market and advocate for a robust retail market.
Florida. Florida is again a little more of a niche, but it’s good opportunity for us behind TECO. It’s the partnership opportunity where we partner with TECO. They provide us C&I customers and we provide natural gas for them. That’s worked out very well, profitable near one, just went into Florida in 2007, already profitable and again expanding that business as well as we’re behind Chesapeake and Central Florida and thus far the arrangement there were again similar to BEO providing a supplier arrangement service for about 7000 customer equivalent. So, we feel very good about our accomplishments in ‘07 in terms of growing new markets.
Now in terms of what are the keys to success in a retail energy business? First, you have to have successful brands. People have to know who you are, it’s a brand they can trust and they feel about. So, what we do is, we don’t believe in one brand for all states across which we serve. We believe in having more of a local brand. So, if you look at how we’re set up from a branding standpoint, Georgia Natural Gas in Georgia, Piedmont Energy in Carolinas, Florida Natural Gas in Florida, Ohio Natural Gas in Ohio. So, wherever we do business we want a local sounding brand that we can leverage. We don’t believe in again leveraging our corporate name SouthStar and trying to leverage that for all the states we go to. Again, very important to have a local brand and build our brand over time. Also, very important in managing retail portfolio. We’ve certainly learnt over time not all retail customers are the same and it’s very important to acquire the right customers with the right plan and manage that portfolio effectively. You got to understand the risk you have as you are adding new customers and the value those customers provide to you. So, again very important in terms of managing that portfolio and we’ve already learnt a lot in the Georgia markets as a result of that.
In terms of assets, again, a lot of markets we’re going to, the market we like, the model we like or assets that go with customers when you acquire them. So, it’s very important to understand asset management, how you create value from assets, how you manage certainly your customer loves it, but certainly how you create incremental value. It’s been a key part of our business in Georgia in being successful. Also risking the business, anytime you acquire a retail customers, there are risks that are inherent managing those customers. We believe our commercial group at SouthStar is headed up Michael Nieman and he has done a great job of understanding the intersect between retail customers’ commercial assets and those risks in how you manage those. So, he has done a fantastic job there and again a key component of how we’ve been successful.
Now in terms of regulatory and legislative. On that, not only in Georgia, you have maintain the model you have, but again in terms of going to other states, you’ve got to be able to advocate for the right model on how we can be successful in terms of our business. Again, we think we’ve done a good job in Georgia, managing and creating a model that makes sense for both marketers as well as customers, as well as the utility, but also trying to grow that into other states.
Now in terms of ‘08 objectives, not too different from our ‘07 objectives though in terms of how we’re moving ahead, no big strategy changes for SouthStar. Again, focused on our core business, core businesses in Georgia, make sure again that that the business is profitable as well as position you for capturing any kind of growth in that market, maintain our leadership position. Number two, on the commercial side again, managing risks, managing assets doing that in a very disciplined manner and creating value there, enhancing corporate image. Hank talked about that in this presentation. It’s very important for our business as well. Whenever you’re dealing with retail customers, it’s important to have the right image, the right brand. Also, in terms of cost in the business, you need to make sure you have a focus on the operations of business cost control, a key there in terms of what we’ve signed a 10-year agreement with Vertex that over a 10-year period should provide us about $31 million of savings. So, a significant transition there.
Also, growing in new states, I talked a lot of about Florida and Ohio. Those are not the only markets we’re looking at, we’re certainly looking at other markets. New York, New Jersey, Michigan, Pennsylvania but for right now we think our efforts were best been on focusing on Ohio primarily and that’s our key opportunity and then again as we grow and get larger in those states, begin to potentially grow in those other states as well.
Now in terms of customer count market share, I talked about this a lot in terms of the other piece of the presentation. So I won’t spend a lot of time on it. But hopefully what you can see is that 2004 very stable market share, prior to 2004 while the market share was higher. That was before I would say, we really began to aggressively start credit checking customers, high-grading our customer portfolio. So, really the difference there wasn’t we lost market share, but we were much more disciplined in terms of how we went out marketed to customers as well as when they called to our call center, which customers we expect that they are serviced. So, that’s really the movement there if you want to say from kind of the ‘01 to ‘03 timeframe, going to ‘04, and then fairly stable after that point. Market share, it’s been around 35% as well. I feel good about that again. Our primary goal isn’t just to grow market share. It’s to create profitable customers and a different portfolio of customers.
Now in terms of customer care and bad debt, Smith comment on that as well. Again the key for 2008 and beyond in customer care is the new Vertek North America relationship. Again, we believe over the 10-year period approximately 39 in savings is very significant. Bad debt, we’ve been very proactive in terms of managing our processes there. As you can see, we’ve been able to manage bad debt very, very well over the past 3, 4 years and we continue to do that for the future, but it requires discipline on an ongoing nature.
Commercial operations in terms of how we create value. You can see in the top quadrant on the left side that storage contributions have been significant. You can in ‘06 and ‘07 $30 million plus from those types of opportunities, so again, a significant driver of SouthStar’s earning. Pipeline capacity utilization, we actually see that moving up. The chart we show here shows how we leverage capacity from, releasing it to the secondary market, as well as leveraging it to our large C&I industrial customers. So, again it appears for ‘08 this is an opportunity to create some extra value. We see capacity value is increasing and we believe we are positioned well to take advantage of that.
In terms of price effectuation and storage from a risk management standpoint, that’s a part of our business where we have offsetting exposures, price effectuations and natural short, storage is a natural long. So, what we’re showing here is just even though there are a lot of different facts to look in the business, some are actually natural hedges that are offsets on our business. So, what we constantly have to evaluate is, when we want to use those different risks because of offsets in our business, when do we want to bifurcate those risk and manage independently and I’ll talk about that a little bit later.
On trade liquidity, we think we’ve done a very, very good job of creating trade liquidity in our business to what we’re able do is go out and buy gas, pay for that in the future, as well as have the ability to trade financial instruments and have some trade credit there as well. So, again that helps on a cash flow side of the business.
Now in terms of hedging philosophy, again, what we try to do is understand all the risk in our business independently and understand those well. After that, we try to understand with all those risk independently, which are those risks are natural offsets our business, natural hedges and when does it make sense to keep some of the natural hedge by price effectuation and storage and when does it makes sense to bifurcate or management them independently. And that’s something we do on our business day to day. It’s an important part of our business. Again the risk management, asset management, it’s a big key to how we run our business and how we create the value that we do.
Keys to continue growth. What do we want to do for the future? Obviously, maintain our operational focus. That’s been one of our keys and our core to success. Don’t want to move off that, stay focused on that and Hank spent a little time on the platform side of his business, that’s the key to our business as well. So, what we’re looking to do is invest in systems that allow us to run our business better, provide better service to customer and manage our risk. So, certainly what we’ve done is in terms of managing cost again sign a 10-year BPO, we’ve put an ETRM system, Allegro, into SouthStar a couple of years ago. That’s helps to manage the commercial side of our business. And we’ve also signed up a new provider to help us in other gross states. So again, keys to our success in terms of moving forward, maintaining that operational focus, maintaining the discipline of our business, as well as having the right systems and platforms to leverage as we move forward.
Growth areas under development. If you look at the existing markets, certainly we want to stay focused on our retail market in Georgia. There we want to continue to acquire high-value customers. Again, it’s not just to game of market share and having as many customers as you can, it’s about having the right portfolio of customers that allow you to run your business and not create a lot of risk. Again, if you just acquired just as many customers you could, a lot of those could be bad debt risk customers that drive your bad debt out significantly and that would not be positive for the business. So, again we’re focused on the right customers and high value customers.
New products and services. We have launched one new product and we’re moving into that business to understand how do we leverage our retail portfolio. What we’ve launched so far is an insurance-type product for gas lines, water lines, things of that nature and again we’ve seen some success on that this year. We continue to expect that business continue to grow. We expect the contribution in that business of about 1 million by 2009 on all products and services. So, again, trying to leverage that retail base we have as well. Large C&I, those are the customers what we try to do is leverage our long haul capacity that we get as we acquire retail customers. So again, as we go our retail base and we have assets to serve those customers, certainly what we want to do is leverage any excess capacity we have there. And what we always trying to do is right size, what does it make sense to leverage that capacity with C&I customers and what does it make sense to leverage that in a secondary market. And then that moves around from year-to-year, but we try to always right size the C&I market for a long-haul capacity as well as the secondary market.
Also we’re going to acquire incremental assets and how we want to do that, is target small monies and kind of asset management type arrangements. So, we’ve looked to doing that. We’ve had success, we have one in Alabama currently and that’s been a great successful. We’ve learned a lot about managing that asset and how to leverage those. So, again that’s been a key of trying to grow our retail business as well as growing our existing footprint primarily in the South East.
Now in terms of expanded growth. We’ve spent a lot of time on Florida and Ohio. No need to go into those in a lot more detail, but again Ohio has the greatest potential for us in the future. We continue to stay focused on that making sure that model develops. Large C&I again, always looking that we acquire assets, always looking to leverage those in whatever states we go into. So, as we get more and more long haul capacity in Ohio as an example, where we’re certainly looking to leverage that C&I base in Ohio as well.
Now in terms of conclusions for SouthStar. Certainly, we had a strong retail organization and what we focus on is again capitalizing on not just the retail portfolio, but also the commercial and the asset piece of the business. So, we think we have very strong organization around both retail and commercial side of the business. We also have well-defined government and risk management and that’s critical in this business in terms of having discipline leadership, managing the risk, and having the right government. We certainly want to always focus on the levers that produce financial results. So, what I want to make sure to all those prioritize what we’re doing, and where we’re, our marketplace, put our resources on the right opportunities. And, we also want to make sure we have the ability to leverage the resources we have today, but people and infrastructure for growing in each state. And again, we believe we’re well-positioned for growth. We’ve got a lot of great success in Georgia, in the South East and we’re looking to expand that into Florida, Ohio, and other states as well.
That’s all I have for the day. Any questions or if we want to save those to end.
Yeah. Mike I think we have -- just we’re running ahead of schedule here. So, we got a couple of minutes. If anybody has any questions for Mike or even for Hank, we got time for a couple of questions.
I have a couple. The first one is, I was just little confused in Ohio, on Veteran Energy, you are the Supply Manager currently, right, so if they eliminate the merchant function and it goes competitive, then you are sort of finding out with the other for each of your shares. So, I’m trying to figure out like was that contract due to expire soon, so if it goes that way. We’re trying to get a sense of the…?
Michael A. Braswell
Well, let me make you understand how that’s going to evolve in the future. Right now, it’s called an SSO and we won a tranche there in 2006 that expires late this summer. There is a new filing for a second SSO that will continue over the winter, so we would start that program in late summer/early fall, that will run through the winter of ‘08, ‘09. After that, they will actually want to a set up with a call on FTP. And so, it’s more of a supply customer type of arrangement. Right now, under the SSO program, we’re purely a supplier. So, when a customer receives their bill, all they see is an example behind DBO, I mean in Ohio.
In the future, as we move to the SCO, you’ll have your name on that bill, this gas is supplied by in this case Ohio Natural Gas. So, what it set up to do is, initially start up a supply arrangement where all customers who not chosen another marketer and they are in a retail choice government. DEO exiting the merchant function, they had a supplier to manage all that supply. So, that’s what we’re doing currently. And, then when it moves into a SCO and that process would be ongoing indefinitely. So, every year they would have an SCO auction like we do currently for the SSO. And so, our goal would be is not only to be an SCO provider and be a supplier there, and start building the relationship with customers through that, but also aggressively going on the retail choice side as well. We are serving some retail customers in Ohio currently. But it’s a fairly small amount, we have a handful. But the goal is to grow on the retail choice side of the business as well as being SSO, SCO provider in the future. And as you are an SCO provider, build relationship with that customer but the bill is going out having your name on there and growing your retail choice business as well.
Okay. So, it’s sort of bifurcated strategy?
Michael A. Braswell
All right. And then in previous years’ presentation there was a lot of talk about late fees and how that contributes to the result and then how do you sort of balance that with manage the bad debt expense in this environment, how do you reconcile -- manage within that?
Michael A. Braswell
What we do is, we go through a customer value model that accesses the risk of, you want to non-payment. In terms of late fees, if the customer is so risky to where they are not paying their bill, it doesn’t really matter. So, what we focus on late fees obviously that you can collect. And the late fees that we collect obliviously what we try to look for is what if the customer that achieves the right balance of, I would say, credit risk as well as the ability to pay their bills. And so, late fees are certainly still a part of our business and I know from ‘06 to ‘07 we actually saw slight uptick in our late fees. I believe it was about $2 million year-over-year. So, again late fees is still an important part of our business. We are still focus on that. But again you are right, you have to have that backdrop of what’s the risk of a customer not paying their bill at all. At that point, at that matter can charge a late fee or not, you don’t get anything for. But it is a balancing act between those two.
Okay. So, I was just tying to figure out which environment is the best. You don’t say you are getting more late fees than you are expected, but not as much fed.. you know what I’m saying?
Michael A. Braswell
It’s a balance, there is no doubt. There is not one right answer in terms of just moving all the way over to one side and I will say being a little more extreme and taking a lot of credit risk and having more late fees or tightening the credit so tight to where if you want to say, it may even impact your market share in late fees. So, it’s a balance of how do you get the right portfolio of customers around credit risk and value.
Okay. And then lastly, for two more years, I believe, there is the option as far as whether or not to buyout your partner, I guess that came up, you thought about it and chose not to – how does the thinking work during the particular process and so what is likely to be each time?
Michael A. Braswell
I’m at SouthStar so I’ll let you, I am indifferent to how that plays out. For a question like that, I’ll turn it over to either John…
Mike, he is in an odd position there. That is an important issue for us. The good news from our standpoint we have a great partner. Piedmont is a good partner. And their incentives are aligned with ours. So, what we’re looking at is there a time -- and the good news about the options we have and the rights we have is they continue on, not only it was a third to third to third, not only for that time period, but even past that time period. So, we still are evaluating that. We did not think that this year was the right time to do it, where you basically could only buy a-third and we will come out of the year where we knew commercial opportunity was very high, we thought that was the wrong time. But that is something we’re seriously looking at moving forward and I can’t tell you today what the likely outcome is. But that something that has value. We would like to own more than 70% of that business, but on the counter side we’ve got a good partner to either way we think we’ll be successful. That’s something we’ll be talking to Piedmont about over the next several years.
There is time for maybe one more question.
In Ohio, can you just address a little bit how you expect to compete with the incumbent or also most of them going after the retail choice customers with affiliate retail businesses?
Michael A. Braswell
Sure. One of the things we’ve noticed behind DEO, one of them was a successful marketers IGS is not affiliated with utility. So, what we’ve seen behind DEO specifically as the incumbent is not necessarily the most dominant player. So, we’ve seen non-affiliated entities be very successful in Ohio in terms of how their model is currently and it’s rolling out. I think there are a lot of opportunities for a nonaffiliated marketer to enter that market and do very, very well. So, again it’s not a market that’s dominated by the affiliates and then everyone else has a small percent of the market share. So, it appears to be a robust retail model and we think with out success and background we can be very successful there.
Okay. I think with that we’ll take about 10-minute break or so and just plan to be back in here around 10:15 and we’ll pick up with the webcast at that time.
RECESS – 15 MINUTES
Douglas N. Schantz
Hi, let’s go get back on the schedule here please. I am Douglas Schantz, I am President of Sequent Energy which is based out of Houston, Texas. I represent the wholesale part of the organization. It is good to see many familiar faces in the audience. And of course, as we talked about before, every year is a New Year. I mean that’s kind of the best thing about the gas business is there is always new and exciting things to talk about there. So, with that, what I’m going to do is 2 things. Kind of go through 2007, then talk about what we did and how the industry looked in 2007 but then after that talk give you some insights into 2008. You know, that’s not of -- when we talk about 2007, John mentioned this for before, it was kind of a return to normal season in the physical wholesale marketing business. Clearly, there is a lot of excitement and a lot changes after the hurricanes and the way 2005 carried on to 2006. As you see, 2007 returned to normalcy and clearly everything else in the business kind of returned to that to the basic level. In 2007 we saw a decent summer but very mild winter and of course there weren’t any tropical disturbances in the Gulf of Mexico or any place else to kind of work around.
So the result, and we’ll show this in a slide in just a second, we’ve kind of returned to our, what I call, our trend in baseline earnings which we’ve established since 2001 which was our inception. John also mentioned in 2007, clearly we’re seeing some enhanced competition mostly from investment banks that kind of came into our space that gave us some heartburn in second quarter of 2007 when we had some turnover but since then turnover, it has been very low and very consistent. So, I think we’re kind of sowing back into the competitive arena and clearly -- hopefully we’re going to see what we saw second quarter of last year.
As many of you know, when you look at the NYMEX futures contract, it’s been very volatile, of course it’s been driven largely by investment hedge funds, they’ve been dominating the activity in terms of that space and that’s obviously what was key part of 2007 in the price movements.
The last 2 items I want to mention as an overview, highlights of 2007. LNG imports were way up. We set records levels for imports in April and May of last year, and also power generation demand was up for two reasons. One is obviously that the summer was warm, and secondly the load factor of all existing units that we deal with and that we saw around the industry, are the capacity utilization is up.
This slide talks about the changing business environment. Clearly, one of the lead indicators, not the only indicator, but the lead indicator is kind of a simple storage single cycle spreads for summer injection, and you see we peaked in ’06 and where we see spread, last year where we see spreads today in terms of just the single cycle storage and there are more typical reservoir storage economics that are pretty consistent with pre-Katrina and hurricane levels. As a result, you can see on the right-hand side, the economic generation that we follow very closely Sequent of course has retuned to a more normal period and unfortunately or very fortunately, that trended us upwards and we’ll talk about that in a second.
This is the trend based on earnings that I’ve talked about. If you look Sequent’s earnings since its inception in 2001, that’s the bar in green line, top line is operating margin. You see it’s increased over time but if you kind of take out the late ‘05 and ‘06 period where we had tremendous volatility related to the hurricanes, we’ve been on a very steady course of earnings growth in the 10 to 20% area. And clearly, we put on the 2007 results which is about $34 million of EBIT and our current budget for 2008 of $40 million. And John expects growth out of our organization of 10 to 15 % and you see we’ve done that consistently pretty much over the time period and we plan to do that over the future and I see nothing in the way of stopping us from achieving that objective.
We talked about the changes in the business last year from ‘06 to ’07, next I would like to talk about the things that haven’t changed for Sequent. First is our business model. Our business model continues to be the same. We are a low risk fiscal arbitrager with the core capability of managing contractual assets, transport and storage, very customer focused, very Eastern focused and clearly that will remain the same.
Second, we’ll talk about growth and clearly growth is important part of our business. Obviously, if you look at what we’re doing, we’re attracting, retaining our key customers, our deal flow in terms of adding new deals, new customers, new assets is increasing and of course we’ve been expanding geographically across United States and growing into new market segments, and that’s in power generators and also retail, what we call commercial industrial markets. In our business model, our credit metrics remain strong. That’s not going to change. And clearly it’s very high and we will show a chart on that in a second. And the last but not least, and clearly the less important part of the slide, is we have a very stable, very good group of talented employees in Houston that are doing very well and clearly we have some spills in that area.
I’ve showed this slide over and over again, so I’m not going to do it again, but clearly this is kind of the business model of Sequent. We’ve some low risk arbitrage that of transport and storage spreads, time and locational, but very business focused. Clearly, we work closely with our customers and if you look at our footprint, we’re strongest along the eastern seaboard. Now that’s changed and we will talk about that change in a second but clearly that’s the strongest part of our footprint, and we also have an organization of about 140 people most of them based in Houston but we’re also, we are kind of founded the very strong systems and processes and controls that help us manage this business. But Sequent is not, and I repeat this over and over again to people, is we are not, and we are not in the speculative business. We’re not taking fixed price positions. We’re not a -- we have a very modest VaR relative to some players in the business and we’re not a market maker of financial derivatives. We use financial derivatives to hedge our customer business in some of our asset positions but what we are not is taking markets and financial derivatives.
I will go through the slide in great detail but this is kind of our dynamic model we call, how we creat value. Think of Sequent as a portfolio of options. There are a lot of options related to time spreads which is storage, some of the time spreads are high cycle spreads with another salt storage capacity but also transport, locational spreads. And of course within that we have tremendous customer base, customers that need us and we do a whole bunch of services for those customers. In any one year part of the portfolio may do well. Now the one things -- one of the things that we have now that we didn’t have before is tremendous geographical diversity and clearly that gives you even more diversification and depending upon where volatility is in United States and in North America, we’re well positioned to take advantage of wherever that comes. So, it’s a very dynamic model, it’s a whole portfolio of options and again usually there is some volatility some place somewhere and I feel very good we’re positioned to take advantage of that.
I mentioned before, our business model is not taking risk and credit, that continues to be the case here. And clearly, if you look at our weighted average portfolio of credit, it’s about 8 months and that again gets back to our business model. We are doing a lot of business with utilities, generators, LVCs, Unis, large industrials and also even working with pipelines you can see we carry a very strong credit mix and our business is not built around taking much credit risk.
Last year at this time I talked about growth and as you an see when you look at the baseline earnings trend in 2001, we’ve grown consistently over time and had a couple of very positive surprises where things get very volatile. This slide is exactly what I showed you last year in terms of our key initiatives of 2007 for growth and I would like to give you an update on where we are on some of those trends. First and not least is moving west and into Canton. We then were an eastern company which is our roots, but the course of west is where a lot of the supplies and there is a lot of action that we can apply out west. And beginning May 1 of last year, we commenced trading at Canton, once we reconfigured our systems. So, right now we’re very well established in the west, we’re managing storage. We have tremendous amount of business in the Northwest United States and Milwaukee and we’re now moving very aggressively into the southwest part of the United States. So, again you will see many more things coming out of this Western area, that’s one of the things we are very excited, very pleased about.
The second is power generation. I talked to all last year about how important power is to us. Again, we’re long on storage and transport assets, especially during the summer time. So, what better place to magnetize it and optimize it than during the summer time. So, we were very successful last year adding some major power clients. In fact, one of our biggest clients that we had last year served the New York City area, that’s probably one of the biggest providers to New York City. So, we are very excited about this business and clearly that kind of kicked off very well for us.
Next, but somewhat related to the power business is our salt storage capacity. Salt is different than reservoir and since that it balances the system and it is very good to service power generators and swings in the marketplace and I’ll show you a chart in a minute that we will be doubling, more than doubling our propriety salt storage capacity for now over the next 18 months. And what I’m most pleased about is we’re doing that at a relatively low value to what the market we’re seeing. So, clearly we’re very pleased about that and we’re very excited. It’s diversified across many different pipes -- many different geographies, but clearly that’s a good thing and we will talk about that more.
Go the West east, now this is kind of, looking back now hindsight, this has all come into place very well and clearly there has been a lot of construction, lot of Rockies construction, lot of shale construction, and we’ve been participating in that either working with producers to help to manage the transport while in some cases taking up some capacity ourselves and moving the gas east which is our bread basket. So, clearly this has been very exciting and we had a very -- we had a lot of good things in 2007 to take us down this path.
Next on the list, aggressively expand producer services. Now, since we’re very customer oriented and we are selling a lot of gas every day, injecting gas, selling gas, transporting gas, we’re constantly short on natural gas. We have no natural equity decision for production. So, we’ve continued to build this nice small mid-cap producer pool and right now it’s running about approximately 3 bcf a day of gas sales, it’s running about 500 million today with this pool of small to mid cap producers and we’re continuing to build that, both in terms of small to mid cap but also producers that want us to help them optimize a lot of their transport they took on Rex, and they’ve taken on Gulf South and other west-east pipelines that don’t get into market, they get them to pooling points and we can work with them there.
Last but not least, the commercial and industrial business, what we call retail. And it’s very important to us because as I said last year, the retail business is a great complement to our wholesale business. Again, we’re long on storage, we’re long on transport and this is a great place to put some of those services at times. And what we did is, we acquired Compass Energy October of last year which is based out of Richmond, has well over a 100 customers and gives us tremendous position in one of key area that we have assets. You know, that’s been a good acquisition so far and you will hear more things about how we’re going to grow and take that business. But these are the things that we talked about last year and clearly I want to give you an update of what we’ve done since then because that’s very important to the credibility of this business.
This chart here shows two of the things I just talked about. One is a map that talks about some of our key initiatives last year both in terms of power, retail, proprietary salt storage in the Western Canada but also you can see some more metrics on our proprietary salt capacity that we’re adding over the next couple of years. Again, it’s a tremendous asset, there is not a lot of it right that’s going to be built to a certain degree and clearly Dana will talk about in a minute. There are some very good fundamentals of this business that relate to everything we talked about in the natural gas business.
Okay, let’s talk about 2008. Of course we are already 3 months into 2008 so I think we get some insight into what the year may bring us. Let’s talk about the winter first. Winter is about done and clearly storage is where it is. The winter, statistically looks to be close to normal on a 30-year basis, a little colder than normal on a 10 year basis, so we had a good one and a lot of activity. LNG imports, I talked about this earlier with some folks, LNG imports are really kind of interesting are at the lowest level since 2003. This compares with the same time last year. We had record imports at the same time. So what’s changed? Well, two things, first and foremost people keep guessing us that there has been a tremendous build up in domestic supply. I mean the E&P companies have been very successful in adding new supply out of the Rockies, keeping mature areas flat and adding new production out of sales and there is more to come. Every time you pull up some press statements someone has released into new shale opportunity, whether it is in Canada or in the US and there is more to come on that, because the technology continues to move. Technology of that business from our perspective never stays fixed, it keeps moving.
And the second thing about LNG imports is that clearly there are better market options for LNG. Spain has a drought. Their hydroelectric production is down so they need some gas for generation, and Japan has very difficult time keeping their nuclear fleet operating. So, those two things largely, that’s probably about two-thirds, three-quarters of what’s behind the shift in LNG imports.
The next point, and this is again kind of new relative to what we talked about last year, is the infrastructure build-up continues, record amount of pipeline construction both in terms of transport and storage. So tremendous and it relates very much with what John said before. Tremendous need in this business for new supplies and for servicing new demand, and that’s what going on right now. So, these are all great things but for our company, obviously we’re always working assets, positioning ourselves with assets. This shakes up the whole kind of risk board here. So, we got to kind of take a look at it and let’s see how we want to position ourselves and how we could best serve our customers.
Power generation, whether it is in the Southeast or elsewhere, I mean power generation is the key. We can’t say enough about power generation. All the customers we deal with have no other alternative over the next 10 to 15 years but to use more and more natural gas, every one of them and John talked that again before, that makes this business grow. And clearly, the generators are going to extend you to lean on natural gas with no insight.
The last point here is you’ll see I think more and more things out of the FERC, most of it positive. I think we are seeing a lot more initiatives there to add to clarify rules and to add transparency to marketplace. So, there are actually some very good things coming out of that area so we will keep our eyes on that.
So where does that lead Sequent for 2008? Right here, again a lot is not going to change but I will tell you the things that will be changing. What will change, we’re going to continue to retain and attract our customers and our asset base. Hank said this earlier, we’ve been very successful in extending all of our affiliate asset management agreements for multiple years. We’ve also been very successful in all of our nonaffiliated. Retention is very important part of this business, just like in retail and we’ve been able to retain, I would say, 90 - 95% of our business plus we’ve been adding more. And the next point here is the point, power, power, and more power. We are right now signing a new agreement to supply a complex of plants right outside of Boston area and I can’t tell you, it’s a delicate sign but clearly this is the perfect match to our business, I can’t say enough about it.
Next point transportation capacity. The one thing we’ve seen with the building of the new Shale systems and Rockies pipeline system, there is all sorts of new capacity of wells produced and developed. But these pipelines don’t go all the way to marketplace. They stop at the pooling point. Right now, Rex will stop at some point in Canton, Ohio. The shale system stops in Alabama, Mississippi. Those aren’t markets. Those are takeaway areas for market what we call pooling points. So, we’ve been accumulating transport and posting to take that to east cast markets and what I consider premier East Coast markets. So, that’s kind of how that game has shifted and how Sequent is positioning itself for that business.
The commercial and industrial marketing business. We had a great start with Compass and we got to do more. We want to make more critical mass in that business. There are economies of scale, and again we have assets all across United States now so we want Compass to evolve and grow and to have coverage in many more areas that we have assets and they are well positioned to do that.
The next point is one that you talked about before. With all these new pipeline systems coming on stream, most of them contracted by producers we can do a lot to help them optimize their transport. That transport has tremendous optionality which producers are now in the business to do. So, clearly we’re going to do more and more of that.
The next point, value shop for additional storage capacity. This is kind of a change for us. Again, I mentioned before, we’re doubling -- more than doubling our salt capacity under contract over the next 2 years. We have a lot of well priced salt storages. And it’s geographically diversified, pipeline diversified, it covers all the options that I kind of alluded to before. So, what we’re going right now, we’re going to be kind of like the market shoppers. So, we will be kind of like the five lean basements of the gas business. So, clearly we’re going to be looking for storage but something well priced and that’s where we are going to be.
Last but not least, continue to focus on containing cost, driving more efficiencies because the company that has as much -- that has 10 to 15% a year growth has and will continue to. We want to leverage the economics of our business. So, clearly we want to keep our fixed cost and our cost efficiencies as tight as possible so that we can get the most out of growing our business.
So that completes my presentation. I just want to say two things before passing it on to Dana Grams since he will be talking about Pivotal. This is -- as John said before, this is an extremely exciting time of the business. I’ve been in this business over 20 years, in the natural gas business and never have I seen this business as exciting or as pulling as much potential as we see right now. And that’s kind of a scary thing to say because usually people find ways to blow it but clearly this company and our business we’re very well positioned to take advantage of it. So, with that I know we will answer questions later, so I will turn over to Dana Grams to talk about Pivotal. Thank you.
Dana A. Grams
Good morning. Many new faces for me in the crowd, I wasn’t here last year. I want to Colorado snow skiing and I came back with a broken leg and I wasn’t able to make last year’s conference. But this year I went back to the mountain and made a mens with it and came back in one feet. So, I look forward to meeting each one of you individually.
As the slide says, my name is Dana Grams, I work in Houston for a business division of AGL or a business unit called Pivotal Energy and we are responsible for the development of projects. Today, I would like to give you a little update, maybe a refresher course on Geology 101 and that’s a little bit scary for you all because I have a degree in geology and I get excited and passionate when I talk about rocks and underground things. I would also like to give you my dissertation on market fundamentals which I think strongly support storage and then get into the details of project updates on Golden Triangle, Jefferson Island, as well as a third project that we have jet to announce. What I am hoping that you can take away today is a feeling that we are in the right business at the right time. I echo what Doug said, it’s very exciting times for the natural gas business.
I would also like to give you some reassurances that we have strong core competencies for the development, operation, and optimization of particularly salt dome storage but storage in general. And lastly, I want to make sure that you understand that the projects that we have selected and that we are pursuing are not by accident. There is a strong vision and strategy associated with them and we’re building towards a synergenic future.
Geology 101, imaging million years ago when the dinosaurs roamed the earth. The Gulf of Mexico, 225 million years ago actually had periods of filling and drying up, filling and drying up. It left a layer of salt, somewhere between 10 and 20,000 feet thick called the Luanne salt which is now buried along the Gulf Coast at about 20,000 feet below the surface. Salt has very, very unique properties compared to other rocks. They can deform, we call it plastic deformation. It actually flows very, very slowly even thought with the hard impervious rock. That layer of salt is covered now by other rock, lime stone, sand stone, shale but the density of the salt is lighter than the overburden from the rocks on top of it. And because it can deform much like a liquid although much slower, it tends to try to find places where the rock above it is weak and it starts to bubble up. And this bubbling is not much different. You see rigids begin to form, you see the salt accelerate up the middle of the shaft and pretty soon it bubbles up like a water tower. And all along the Gulf Coast, there are literally hundreds of salt domes that are in various stages of development and these are of course very conducive for the storage of natural gas.
The development of a cavernous store natural gas is also a very, very simple process. There are three things you need to do to develop a cavern for natural gas. You need fresh water, a strong fresh water supply source, you need to drill a well and circulate that fresh water down into the salt, and the salt actually dissolves much like putting a block of ice in your sink, turning on the water faucet very, very slowly and watching the ice melt down into a cone shape in the middle of the block. And then once that water is put into the salt and the salt is dissolved, you need to pull that water out and dispose it off somewhere. Those are the three main challenges of what we’re doing and I know it sounds simple but there is a lot of complex detail.
This is a graph of a well log and I’m going to emphasize a little bit about the challenges that every project faces. Fresh water supply, the more you go to the eastern side of the Gulf of Mexico, there is much more of a challenge as well as finding zones to dispose the brine. At our Golden Triangle side, our brine disposal wells are about a mile away from our site and we drill down somewhere 6 to 7,000 feet into formation that have water that is not suitable for drinking, most of it tends to be brownish anyway or brackish and we inject water into those reservoirs at a rate somewhere around 4000 gallops per minute and that rate has a lot of variability to it depending on the stages of formation of the cavern. It also depends on the pipelines, the pumps, the electrical supply. There is a whole process of moving brine water away from the cavern that’s being developed.
Market fundamentals. I believe they strongly support rapid cycle storage. If you can imagine several fire hoses all attached to the same main, out of control all at one time, there is a picture of chaos that I would like to paint for you. Supply basins are changing. The Gulf of Mexico was typically the prolific supply basin, I personally believe the Gulf of Mexico is in decline. Those reserves are being replaced by other sources of domestic supply, the rocky mountain, the Central Texas, the tight sands and sales. That’s creating a very, very strong need for infrastructure that was talked about earlier.
The changing part of the supply basins though is not just the geographic location, it has to do with characteristics of the producing well. The Gulf of Mexico tended to have wells. (audio transmission ends)
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