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Sempra Energy (NYSE:SRE)

Q4 FY07 Earnings Call

February 26, 2008, 01:00 PM ET

Executives

Jeffrey W. Martin - VP of IR

Donald E. Felsinger - Chairman and CEO

Mark A. Snell - EVP and CFO

Neal E. Schmale - President and COO

Debra L. Reed - President and CEO of San Diego Gas & Electric and Southern California Gas Co.

Analysts

John Kiani - Deutsche Bank

Lasan Johong - RBC Capital Markets

Paul Patterson - Glenrock Associates

Samuel Brothwell - Wachovia Capital Markets

Winfried Fruehauf - W. Fruehauf Consulting

Michael Lapides - Goldman Sachs

Patrick Forkin - Tejas Security

Peter Hark - Talon Capital

Faisel Khan - Citigroup

Operator

Good day and welcome to the Sempra Energy Fourth Quarter and Full-Year 2007 Financial Results Conference Call. As a reminder, today's conference is being recorded. For opening remarks and introductions, I would now like to turn the call over to Mr. Jeff Martin. Please go ahead sir.

Jeffrey W. Martin - Vice President of Investor Relations

Good afternoon. I would like to thank you for joining us to discuss Sempra Energy's 2007 financial results. A live webcast of this teleconference and slide presentation is available on our website under the Investor section.

With us today in San Diego are several members of our management team, including Don Felsinger, Chairman and Chief Executive Officer; Neal Schmale, President and Chief Operating Officer; Mark Snell, Executive Vice President and Chief Financial Officer; Debbie Reed, President and CEO of Sempra Utilities, and Joe Householder, Senior Vice President and Controller.

You will note that slide 2 contains our Safe Harbor statement. I would like to remind you that this call contains forward-looking statements that are not historical facts, and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of performance. As you know they involve risks, uncertainties and assumptions that future results may differ materially from those expressed on our call. These risks, uncertainties and assumptions are described at the bottom of today's press release and are further discussed in the company's reports filed with the Securities and Exchange Commission. In addition, it's also important to note that all of the earnings per share amounts in our presentation today are shown on a diluted basis.

Finally, I want to mention that we are hosting our Analyst Conference on March 27 this year. Because we are holding it in New York City, there has been a lot of interest and we are hopeful that you will each make time to join us.

And with that, I'd now like to turn it over to Don who will begin with slide 3.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks Jeff, and thanks to each of you for joining us. Here is how I would like to proceed with today's call. Mark Snell and I will start with the financial results, and I will update you on the status of our key business activities, and finally we will close with any questions that you may have.

Before turning the call over to Mark, I'd like to mention how pleased I am with the strength of our financial results. All of our operating businesses performed well for the quarter and for the full year. In fact, 2007 was a record year for income from continuing operations, all in all, a very good year and a great foundation for our future growth.

Based on our outlook for the remainder of this year, we are reaffirming our previously announced 2008 earnings guidance of $3.65 to $3.85 per share. This guidance reflects the closing of the Royal Bank of Scotland transaction and our reduced ownership in Sempra Commodities and the positive impact of our planned share repurchase program.

And with that, I am going to ask Mark to take you through the financial results in more detail.

Mark A. Snell - Executive Vice President and Chief Financial Officer

Thanks Don. Well, earlier this morning, we reported fourth quarter income from continuing operations of $288 million or $1.10 per share. Fourth quarter 2006 income from continuing operations was $129 million or $0.49 per share. This included $221 million for the impairment of our Argentine assets.

Net income for the fourth quarter was $289 million or $1.10 per share compared with net income in the prior year quarter of $125 million or $0.47 per share. Income from continuing operations increased to a record $1.13 billion or $4.26 per share for the full year 2007. That's up from $1.09 billion or $4.17 per share in 2006. Last year's results included $204 million in gains on asset sales and the Argentine write-down.

Now let's review the financial results for each of our business units. I'll start with Sempra Utilities on slide 4. Sempra Utilities reported fourth quarter net income of $105 million, compared with the $110 million in the year ago period. San Diego Gas & Electric's net income for the fourth quarter was $47 million, that compares with $55 million in the year ago quarter, primarily due to lower taxes in 2006.

At Southern California Gas, fourth quarter 2007 net income was $58 million. That compares with $55 million in the prior year's quarter. For the full year 2007, Sempra Utilities reported net income of $513 million, a 12% increase over the $460 million posted in 06.

Net income for SDG&E rose to $283 million in 2007 from $237 million in 2006. That was due primarily to favorable resolution of tax issues, together with higher electric transmission and generation earnings. 2000 (sic) [2007] net income for SoCalGas increased to $230 million from $223 million in 2006, due primarily to higher operating margins. Now let's go to slide 5.

Sempra Commodities reported fourth quarter net income of $186 million in 2007, compared with $214 in the prior year's quarter. This is primarily due to reduced earnings from our natural gas and synthetic fuel tax credit operations. For the full year 2007, Sempra Commodities recorded net income of $499 million compared with 2006 earnings of $504 million.

And with that, I'll also bring you a short update on our planned joint venture with RBS. We plan to close the transaction by April depending on the timing of our last regulatory approval. You'll recall that the transaction was approved by the FERC and the UK's Financial Services Authority last call, and we're now awaiting approval from the Federal Reserve Board which we expect in March.

At this point, we don't envision any material issues and we believe we will receive Federal approval as previously mentioned by the end of the quarter. While we and RBS are disappointed that the approval process has taken longer than anticipated, there certainly has been some other significant issues in the financial markets that has taken up a lot of the regulators' time and attention.

One change I would like to mention is that the amount of regulatory capital or equity of the commodities business required has increased over our original estimates. The change, this is driven by significant increases in commodity prices since the deal was first announced and recent changes in banking regulations.

Considering this and the 15% preferred returns dictated by the partnership agreement, we requested and the partners agreed to increase our investment. As currently contemplated, Sempra will now invest $1.6 billion to $1.7 billion at closing. This increase from $1.3 billion to $1.5 billion that we had originally contemplated, does not affect any other aspects of the transaction nor will it affect our planned stock buyback or dividend increase.

And with respect to those, post closing we begin the first $1 billion of our $1.5 billion to $2 billion share repurchase program and again will raise our dividend. Earlier this month we raised our quarterly dividend 3.2% to $0.32 per share and we expect to increase the quarterly dividend the second time to $0.35 a share once we close the transaction. This will reflect the 35% to 40% payout ratio at an annual rate of $1.40 per share.

Now we will move onto slide 6. Fourth quarter net income for our generation business was $40 million compared with $53 million in the same quarter in 2006, due primarily to a 3 month outage of the company's El Dorado Energy plant in Nevada and higher taxes. The El Dorado plant was placed back in service on January 7th of this year.

For the full year 2007, net income for Sempra Generation was $162 million compared with $375 million in 2006, which included $204 million related to the sale of the Topaz Power plant.

Now please move to slide 7. In the fourth quarter, 2007 Sempra Pipelines & Storage reported net income of $14 million compared with a net loss of $223 million in the same period in 2006. Fourth quarter 2006 results included a $221 million write-down on the company's Argentine Utility investments, together with $24 million in taxes on repatriated foreign earnings.

For the full year of 2007, net income was $64 million compared with net loss of $165 million in 2006. The prior year results included the previously mentioned write-down and taxes on repatriation offset by $10 million from the favorable resolution of prior year tax issues.

Please turn to slide 8. This slide provides the summary of our business unit results, and I'll highlight a few points and I will start with our LNG business. Sempra LNG recorded a net loss of $19 million in the fourth quarter of '07, that's compared with a net loss of $7 million in the prior year. The increase was due primarily to a mark-to-market loss on a marketing agreement with Sempra Commodities where this loss was offset by a corresponding gain.

Parent and other reported a net loss of $38 million in the fourth quarter of 2007, compared with a net loss of $18 million in the fourth quarter of 2006, primarily due to increased charitable contributions and income taxes.

Please turn to slide 9. We are very pleased with our 2007 results. Income from continuing operations set a new record for the company and our financial results were bolstered by strong earnings from our California Utilities and Sempra Commodities. Second, we continue to have a strong balance sheet, ample liquidity with over $650 million of cash on hand and $5 billion in unused credit line.

We also finished the year with a debt-to-total cap ratio of 39%, a 3% drop from 2006. That's noteworthy, because as we close the RBS transaction, we've made the commitment to restructure our balance sheet by repurchasing shares and increasing the dividend, both of which will directly benefit shareholders.

Now I would like to turn it back to Don, with slide 10.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks Mark. Let me start with a short business update beginning with our utilities. In December, SDG&A received a final decision on its cost of capital proceeding which increased its authorized return on equity to 11.1% from 10.7%. This increase was effective on January 1st. You will also recall that last year the FERC increased our authorized return on equity on transmission assets to 11.35%.

In regard to our general rate cases for SDG&E and SoCalGas, we reached settlements on major aspects of those proceedings. We now expect a final decision from the California Public Utilities Commission in the second quarter of this year, and we have filed for rates to be retroactive to January 1st of this year.

In November, SDG&E's purchase of Sempra Generation's El Dorado power plant was approved by the CPUC. The purchase will be effective in late 2011. As for the Sunrise Powerlink 500 KV transmission project, we received a draft environmental impact study last month which is an important project milestone. We expect a final decision on the project in the second half of this year which would result in the line being placed into service in 2011.

Now let me update you on our LNG business on slide 11. Our Energía Costa Azul terminal will begin operations in the second quarter. While the revised start date is a couple of month later than expected, the net income impact of this delay is negligible. As you would expect, there is lot of excitement about placing into service the first LNG receipt terminal on the West Coast of North America. We secured initial test cargos for the commissioning and completed the connecting pipeline. At the end of 2007, we also finalized an agreement to develop the $125 million nitrogen injection facility at the terminal. As many of you know, California has adopted some of the most stringent gas quality specifications in the country. This new nitrogen facility will allow gas from the expanded number of sources around the world to meet these more stringent specifications.

Recently an affirmation of our LNG strategy was reiterated by FERC Chairman, Kelliher, who forecasted that the U.S. will become the largest LNG importer by 2011, due to heating and natural gas fuel generation growth. Chairman, Kelliher also said that our Energía Costa Azul project is very important because with its commissioning, the U.S. will be the only LNG importer with ready access to both the Atlantic and Pacific markets. This will make the U.S. market increasingly attractive to LNG importers. In Louisiana, our Cameron receipt facility is 75% complete. This project remains on track for operations in early 2009 and we are still focused on contracting the remainder of capacity at Cameron.

Now let's move to slide 12, for an update on pipelines and storage and the Rockies Express pipeline project. A major milestone occurred in January when we began interim service on the 500 mile segment of the Rockies Express west portion of the pipeline that runs from Colorado to Kansas. We expect the entire 700 mile western portion of the pipeline which ends in Missouri to be in full service next month. As for Rockies Express East, we are continuing to work closely with the FERC on permitting and expect to receive approval sometime in the spring. This will enable us to start construction in early summer and need a December 2008 interim service date.

The total cost of the Rockies Express pipeline is now estimated to be $4.9 billion, an increase of $500 million from the original estimate. Sempra Energy's 25% share of the overall project cost is roughly $1.2 billion. As many of you know, there continues to be a lot of interest in a follow on project to the Rockies Express Pipeline that would deliver natural gas to markets further east.

Late last year, we completed an open season for the Northeast Express Pipeline project that would extend service from Clarington, Ohio to Princeton, New Jersey. We are now negotiating with interested parties for firm contracts with a view towards making a final decision on the project sometime in the next quarter.

Please turn now to slide 13. In summary, here is a couple of key highlights. First, all of our businesses units have performed well. 2007 saw record income from continuing operations, driven in large part by a strong year from our California utilities and our commodities business. In addition, we have some important milestones taking place this year. The closing of our joint venture with RBS, the conclusion of our general rate cases, REX-West is now flowing gas, we are commissioning our Costa Azul receipt facility in the second quarter and we have several more major projects coming online this year, an exciting time as many of our projects and activities move into the operations and earnings phase.

With that, our outlook for 2008 has a lot of certainty and we reaffirm our earnings guidance with a range of $3.65 to $3.85 per share. In 2009, we will be seeing the first full year of operations for many of the projects I just discussed, and that will be reflected in significantly stronger earnings growth in the future. We'll get into the detail behind that growth at our Analyst Conference coming up in March.

And with that, let me now open up the call and take any questions that you might have.

Question And Answer

Operator

: Thank you. [Operator Instructions]. And our first question comes from John Kiani with Deutsche Bank.

John Kiani - Deutsche Bank

Good morning.

Donald E. Felsinger - Chairman and Chief Executive Officer

Good morning, John.

John Kiani - Deutsche Bank

I know you made some comments earlier on in your discussion about the RBS commodities joint venture. Can you talk a little about any... did you had any recent discussion with RBS or with the U.S. Fed?

Donald E. Felsinger - Chairman and Chief Executive Officer

Let me have Mark answer your question, but we are in contact with RBS almost on a daily basis and just to want to reaffirm to you that we expect this transaction to close here within a month.

Mark A. Snell - Executive Vice President and Chief Financial Officer

: Yes, John this is Mark, I think the transaction took a little longer to close than we had anticipated, but I don't think could have anticipated the kind of financial turmoil.

John Kiani - Deutsche Bank

Right.

Mark A. Snell - Executive Vice President and Chief Financial Officer

: That the regulators have been at and you know I want to say that I think it's on... in my conversations with them, they are being diligent and they are really trying to get this done, trying to get the attention of all of the people that they need to get. It's been understandably difficult and I think this just took longer than they expected as well and so... but we are getting there and I think we'll... we expect to get that this month and we expect to close shortly thereafter.

And as far as the conversations we have with RBS, they are meeting with us on a daily basis. We are working to integrate the two businesses and I think from the get go we're going to be ready to move forward.

John Kiani - Deutsche Bank

Okay, thanks, that's helpful. And then can you talk a little bit about this gas-fired power plant that you have in early stage development in Maryland. I think I saw something for around 500 or 600 megawatts?

Donald E. Felsinger - Chairman and Chief Executive Officer

We had a site in Maryland for a number of years that we have not developed because the market hasn't given us the right price signals. And as we look at what's taking place right now on PJM and the fact that they've gone out for capacity payments in 2011. If in fact these capacity payments get approved by the FERC, which we think they will and we're able to deal with some local issues regarding taxes and get our construction cost at a point that they make sense to us, it's a project we will move forward with. But there is still a few open items, but it looks very positive from the standpoint of what we're seeing today.

John Kiani - Deutsche Bank

So just to be clear, it sounds like your expectation is that the new and higher corn prices are approved and therefore we might continue to see pretty robust PJM capacity pricing and specifically in the region in which you have sub region where you have the site and if that's the case, you very well may push forward with this development?

Donald E. Felsinger - Chairman and Chief Executive Officer

Well, I think as you watch construction cost for new combined cycle, we're seeing cost in a range now of $900 to $1000 of megawatt or KW. When we look at what's happening in PJM, is they need capacity and we think the prices that they have adopted and they sent to the FERC to get approved would in fact support new generation. We also think we have one of the few sites that's ready to be built upon and meet the 2011 date. So, once again, if the prices get approved by the FERC and we are able to get our construction cost estimates coming into the price range that supports our economics and deal one or two the minor issues, it's a project that in fact we will move forward with.

John Kiani - Deutsche Bank

Okay, thank you very much.

Operator

Our next question comes from Lasan Johong with RBC Capital Markets.

Lasan Johong - RBC Capital Markets

Thank you. Don, first of all, congratulations on a good year, but more kind of looking out globally, I can't imagine you seeing back and saying to yourself, there are no acquisition opportunities on the horizon... or in the mixed today that you are looking out and I can probably give you three companies that might be of interest to you. How you kind of looking at the landscape today relative to the fact that you are throwing of enormous amount of free cash flow, or we expect to?

Donald E. Felsinger - Chairman and Chief Executive Officer

Lasan, thank you for the congratulations on the year. We are always looking at opportunities to buy assets or it may be assets or companies, we are no different than anyone else. But key thing that we have before us is to close the RBS transaction, so in fact that we can do a restructuring of our balance sheet and so that's primary on our focus and we are going to do that, and when we see a right opportunity come along that make sense for us in the space, we want to be in, we will be an active player.

Lasan Johong - RBC Capital Markets

Okay. Mark, you had mentioned that the capital infusion at the JV would probably have to increase by at least $100 million to $200 million it sounds like. Is that a physical cash injection or is that the amount of capital being returned would be reduced, how is that going to work?

Mark A. Snell - Executive Vice President and Chief Financial Officer

No, I think they are one and the same, but let me make it clear that it's not something we have to do with, something that we know that we wanted to do may help us, it helps preserve our earnings and actually increases our earnings slightly because of the preferred return. It is... when these new regulations came out and with the high commodity pricing, the regulatory capital calculation was higher than what we had originally anticipated and we just sat down with our partners and worked out something that was equitable for both of us.

Lasan Johong - RBC Capital Markets

So is it a cash infusion or is it a less cash return?

Mark A. Snell - Executive Vice President and Chief Financial Officer

I guess it's less cash return. There's about 2 days difference between the two, so I am not sure it makes any difference.

Lasan Johong - RBC Capital Markets

Okay. In terms of global liquefaction capacity, are you guys seeing any differently? It seems like this more announcements coming out about either for fraction capacity?

Donald E. Felsinger - Chairman and Chief Executive Officer

Neal, you want to address this?

Neal E. Schmale - President and Chief Operating Officer

I think generally our view of this market is pretty consistent with the way we have seen it. There's a lot of liquefaction capacity going to be coming on in the next few years and that will have an impact on the market. But generally, our view around this global market has been positive and it continues to be so.

Lasan Johong - RBC Capital Markets

Okay. And any kind of thoughts on what Schneier announced recently about strategic review?

Donald E. Felsinger - Chairman and Chief Executive Officer

Neal, follow on with that.

Neal E. Schmale - President and Chief Operating Officer

Just consistent with what I just said. I think we don't generally comment on other companies, but essentially Schneier announcement came out, we looked at the company and looked at what the market resource saying about Schneier. And I think once again in general terms, when you look at the long-term for energy and the long-term for LNG, market has a pretty good view of Schneier and I think it reflects very well on the access that we hold.

Lasan Johong - RBC Capital Markets

Okay. And if I may, one last question, there is lot of discussion going on about building a REX equivalent to the West; Ruby and Bronco would do that and think of. How is that going to impact REX, is there going to be enough capacity out of the Rockies to feed both sides of the equation.

Donald E. Felsinger - Chairman and Chief Executive Officer

Lasan, the reserve forecast we have... when we looked at building REX to the Eastern markets, there were adequate reserves there to support that project for 20 plus years and there have been reserve increases in the interim. So, no one would build a pipeline unless they felt comfortable about the reserves being there versus those which have been committed slightly, but yes, the reserves are in the Rockies to support a pipeline of project to the West.

Lasan Johong - RBC Capital Markets

And why give them an opportunity to build and why don't you just take it away by building those spur on REX?

Donald E. Felsinger - Chairman and Chief Executive Officer

If the opportunity present itself for us to do that, we would. We are looking at all the options that are out there with gas flowing to the west and we have made no decisions.

Lasan Johong - RBC Capital Markets

Okay, thank you.

Operator

Our next question comes from Paul Patterson with Glenrock Associates.

Donald E. Felsinger - Chairman and Chief Executive Officer

Good morning.

Operator

Sir, your line is open.

Paul Patterson - Glenrock Associates

Hi, can you hear me?

Donald E. Felsinger - Chairman and Chief Executive Officer

Yes, go ahead.

Paul Patterson - Glenrock Associates

Okay, sorry about that. Wanted to touch basically first on the timing between the Fed approval and the actual close? You mentioned that you probably are going to be I guess the approval would have in March and it should actually close it in April?

Mark A. Snell - Executive Vice President and Chief Financial Officer

Yes that's right.

Donald E. Felsinger - Chairman and Chief Executive Officer

It's Mark Snell.

Mark A. Snell - Executive Vice President and Chief Financial Officer

I... assuming that we get the Fed approval in the next few weeks, we would... our plan is to close it on April 1. We have been looking at trying to close it on the first of the month and made it easier for some things, but we are also exploring the possibility of closing at mid month.

Paul Patterson - Glenrock Associates

So it could happen earlier than April?

Mark A. Snell - Executive Vice President and Chief Financial Officer

It could.

Paul Patterson - Glenrock Associates

Okay. And then in terms of Port Arthur, you guys I think have delayed due to the contracting situation there, the LNG development. And I was just wondering if you could sort of comment on that, what's your thoughts on in terms of the pricing environment that we are going to have to see in terms of the LNG outlook going forward in the U.S. the other market.

Donald E. Felsinger - Chairman and Chief Executive Officer

I think we had a discussion in the last call, maybe the call before that as you are aware we have gone forward and seek the expansion approval for both Costa Azul and for Cameron. So we now have the ability without launching Port Arthur to increase the capacity in our Mexican facility up to about 2.5 Bcf a day and about 2.6 Bcf at Cameron.

And what we have done is we have left ourselves from little room to look at how the upstream market develops and if it made more sense to expand one of our existing facilities for incremental supply or to launch a whole new facility. So, we are very well positioned, we can expand in Mexico, we can expand in Cameron or we have permit some place where we can move forward with Port Arthur. So, I think it really is a function of how quickly the liquefaction market develops and how robust the market is in the U.S. to support the new LNG supplies. That's at the end of the day, we have as much flexibility as anybody out there to take advantage of what happens or what doesn't happen.

Paul Patterson - Glenrock Associates

Right. So, I guess I am wondering when do you see that liquefaction market will show up and what kind of contracting are we looking at in terms of when we actually might see that development... that additional development to take place.

Donald E. Felsinger - Chairman and Chief Executive Officer

Well let me just looking at the projects that are currently under construction, it looks like the water shed years are going be 2011 and later.

Paul Patterson - Glenrock Associates

Right. And the contracting, I mean you would expect that to sort of develop, when do you think there will be a picture on the contract?

Donald E. Felsinger - Chairman and Chief Executive Officer

I would think that as most of these projects get 18 months or so away from completion, that I would expect that upstream suppliers would start making sure they have a place to unload this someplace, whether it be in North America, Asia or Europe.

Paul Patterson - Glenrock Associates

Okay. And then finally, the level of non-investment grade on the trading book, it seems to have increased again over the quarter. Just elaborate a little bit more on the activity that is happening here in driving that?

Donald E. Felsinger - Chairman and Chief Executive Officer

Mark, do you want to take that?

Mark A. Snell - Executive Vice President and Chief Financial Officer

Sure. There really hasn't been... it's a relatively small difference and I think these are just things that happen from time-to-time. We really aren't noticing anything really different in our book of business, and frankly, if you are thinking that it might be a reflection of some of our customers being downgraded, that really hasn't happened yet with the majority of our customers. So I think from the most part, it's just a fluctuation that will probably correct itself over time.

Paul Patterson - Glenrock Associates

Okay, great. Thanks a lot.

Operator

We'll go next to Sam Brothwell with Wachovia.

Samuel Brothwell - Wachovia Capital Markets

Hi, thanks. My questions have been addressed.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks, Sam.

Operator

We'll go next to Winfried Fruehauf with Fruehauf Consulting.

Winfried Fruehauf - W. Fruehauf Consulting

Good morning. My first question is on the allowance for funds used in construction. What was that amount in the fourth quarter and the year versus 2006?

Mark A. Snell - Executive Vice President and Chief Financial Officer

Hang on just a second, Winfried.

Winfried Fruehauf - W. Fruehauf Consulting

Thank you.

Mark A. Snell - Executive Vice President and Chief Financial Officer

I want to get you... I want to give you the right answer so.

Winfried Fruehauf - W. Fruehauf Consulting

Okay.

Mark A. Snell - Executive Vice President and Chief Financial Officer

Yes, Winfried, why don't you go ahead and give me your second question and we'll --.

Winfried Fruehauf - W. Fruehauf Consulting

All right. The second question relates to the large increase in short term debts year-over-year on your balance sheet to a little bit over $1 billion. What does that reflect and how you are going to refinance this large amount of short term debt?

Mark A. Snell - Executive Vice President and Chief Financial Officer

That just reflects some of our current borrowings that we have taken down, one of those things that we have done is moved out of some of our commercial paper market and our and... notes that are long-term notes that re-price on a monthly basis we moved into more shorter term paper. But we have adequate, our credit lines if we don't end up going back into the bond market, we will just use our credit lines to finance that there are almost multiyear lines.

Winfried Fruehauf - W. Fruehauf Consulting

Okay. What is your current estimate of the final construction cost for Costa Azul, given the cost of the nitrogen facility and some delay? And if you could please tell me whether that includes or excludes an allowance for funds used in construction?

Donald E. Felsinger - Chairman and Chief Executive Officer

I want to give this to Neal.

Neal E. Schmale - President and Chief Operating Officer

Yes, at Costa Azul, we estimate that the final cost will be about $975 million. Now that includes capitalized interest and it excludes the nitrogen plant of $125 million and some pre-expansion cost of around $66 million.

Winfried Fruehauf - W. Fruehauf Consulting

Okay. And next question is on Entrega, what was the net income contribution from Entrega in the fourth quarter?

Donald E. Felsinger - Chairman and Chief Executive Officer

In the fourth quarter of?

Winfried Fruehauf - W. Fruehauf Consulting

2007, yes.

Donald E. Felsinger - Chairman and Chief Executive Officer

We have that -- broken down?

Mark A. Snell - Executive Vice President and Chief Financial Officer

No, we won't disclose that.

Donald E. Felsinger - Chairman and Chief Executive Officer

Yes, if I had, I couldn't give it to you.

Winfried Fruehauf - W. Fruehauf Consulting

All right, okay.

Donald E. Felsinger - Chairman and Chief Executive Officer

And I don't. Let's go back to your first question. This is Neal.

Neal E. Schmale - President and Chief Operating Officer

I will cover. The AFQDC for the year for SDG&E equity was 17 for the year and SoCal was 5.

Winfried Fruehauf - W. Fruehauf Consulting

Okay and for the quarter?

Neal E. Schmale - President and Chief Operating Officer

5 for SDG&A and 2 for SoCal.

Winfried Fruehauf - W. Fruehauf Consulting

Okay. Thanks very much.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks Winfried.

Operator

We will go next to Michael Lapides with Goldman Sachs.

Michael Lapides - Goldman Sachs

: Hi, guys. Congrats on a good year. When we think about the incremental cost for REX, the $125 million to you. How does that impact your returns on invested capital on the project?

Mark A. Snell - Executive Vice President and Chief Financial Officer

It's negligible from the standpoint of the overall returns. I think it moves at few basis points.

Neal E. Schmale - President and Chief Operating Officer

This time the numbers will move it kind of in proportion of the capital a little bit less so it's a very small impact.

Michael Lapides - Goldman Sachs

: I mean, it's almost a 10% cost increase if I look at it from the overall project levels. I mean... how should we think about and... maybe I'll rephrase the question, what's the right... whether its ROE or ROIC target that investors should think about in terms for this projects?

Neal E. Schmale - President and Chief Operating Officer

Once again, when you look at the impact of this kind of a capital increase, it will move in more or less in kind of in proportion to the total capital. Now on an ROE basis, it should be a little bit less because of the impact of the leverage, but on ROA, return on absolute capital basis, that we've given particular forecast.

Michael Lapides - Goldman Sachs

I understand. What's the ROE assumption for REX?

Donald E. Felsinger - Chairman and Chief Executive Officer

I don't think we ever gave that.

Michael Lapides - Goldman Sachs

Okay. And last question, and this is kind of touching based on the utilities a little bit, had a lot of utility related question today. How do we think about what the new generation needs are especially after the CPUC filings at the backend of the year '07 for San Diego Gas and Electric?

Donald E. Felsinger - Chairman and Chief Executive Officer

Debbie, you want to address that?

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

Sure, we have to... this is Debbie Reed, Michael. We have to file at the CPUC a 10 year long-term resource plan which was just basically approved by the CPUC that looks out on the generation needs going forward. And as Don mentioned in his remarks, not only do we have generation assets that are part of our portfolio today but we did receive approval to acquire El Dorado in 2011, and so we will have quite a bit of utility own generation as part of our portfolio. We will then add a compliment of peaking generation to meet our reliability and resource adequacy needs going forward, and that in addition to the Calpine plant that is under construction as well as our acquisition at El Dorado and in some peaking generation should meet our needs for the next 10 years or so.

Michael Lapides - Goldman Sachs

And if Sunrise is delayed, I think that 10 year procurements approval by the CPUC mentioned about another incremental 400 megawatts of capacity at Sunrises delay, where would that 400 come from?

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

Again, we would look at principally peaking generation and we would go through the required CPUC request for proposal process necessary to get down.

Michael Lapides - Goldman Sachs

I got it. Okay, thank you.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks, Michael.

Operator

We go next to Patrick Forkin with Tejas Security.

Patrick Forkin - Tejas Security

Good morning I was wondering if you could give us an update on your advanced metering program. Have you made the technology selection and what's your time table for regulatory approval?

Donald E. Felsinger - Chairman and Chief Executive Officer

Debbie Reed again.

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

Hi Patrick. We received regulatory approval for smart meter program last year and the CPUC authorized $572 million budget, $500 million of which approximately of capital. We will begin deployment of the first 5000 test meters in the second quarter of this year and then we will be again full deployment in Q4 of this year of all of the meters to be completed and installed in SDG&E service territory by early 2011 and that will be 1.4 million electric and 900,000 gas. We are still in negotiations with the vendor and so we are not at a point where we can release the name of the vendors that we have selected yet.

Patrick Forkin - Tejas Security

Okay, but on the core metering you have made a technology selection.

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

Yes.

Patrick Forkin - Tejas Security

Okay, thank you very much.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks Patrick.

Operator

We will go next to Peter Hark with Talon Capital.

Peter Hark - Talon Capital

Hello, Don and Mark. It's Peter Hark, how are you doing?

Donald E. Felsinger - Chairman and Chief Executive Officer

Hi Peter, how are you?

Peter Hark - Talon Capital

Very good. Thank you. Just a couple of quick questions on the RBS deal. First, could you review for us in more detail the factors that influenced your decision to revise the agreement in the first place? And is there a possibility that there will be further revisions coming. And lastly, is your increased capital contribution being matched by RBS also so that your respectable ownership interest are intact?

Mark A. Snell - Executive Vice President and Chief Financial Officer

Okay, well the decision, our partnership agreement that calls for a 15% preferred return on regulatory capital and so as we saw the numbers go up we decided that it would make more sense for us to put a little bit more -- to leave a little bit more money in the business. The couple of things that happened, because some of this was driven by higher commodity prices, we're actually... when we sell the business because we're essentially selling the kind of a book value, we are actually pulling a little more money out of the business and our cash flow from the businesses has been higher this year than we anticipated.

So actually our net proceeds that are coming out are going to be roughly the same as what they would had been, what we have been anticipate earlier and just they would have been a little bit higher. And so it was pretty easy decision for us to make. We are still under the agreement limited on how much that we can be required to put in or how much we can... we may want to put in. So we don't expect to be... to see any further changes in that.

And then long-term, we think partly this was relatively short-term issue with us. Then these new bank regulations drove some of the... I will refer to it as Basel II, which I think some of you might be familiar with and that have started to affect the European bank as of January 1st. And it will come into play here in the U.S. next January. That drove up some of the requirements, but under that Basel II requirements as well as the old requirements, we will be able to go to a far based model for determining regulatory capital instead of the formal lag model that happened before you can get your bar model approved. And once we do that, that will bring the capital back down again. So we are not... we are thinking the business more of a 12 to 15 months kind of issue and we will give the capital numbers back in balance where we thought we were a year from now.

Peter Hark - Talon Capital

Thank you, Mark, for explaining that and just to be clear then, RBS is not posting additional --?

Mark A. Snell - Executive Vice President and Chief Financial Officer

I am glad you brought that up, they will post about an equal amount more too, they will always, because the initial ownership percentage is 51.40, 49 they will always be just slightly more capital than us.

Peter Hark - Talon Capital

Okay, perfect. And then just also to be clear, is any of these being driven by either credit or collateral obligation?

Mark A. Snell - Executive Vice President and Chief Financial Officer

No, it's really just is driven by the pure fact that commodity prices are higher so things like that requires more capital in the business and then the other part is like, like I said that these regulatory changes which until we... yes, we knew they were coming, but until we had worked through all of the numbers we really didn't know how they were going to turn out.

Peter Hark - Talon Capital

I got you. Thanks. And then lastly, for clarification I think, answer to Jason's [ph] question. I think you said there was a two day difference in cap rating return, I am not sure, what you meant by that.

Mark A. Snell - Executive Vice President and Chief Financial Officer

I am sorry, I was probably was a little misleading. All I was really saying was that he was asking... Lasan was asking whether we were putting more money in or taking less money out and I said, this happens about the same time, it's hard to tell, which is which, but I think the net result is about the same.

Peter Hark - Talon Capital

Okay. Thank you very much, Mark.

Mark A. Snell - Executive Vice President and Chief Financial Officer

Okay.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks Peter.

Operator

[Operator Instructions]. And we will go next to Faisel Khan with Citi.

Faisel Khan - Citigroup

Good afternoon.

Mark A. Snell - Executive Vice President and Chief Financial Officer

Hi Faisel.

Faisel Khan - Citigroup

Hi. Just one follow-up question on the RBS transaction. The profits will still get paid out at the end of every year, is that correct?

Donald E. Felsinger - Chairman and Chief Executive Officer

Correct.

Mark A. Snell - Executive Vice President and Chief Financial Officer

That's correct.

Faisel Khan - Citigroup

Okay. And assuming the transaction goes through, will you bring down the additional amount of your credit also.

Donald E. Felsinger - Chairman and Chief Executive Officer

That's correct.

Faisel Khan - Citigroup

Okay. And in the... can you discuss what happened to tax rate in the fourth quarter achieved relatively high compared to last?

Donald E. Felsinger - Chairman and Chief Executive Officer

The tax rate in the fourth quarter?

Faisel Khan - Citigroup

That's right.

Mark A. Snell - Executive Vice President and Chief Financial Officer

The fourth quarter was a little bit higher. That was partially because of the phase out of the Section 29 credit went up quite a bit and also we had lower income from lower tax jurisdictions during the quarter, just for the year it's about 34% in both years, next year we expect them to go up 3% because there are no Section 29.

Faisel Khan - Citigroup

Okay.

Donald E. Felsinger - Chairman and Chief Executive Officer

And that was your householder.

Faisel Khan - Citigroup

Got you. And then in terms of your guidance, does that include any potential settlement discussions you are having with ISTG and inside CalGas?

Donald E. Felsinger - Chairman and Chief Executive Officer

It includes our best estimate of what the year is going to look like.

Faisel Khan - Citigroup

Okay. Fair enough. In terms of the cool-down cargoes you are receiving at Costa Azul, are those part... is that part of the capital that will be part of the investor capital in Costa Azul or is it?

Donald E. Felsinger - Chairman and Chief Executive Officer

I think of it as working gas. It is like capital

Faisel Khan - Citigroup

Okay. And any, given your operational in the second quarter other opportunities that you are looking at or potential spot cargoes given that there is a time difference between when your contracts ramp up, between what the facility comes on line?

Donald E. Felsinger - Chairman and Chief Executive Officer

Yes, there is.

Faisel Khan - Citigroup

And how are you guys looking at that?

Donald E. Felsinger - Chairman and Chief Executive Officer

Well, I mean the opportunity here is just as... just this aside, we were in a different meeting yesterday and had some people on the phone and it was interesting that we had LNG people all over the world and they're outselling capacity and looking for spot cargoes. So, as this facility goes operational and there is the ability to bring gas into it before the BP contract starts. We will be out there trying to convince people to bring it to Costa Azul.

Faisel Khan - Citigroup

Okay. Anyway to talk about the cost for MMBTU, the test cargoes cost?

Donald E. Felsinger - Chairman and Chief Executive Officer

I would only say that we are paying market prices and as we went through the analysis of what these things are worth to us we can't start getting revenues from our customers until such times as we can prove that facilities commercial and you can't make it be it commercial and so you run test cargo through it so.

Faisel Khan - Citigroup

Okay.

Neal E. Schmale - President and Chief Operating Officer

One point on is that these test cargoes are part of the start up operation in their capitalized.

Donald E. Felsinger - Chairman and Chief Executive Officer

You were sleeping when we said that.

Faisel Khan - Citigroup

Fair enough. On the Port Arthur, you guys talked about the open season for oil terminal capabilities, where are you guys at open season?

Donald E. Felsinger - Chairman and Chief Executive Officer

I'll have Neal address this but I just on the surplus we announced that in fact we are having an open season that was the end of last year and we had good response and we are in the process now of looking at those responders and seeing there is in fact there is enough interest to turn these into contracts to build terminaling.

Neal E. Schmale - President and Chief Operating Officer

Now this really is not in terms of the open season a lot to elaborate there, but I think it is worth underlining that both with respect to its possible uses in LNG terminal and with respect to its use at the possible oil terminal, the plot of land that we have down there is very well located, so long term this is going to be a very quality asset with a lot of potential.

Faisel Khan - Citigroup

Okay. And on the... at the generation segment, the outage of El Dorado I think it was a forced outage?

Donald E. Felsinger - Chairman and Chief Executive Officer

It's started out as a planned outage and as we started the plan up it was a problem in the way it was put back together so it turned into a forced outage.

Faisel Khan - Citigroup

And did you guys talk about the impact from that forced outage on income?

Mark A. Snell - Executive Vice President and Chief Financial Officer

You know it was negligible.

Faisel Khan - Citigroup

Okay. And then looking at the wind farm assets that you guys have under construction, where are you in terms of construction of those assets, the first phase and how is the second phase, third phase kind of looking?

Donald E. Felsinger - Chairman and Chief Executive Officer

I think you're referencing the wind project that we have in Sempra generation.

Faisel Khan - Citigroup

That's right. The 1000 megawatts potential wind capacity?

Donald E. Felsinger - Chairman and Chief Executive Officer

I think the status is as we've secured a good resource in terms of land and we've signed a contract with Southern California Edison. We have not started construction; we have two factors that are impeding that. One is as you're... I guess we all are painfully aware, we just don't have transmission in this region to move renewals to market and our project that we have in Mexico is a victim of that same outcome. So we are waiting for the transmission issues to get resolved. But beyond that, some of the equipment prices come in as planned will move forward once we have the transmission issues resolved.

Faisel Khan - Citigroup

And are you talking about having Sunrise Transmission via linked to those asset or is it versus --?

Donald E. Felsinger - Chairman and Chief Executive Officer

That's Sunrise or some other transmission solution and our generation company is working both with the ISO and with the government of Mexico to see if we can find a transmission solution.

Faisel Khan - Citigroup

Okay, great. Thanks for the time, guys.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thank you.

Operator

And we will take a follow-up from Winfried Fruehauf with the Fruehauf Consulting Company.

Winfried Fruehauf - W. Fruehauf Consulting

Thank you. Regarding the Paloma outage, are you in anyway protected either by warranties and or insurance business interruption or insurance?

Donald E. Felsinger - Chairman and Chief Executive Officer

We have a claim pending against people who did the repair work.

Winfried Fruehauf - W. Fruehauf Consulting

And are you in a position to assess the chances of your succeeding?

Donald E. Felsinger - Chairman and Chief Executive Officer

Well, if we didn't think we had a chance, we wouldn't waste our time filing it so.

Winfried Fruehauf - W. Fruehauf Consulting

Can you disclose the amount that you are claiming?

Donald E. Felsinger - Chairman and Chief Executive Officer

Not at this time.

Winfried Fruehauf - W. Fruehauf Consulting

Okay. That's all I have. Thank you.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thank you.

Operator

And we will take a follow-up from Lasan Johong with RBC Capital Markets.

Lasan Johong - RBC Capital Markets

Yes, just three quick follow-ups. How are sales of Argentine business going?

Donald E. Felsinger - Chairman and Chief Executive Officer

I didn't hear that, go ahead.

Lasan Johong - RBC Capital Markets

I am sorry, sales of the Argentine business?

Donald E. Felsinger - Chairman and Chief Executive Officer

As you know, we're still trying to collect up on the claim that was awarded in our favor in Argentina, and so our plan there is to pursue a two courses of action. One is to dispose those assets in the market and secondly, collect from the claim against the government, and we are moving on both those.

Lasan Johong - RBC Capital Markets

Okay. And then if I understood your comments on REX Northeast correctly, it sounds like there was enough interest in terms of people wanting to deserve capacity, so it sounds like it's coming down to negotiation of price, is that about the sum of it?

Donald E. Felsinger - Chairman and Chief Executive Officer

Well I guess I would maybe approach it a little differently, Lasan, as they were... I don't have a correct count here, but they were some between 8 and 12 projects that were one-time proposed that would basically take gas further east and they ended up in different locations, they carry different volumes. What we are doing is we're having discussions with the people that participate in our open season and we are as you know we're building a much larger pipeline that has a much lower rate, but requires much larger volumes to make it work. And we will see in the next couple of months whether or not there is enough market interest to have people sign up long-term contract to make this project to reality. I would say again that of all the people that are out there from the standpoint of those that have track record, have the creditability, have the team put together that we have a good... as good a shot as anybody in fact in extending this pipeline into the eastern markets.

Lasan Johong - RBC Capital Markets

Okay. And then last question, Don, while ago, when we chatted you said the potential that Sempra may take a position in a liquefaction facility somewhere else, is that still kind of what you are looking for hoping for to achieve?

Donald E. Felsinger - Chairman and Chief Executive Officer

I think it's a space that we look that we bring some strengths to with our marketing capability, so as we're afforded opportunities to participate in liquefaction, the interest is not so much in just having equity in liquefaction, but having the marketing rights to go with it. And so in every case, we are looking at the opportunity to invest in liquefaction we're in fact we can have a disproportion share of the uptake to market.

Lasan Johong - RBC Capital Markets

Thank you.

Donald E. Felsinger - Chairman and Chief Executive Officer

Thank you.

Operator

We will take a follow-up from Faisel Khan with Citi.

Faisel Khan - Citigroup

Sorry, couple more question. What did you guys book in the year for your attrition filing, SoCalGas, SDG&E?

Donald E. Felsinger - Chairman and Chief Executive Officer

It's Debbie Reed here.

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

Yes, in 2006 to 2007, our attrition was about $73 million to both utility.

Faisel Khan - Citigroup

Okay, and then if I look at the operating income of both utilities over that timeframe, there was not that much growth in your operating profit number, so I assume that the attrition amount have been higher than O&M?

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

There was actually a number of factors on the operating income side and we did in that having at SoCalGas a positive benefit from the attrition mechanism and a slight positive benefit at SDG&E last year and these were offset licensing like litigation costs in other item.

Faisel Khan - Citigroup

Okay. But generally, the attrition amount seemed to be working in a way they were supposed to basically offsetting cost inflation overall of operation?

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

Absolutely, and we manage our costs based upon as we look ahead and we forecast what the attrition is going to be and we manage our business so that we can stay within that attrition amount.

Faisel Khan - Citigroup

In terms of your other performance-based mechanisms, GCIM or other purchase gas costs... where you guys stand with that?

Debra L. Reed - President and Chief Executive Officer of San Diego Gas & Electric and Southern California Gas Co.

If you look at all of our mechanisms for 2007, we had a total of $33 million pre-tax and $20 million after tax out of all of the incentive mechanisms from both utilities. That was about $10.6 million pre-tax at SoCalGas from PVR and GCIM 12 and then at SCG&E from the PVR was about $8.8 million pre-tax, a DSM incentive of $12 million and then PVR on the gas purchasing of about $2.3 million.

Faisel Khan - Citigroup

Okay, I got you. Then last question on the equity earnings of certain of the subsidiaries underneath your pipeline storage segments. I think you have roughly $59 million for the year. Can I assume that a lot of that is related to your equity interest interact or is that something else?

Mark A. Snell - Executive Vice President and Chief Financial Officer

It's in ultimately South America too.

Faisel Khan - Citigroup

Okay, got you. Thanks

Donald E. Felsinger - Chairman and Chief Executive Officer

Thanks Faisel.

Operator

With that we have no further questions in queue. At this time, I would like to turn conference back to Mr. Don Felsinger for closing remarks.

Donald E. Felsinger - Chairman and Chief Executive Officer

Well, once again, thanks to all of you for joining us for the 2007 earning call. If you have any follow-on questions, you have Jeff, Glen or Scott a call and if not, we will you see you end of March in New York. Have a great day.

Operator

This does conclude today's conference, ladies and gentleman. Again thank you for your participation and you may disconnect at any time.

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Source: Sempra Energy Q1 2008 Earnings Call Transcript
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