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Northwest Natural Gas Company (NYSE:NWN)

Q2 2008 Earnings Call

July 25, 2008 10:00 am ET

Executives

Mark S. Dodson - Chief Executive Officer, Director

Gregg S. Kantor - President, Chief Operating Officer

David Hugo Anderson - Chief Financial Officer, Senior Vice President

Margaret D. Kirkpatrick - Vice President, General Counsel

Stephen P. Feltz - Treasurer, Controller

Robert S. Hess - Director of Investor Relations

[Alex Miller]

Analysts

Analyst for Ron Barone - UBS

James Lykins - Hilliard Lyons

Analyst for Zach Berger - Bank of America

Dan Fidell - A.G. Edwards

Operator

Welcome to the Northwest Natural Gas Company’s second quarter earnings teleconference. (Operator Instructions) Now I would like to turn the conference over to Bob Hess.

Robert S. Hess

Good morning and welcome to the second quarter 2008 earnings call for Northwest Natural Gas. As a reminder, some of the things that we say this morning contain forward-looking statements. They’re based on management’s assumptions which may or may not come true and you should refer to the language at the end of our news release for the appropriate precautionary statements and also our SEC filings for additional information. We are planning to file our second quarter 10Q by Thursday, August 7. As a reminder, this call is being recorded and will be available on our website later today.

Speaking today are Mark Dodson, Chief Executive Officer of Northwest Natural, and David Anderson, Senior Vice President and Chief Financial Officer. Mark and David have some opening remarks and then we’ll be available to answer your questions. Also joining us today are Gregg Kantor, President and Chief Operating Officer, Margaret Kirkpatrick, General Counsel, and Steve Feltz, Treasurer and Controller. With that let me turn you over to Mark.

Mark S. Dodson

Thanks for joining us today for our second quarter earnings report. In a few moments I’ll turn the microphone over to David who will fill you in on the details for the period. Right now I’d like to take a few minutes to talk generally about our second quarter performance. Overall our results for the period were on target. As you may recall, last year’s results reflected record gas cost savings for customers and shareholders. With higher gas prices and a long cold spring we experienced an unusual gas commodity loss in the period due to our sharing mechanism in Oregon. As we mentioned last quarter we are currently working with the Oregon Public Utility Commission in reviewing this sharing mechanism. Our existing mechanism is more than a decade old and was created at a time when natural gas prices were stable. Given the volatility of prices today we believe updating the mechanism to create a more appropriate risk reward balance for customers and shareholders makes sense. Changes to the mechanism must be approved by the OPUC and our target is to be implemented with the next heating season effective November 1, 2008.

Higher residential and commercial margins, strong storage, effective cost controls, and continued customer growth more than offset losses from higher gas costs generating solid second quarter results. We also continue to benefit from the major organizational changes we completed over the last two years. Today our operations are more efficient than ever before, we have more automated and integrated technology systems, and we’re relying more on contractors for new service installations and other routine work. So we’re in a better position to respond to market changes without adding or reducing employees. While housing starts have slowed, Oregon has been less affected by the mortgage crisis than many other parts of the country. We continue to add customers above the national average and we continue to add them profitably.

The last time we spoke you heard David talk about the sale of the Boeing 737 airplane we leased to Continental Airlines. I’m pleased to report that we completed the sale during the second quarter. Our business development initiatives are also progressing and I’ll provide you an update after David gives you more details on the quarter.

David Hugo Anderson

I will review our financial results for the second quarter and for the first six months of 2008 and then comment on our earnings guidance for the year.

As reported earlier today, results for the second quarter ended June 30 reflected earnings of $0.12 per share on net income of $3.3 million. This compares to $0.10 per share on $2.6 million on net income in 2007. As a reminder, we typically see lower financial results in the second and third quarters due to the seasonal nature of customer usage. Utility operations, our largest segment, had a net loss of $700,000 for the quarter compared to $100,000 loss last year. Total gas deliveries in the second quarter excluding deliveries of gas stored for others were 263 million therms, up 12% from 234 million therms last year due mainly to residential and commercial customer growth and weather that was 23% colder than last year and 26% colder than average in the period. Utility margin in the quarter was $57 million down 3% from $59 million last year due mainly to higher gas costs and the cold weather I just mentioned.

Sales of residential and commercial customers in the second quarter were 131 million therms up 27% from last year’s 103 million therms due primarily to customer growth and again significantly colder weather. Residential and commercial sales in the quarter contributed $63 million to margin compared to $51 million last year or a 23% increase. This increase was mainly due to colder weather in the period and higher customer growth and usage. Our weather and decoupling mechanisms reduced margin by $8.3 million compared to a net margin contribution gain of $0.8 million last year. Gas delivery to industrial sales and transportation customers in the quarter were essentially unchanged from last year at 132 million therms. However margin was down 6% to $7.1 million due mainly to higher volumes and lower margin rate schedules and temporary cut backs for some industrial customers due to a general economic slowdown in the area.

For the first time in many years we have been experiencing gas cost losses from our PGA and incentive sharing mechanism in Oregon. Weather for the winter months and for the second quarter was much colder than average. Colder weather depletes our storage inventories at rates faster than planned. In addition prices for natural gas, like oil, have continued to climb. Despite the recent pullback in natural gas prices lately our purchases so far this year have been above those assumed when the PGA or our purchased gap adjustment mechanism was set last November. Over the past 20 years of the Oregon PGA incentive sharing mechanism that the incentive sharing mechanism has been place our hedge positions have fluctuated. Over the past several years we have tended to pay at the 90% level but were at a 75% to 80% level for the past two heating seasons.

Last year as Mark indicated we reported record gains for customers and shareholders. This year our year-to-date results reflected commodity cost losses of $5.8 million of which $5.5 million was reported in the second quarter. This compares to record gains of $10.6 million for the 2007 year-to-date period. Today and importantly we have managed to offset the majority of these losses with higher residential and commercial margins, lower expenses and a gain on sale of a non-utility asset in the period. In Washington where we have about 10% of our customers, all gas costs are passed through to customers.

As we discussed last quarter we continue to work to modify the structure of our current PGA in Oregon. We along with the OPUC staff, other Oregon gas distribution companies, and a consumer group filed a stipulation and testimony in support of a modified PGA mechanism. The proposed mechanism contemplates that each year each gas distribution company would elect a sharing ratio for the subsequent year, either the current two-thirds/one-third sharing ratio or perhaps 80/20 or 90/10. It also uses first-of-the-month index prices to establish a WACOG benchmark versus our current practice of an annual benchmark set November 1. Obviously any change in the mechanism like this is complicated which has resulted in this taking longer to resolve than we first anticipated. One customer group has declined to join the filed stipulation. We believe the proposed mechanism better aligns customer and shareholder interests. If the proposed mechanism is not adopted, we will likely request an interim mechanism for the coming PGA year. We believe the OPUC will adopt changes to the PGA mechanism before November 1 that will better align customer and shareholder interests. If for some reason the decision is delayed or not reached, we have the ability to address this issue by increasing our hedge position for the coming PGA year at a level higher than our current target of 75%.

Turning back now to the quarterly results, the company also earned $2.5 million from gas storage in the quarter which was down from $2.7 million last year. Other non-utility activities resulted in a gain of $1.5 million for the quarter compared to a small gain last year. In April we completed the sale of our Boeing 737 airplane that has been leased to Continental Airlines since 1987. Cash proceeds from the sale of $6.8 million resulted in a $1.1 million after-tax gain in the quarter. This marks the last significant sale of non-core assets which we have been able to convert into cash as planned since 2005. The company also sold solar electric generating systems and wind power electric generation projects between 2005 and 2007. These sales allow us to concentrate on our core utility gas storage and gas transmission pipeline activities going forward.

O&M expense for the second quarter of 2008 decreased 9% over the same period last year. The lower expense in the second quarter of 2008 was largely due to reduced employee related expenses including lower incentive accruals due to reduced results. In addition we continue to keep our eye on bad debt expense which remains well below 1% of revenues at 0.31% of revenues for the 12 months ended June 2008.

Turning to year-to-date results through June 30, net income was approximately $47 million. That compares to $51 million last year or 8% lower. Of that total utility operations earned almost $40 million compared to $46 million last year due mainly to high gas costs versus record gains last year. We also earned $4.9 million from our gas storage activities compared to $4.5 million in 2007 while our non-utility activities resulted in a net income of $1.8 million versus $200,000 last year mainly due to the gain on the sale of the airplane I just mentioned. Total gas sales and transportation deliveries in the first six months of 2008 excluding deliveries of gas for others were 712 million therms up 10% from last year. This was due to higher residential and commercial customer growth combined with the weather in the period that was 11% colder than last year and 11% colder than normal. As reflected in the quarter O&M costs for the six month period were 5% lower than in 2007 primarily related to lower payroll and employee expenses incurred in the current period including reduced incentive accruals. Cash provided by operations at June 30 was $138 million compared to $180 million in 2007. The lower cash flows reflect lower operating results mainly driven by higher gas costs in 2008 compared to the record commodity cost savings last year. Cash requirements for investing activities at June 2008 totaled $47 million in the period and that’s down from $53 million in the same period last year. The decrease mainly reflects additional business development costs for the Palomar Pipeline and Gill Ranch storage projects offset by proceeds from the sale of the non-utility airplane investment and last year’s investment and storage expansion at our Mist storage facility.

Our overall financial condition remains strong with a capital structure made up of 51.6% common equity, 42.4% long-term debt, and 6% short-term debt at quarter end.

Turing to our earnings guidance, we reaffirmed today our prior estimate that full-year earnings per share in 2008 are expected to be in the range of $2.48 per share to $2.63 per share. Our estimate assumes normal weather for the remainder of the year, continued customer growth, benefits from the cost reduction initiatives, no significant changes in current regulatory policies, and no estimate of future gains or losses from our PGA sharing mechanism since we are unable to predict future gas cost increases or decreases with reasonable certainty. To the extent that gas costs remain above levels set in our purchased gas adjustment mechanism, the company could recognize additional gas expense. The company continues to target long-term earnings per share growth of 5% or more and to maintain dividend payout ratios at 60% to 70% of earnings.

With that here’s Mark to wrap things up.

Mark S. Dodson

You’ve heard us talk about our successful efforts to improve customer service and streamline our operations. An important part of these efforts is the deployment of automated meter reading. Last year we finished Phase 1 which automated 250,000 meters. That portion of the project was completed on time and under budget and is working very well. Next month we start retrofitting the remaining 375,000 meters and we expect to complete the project in 2010. Overall costs for the project are anticipated to be approximately $30 million. We will be seeking recovery of our costs for this project from regulators in the future rate proceedings.

On the business development front we continue to make progress on Gill Ranch and Palomar. These two major projects build on our core strengths and they also position Northwest Natural to play a central role in the West Coast’s energy future. Gill Ranch is our 20 Bcf storage project planned near Fresno that we’re developing with California’s Pacific Gas and Electric. By early next week we expect to file our permanent application with the California Public Utility Commission. Our plan is to have all necessary permits by 2009 to start storage operations by the end of 2010. In preparation for that timeline we recently ordered the compressors for the storage facility locking in current prices.

Also moving forward are plans to develop Palomar Pipeline in partnership with GTN. We continue to gather the route information needed to complete our first application scheduled to be submitted later this year. We also continue to work with local governments to explain the need for the pipeline and provide education on the safety and environmental regulations and practices that will be followed. Oregon is only one of a few states in the nation to rely on a single interstate pipeline to serve its major population areas. Developing Palomar to connect our distribution system to GTN’s interstate system has been a long-time goal of ours. It would diversify our delivery options and enhance supply reliability. Palomar is uniquely positioned among the gas infrastructure projects currently being proposed for Oregon because it could be extended to connect to one of the L&G terminals being proposed on the Columbia River or to a new pipeline from the Rockies.

These days there’s a consensus in the energy community. An economy working under carbon constraints will need abundant natural gas supplies. With new energy projections we feel more confident that we have the correct strategic decision to invest in natural gas infrastructure.

To close, our operations continue to perform well. Although our gas prices are a challenge this year we remain focused on delivering consistent shareholder returns and providing long-term growth for our company. We appreciate your interest in Northwest Natural and thanks for listening this morning.

While callers are queuing up for questions, let me anticipate a question that I would ask if I was a shareholder and of course I am a shareholder. Basically, bottom line, how’s the economy and the market affecting your business and your future strategy? And I guess I’d make three observations. First of all, I’d ask are your customers paying their bills? As David just said, 0.31% we’ve got a very remarkable record there and we’re monitoring it. Of course it isn’t coincidental that we’ve had good success there. We continue to monitor that.

Second, how’s the economy affecting your growth? Well, as we’ve said for years we have a remarkable market with great possibility for conversions. So while gas prices are up, oil prices are up, and you can buy a high efficiency gas furnace. In fact, if you read the US News and World Report article in May, apparently Portland, Oregon still leads the nation in high efficiency furnaces. Also while construction is slowing, because of the urban growth boundary which we’ve talked about a lot we’re not overbuilt like a lot of other areas. So as the economy rebounds I would expect construction to rise here, maybe faster than some other parts of the western part of the United States.

And third, “What about your long-term strategy in terms of gas infrastructure?” Well as I just said, there is growing consensus in this part of the country that we’re going to need natural gas. Even opponents of L&G acknowledge that we’re going to need gas primarily from the Rockies. And I don’t know whether it’s a commitment to the renewable that the Governor and the legislature have committed us to or just kind of Oregon realism. I think people in this part of the country really feel like they’ve got their feet on the ground but they’re very supportive of L&G. I’ve been in this business community for a long time. I don’t remember an issue where the four major business organizations have moved more quickly than in support of L&G. They sent a letter to the Governor this week. And I think one of the big pleasant surprises for me was our local newspaper, which is probably one of the more environmentally conscious regional newspapers but it reflects the population and its readership, came out with a very strong editorial in support of L&G. So I can’t think of a way that we could have positioned our company to make a better contribution to the region and to our shareholders.

We’ll be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Analyst for Ron Barone - UBS.

Analyst for Ron Barone - UBS

I just had a couple of quick questions here. The first question is with respect to O&M. What do you view your trend rate over the next couple of years? Do you expect it to be ticking down kind of at the same pace you’ve seen in the last two quarters or do you kind of expect it to level off? I was just trying to get some color with respect to that.

David Hugo Anderson

I wish I could tell you we could reduce O&M 9% every quarter going forward but what we started off about a little over two years ago, we’ve redesigned our entire operations. And the goal was to get us into a top four top perspective and we were pretty close to that anyway, so we put long-term plans in place mainly using technology and becoming more of a process focused organization. In our attempts long-term was to make sure that our O&M growth rates were lower than our customer growth rates on a normalized basis and so we’ve been able actually to achieve that for the last couple of years and I think you’ve seen O&M growth rates of 1% and 2%. And for us customer growth rates should be in the 2% to 3%. Probably when the economy comes back we’ll be closer to 3%. So I would be targeting that 1% to 2%. This year’s a little unusual. I’ll remind you last year we had the record WACOG or what we call weighted average cost of gas benefits and we elected to free up some one-time spend of $5 million for system maintenance and reliability. So comparison wise it’s going to be a little difficult this year. And also with reduced results this year we have lower expenses. In general thought, 1% to 2% long-term growth rate would be what we are targeting which would be quite an accomplishment considering inflation, but I feel good about the processes we have in place.

Analyst for Ron Barone - UBS

With respect to the PGA issues, you had a hedging option as a kind of mitigation. Are you able to basically recover all of that and it would just be what’s open that goes to the customers? If you could just sort of give us some more clarity or more color with respect to the impact of how you can mitigate the issues on a go-forward basis, especially given the record high gas prices we’ve talked about?

David Hugo Anderson

What we do every November 1 is we set our price in the PGA mechanism that we start recovering from customers and that includes our hedge position, both our financial position and our physical position. For instance when I give you that 75% of hedge position, about 15% is from our physical storage facility. So where there’s a 25% unhedged position, actually our PGA also prices that as a forward curve at the time so as long as we make purchases during the year that are below that forward curve level set on the unhedged position is when we can save customers money and also produce shareholder gains. A lot of this is determined on volumes which is obviously whether you have a great cold winter or a warm winter in terms of how many volumes you have to purchase. So for us going into a PGA year it’s important to set the hedge level at the level that appropriately balances customer and shareholder risks. And in past years it’s been 90% as I indicated earlier. We believe in this market 75% is probably better for customers but if you do that you take a higher unhedged position. We need to adjust the PGA sharing mechanism from a two-third/one-third to some other type mechanism as I indicated just to balance out the relationship between the shareholder and the customer. And what I was trying to get across is if for some reason things are delayed down at the PUC and we don’t get the decision or the decision comes out a little bit differently, we can address that unhedged position or exposure if you will by hedging more. And you would simply just do that in the financial markets with swaps and options and things like that. Is that responsive?

Analyst for Ron Barone - UBS

Absolutely. One last clarification. You reaffirmed your guidance today. Can I assume that’s on a GAAP basis and also includes the sale of the airplane in there as well, too?

David Hugo Anderson

Yes it does.

Operator

Our next question comes from James Lykins - Hilliard Lyons.

James Lykins - Hilliard Lyons

A couple more margin questions. First of all I was wondering if you could give us a little more color on what the employee related expenses were and the reduced incentive accruals? And I was also wondering if you could give us some kind of feel for how much can be attributed to margin improvement with the AMR program? I know you’re going to go from 262,000 to 375,000 additional meters. Can we get a feel for how much that’s going to improve O&M?

David Hugo Anderson

On the employee expenses, if you eliminate employee accruals, basically O&M was about flat for the quarter. That included lower payroll expenses and included lower pension expenses, but the main driver was lower incentive accruals for the period versus the prior period. Regarding your margin improvement on the AMR system, we just started the second phase of the AMR system which is going to be around a $30 million capital project. Probably $7 million to $10 million of that capital project will be expended this year and then the remainder in the 2009 with completion in the 2009 period. We are going to seek regulatory recovery of that. Jim as I think you recall, Phase 1 of that the first 250,000 or so meters we did on our own but Phase 2 is putting meters in place in an area where we’ve had a joint meter-reading effort with a local utility. That has been quite cost effective so it’s important for us and we’ve talked to the regulator to get recovery from this and we will be filing for that. So in terms of margin we would like to do this in a simple form as a tracker that would just track it like you would a rate-based type item. And we’re still working through the process on whether the $7 million to $10 million in this year will be tracked in or it’ll be at the completion of the project. We have not gone into those details with the regulator yet.

James Lykins - Hilliard Lyons

Customer growth. At 2.5% you guys are definitely at the higher end of your peer group, but I’m just wondering if you can give us a feel for how you see that trending over the rest of 08 and into 09?

Mark S. Dodson

I expect Jim that we’d be closer to the 2% than the 3% going forward but it’s very hard to know of course going forward. But I think as the economy picks up, we talked about the urban growth boundary, we’re not in the same situation let’s say that Phoenix or Las Vegas or other places are in where we’re not overbuilt. I would expect that to pick back up again just the way it has over the last 20 years.

David Hugo Anderson

I’ll remind you that we have new customer growth and conversion opportunities in our area and actually conversions right now for us are running ahead of schedule because propane and fuel oil are at a much higher cost than natural gas, so we’ve got an advantage there. And I think one of the reasons like Mark says we are still anticipating 2%, I think the 2.5% you have to factor in we had a very cold second quarter and probably because we do have customers that disconnect during the summer months and I think they just held off some of those disconnections. So I hope we’re higher than 2% but our internal plans have us coming down to around 2% at year end, which I still think will be twice the national average by that point in time.

James Lykins - Hilliard Lyons

Can we also get the mix for the organic versus conversions for the quarter?

David Hugo Anderson

Exactly. The conversion market has been doing very well and that’s quite frankly a benefit of the ops model our restructuring that we’ve talked to you about. It was not just about cost, it was about how we could do business better and try to gain additional revenues and this is the outcome of that review.

James Lykins - Hilliard Lyons

Do you know what the actual mix was between organic versus conversions for the quarter?

David Hugo Anderson

I think it was about 60% / 40%. We’ve been typically 75% / 25% but I’m thinking we’re about 60% / 40%. I’d probably have to go back and get a little more detail on that Jim.

Mark S. Dodson

It’s trending more toward conversions in the direction it’s going Jim.

Operator

Our next question comes from Analyst for Zach Berger - Bank of America.

Analyst for Zach Berger - Bank of America

I know you’ve been able to keep your bad debt expense down to I think you said it was about 0.31% of revenues for the quarter. If you need to raise the gas rates going forward anywhere up to a 40% increase, what’s your view on bad debt expense given that type of increase in rates, and what are some of the things you can do to kind of help mitigate an increase in bad debt expense?

David Hugo Anderson

That’s a great question . We were just actually reviewing this with our board yesterday and if you look at our results overall since 1999, actually our bad debt expense has gone down during that point of time despite overall prices tripling for the customer. So we’ve already had some experience here in a pretty substantial increase in commodity markets. But I think you’re exactly right when you have a pretty large price increase in front of you, you have to be very concerned about that. We actively use payment plans which we’ve had very very good history with payment plans. It just kind of equalizes the payment over the entire 12-month period. So we’ll continue to watch this very carefully. Certainly I think this is also an area that you have to be very diligent and very quick to respond that when a customer gets behind, you proactively reach out to that customer to try to help them out. And then ultimately you have to be very quick on the draw if you need to disconnect a customer that is no longer paying their bills. And that’s just a function of just good strong hard work and manual labor behind the process. I will remind you though that we do have a little bit of a tracker mechanism with our PGA overall that if bad debt expense goes up, the gas portion of the bad debt part of the bill which is roughly two-thirds, actually a little higher than two-thirds now will be adjusted in the next PGA cycle. So we have some exposure but overall it’s a fairly nominal exposure. But we’re still continuing to watch it very very closely.

Analyst for Zach Berger - Bank of America

So it would take about a year to recover that through the tracker that you just mentioned?

David Hugo Anderson

If it goes up, yes you would wait until the next November PGA tracker to kind of work that in.

Analyst for Zach Berger - Bank of America

With respect to Gill Ranch storage and Palomar, specifically we’ve seen a lot of labor and materials cost escalation throughout the industry and I know for Gill Ranch storage you had mentioned that you bought compression so you were able to lock in some of those prices. What other types of things have you done to maybe help mitigate some of this cost escalation and in particular how are you looking at labor costs?

David Hugo Anderson

I’ll start on Gill Ranch and you’re right, we did buy the compressors. Thos have been locked in at 2008 prices. Obviously when you do a project like this you have contingencies built in for all sorts of issues. You are absolutely correct that steel is probably the biggest variable out there for us and that is an item we’re still looking at and that is an exposure. When we built our original project estimates we took into account certain things possibly not being right and steel prices were one of those. So we’ll continue to evaluate that and at the appropriate time we will buy the steel and move forward with that. Palomar is just in the permitting stages right now , so for us to be locking down steel prices or doing anything else at this point of time would not be a prudent move.

Analyst for Zach Berger - Bank of America

And what about thoughts on labor for Gill Ranch?

Gregg S. Kantor

Really we’re at the point now where we’re starting to look at those costs. We’re actually going through a very comprehensive cost review that we expect to have done in the next month or so. We’re doing work in an area that is pretty hard hit economically and we’re going to do our best to use labor from that area, so we’re feeling pretty good. Labor is not a cost that we’re as concerned about really as the steel prices.

Operator

Our next question comes from Dan Fidell - A.G. Edwards.

Dan Fidell - A.G. Edwards

Can you give us any kind of additional specifics in terms of timing for recovery of AMR costs? Is that something you’ll need a formal general rate proceeding for or is that just a one off filing?

David Hugo Anderson

We’re just now starting the project and as you recall we have a rate case moratorium here in Oregon when we extended our weather and our decoupling until 11/2012 time period but one of the items that we put in there was the ability to have AMR as a supplemental item that we would file for. As I indicated earlier probably $7 million to $10 million of capital this year and the remainder call it $20 million in 2009 that we would add and subtract in. Alex, do you want to talk a little bit about our thoughts on how we would file them?

Alex Miller

It would be a one off filing and we’re working with the parties now to develop the shape of that filing. We’ve had some very good meetings with the parties so we would expect it to be one off filed sometime this year and hopefully put in rates sometime next year.

Dan Fidell - A.G. Edwards

Maybe you could give us just a quick update in terms of the status of the Washington rate case and where we stand in terms of a potential decoupling and just a general update on that case?

Alex Miller

The case remains in its discovery phase so we’ve been answering data requests, so we don’t really have any indication of where the parties are right now. The next milestone date is the settlement conference in late September. We’ll get the intervener’s filings in late October. We’ll respond in late November. And if we don’t reach settlement, which we hope to do earlier, rates will go into effect on March 1 of next year.

Mark S. Dodson

Both of us have a real commitment to decouplings. The National Association of Regulatory Commissioners had their annual meeting here in Portland this week and the National Resource Defense Council and [Cheryl Carter] from that organization, I represented the AGA made a presentation to the entire NARC on decoupling and direct use of gas which was very well received. So we’re still seeing a trend in that direction nationwide. In fact I was quite surprised at how well received it was by the Commissioners this time.

Dan Fidell - A.G. Edwards

Will share repurchase activity remain part of your strategy for the remainder of 2008?

Mark S. Dodson

The Board did re-up the program. I think as you saw earlier and we were pretty accurate last year and the year before on share repurchases. Right now with the capital projects that we have in front of us as soon as the successful completion of those, we are going to probably not purchase shares in the open market as we move forward on those projects.

Operator

Our next question comes from Greg McGowen - Sedodi and Company.

Greg McGowen - Sedodi and Company

On the gas cost sharing mechanism, do you think there’s a chance to get that decision on restructuring that mechanism prior to November 1?

Mark S. Dodson

Yes, I think we do. We’ve been doing this for quite a while and it’s taking a little bit longer than we thought, but it’s a complicated process and there are a lot of parties including other utilities involved. I do believe and we believe in general that we will have something by November 1.

Greg McGowen - Sedodi and Company

How did the open season go for the Palomar Pipeline? Can you give us some color there because I think there was a second open season that was held?

Gregg S. Kantor

It went as we expected. We’re not going through the specific results of it but again we had the second open season because there’s been a lot of activity with other pipelines and we wanted to make sure people really understood that Palomar is there and moving forward. And we were encouraged by the results, continue to be encouraged, and our permitting process continues to move forward as we had hoped.

Greg McGowen - Sedodi and Company

I think I saw an article somewhere about that [Bradwood] being the only facility that might not be put into service until sometime around 2013. Should we kind of push back our expectations as to when Palomar should come to service?

Gregg S. Kantor

Well it’s not our project so we haven’t changed our view of when it might come into service and there’s a lot of speculation about it. All I know is that the supporters of the project feel pretty good about it, the FDIS was released about a month ago, it was actually scheduled to be on the first docket for last week and it was pulled at the last minute, but they are very confident, the supporters of the project, that they’re going to get their license. When exactly it gets built, there are still a number of state permits that need to be gotten as well as the federal license. So I think it’s probably too hard to be or not possibly but very certainly exactly when that in service date will be.

Greg McGowen - Sedodi and Company

I’m assuming that the gain on the asset sale is in the other income line?

David Hugo Anderson

Yes.

Operator

Our next question comes from Eric Beaumont - Kopia Capital.

Eric Beaumont - Kopia Capital

You did say that your guidance for the remainder of the year does include the $0.04 from the aircraft sale?

Mark S. Dodson

Yes, and it also includes the losses year-to-date that we’ve experienced in the WACOG mechanism.

Eric Beaumont - Kopia Capital

Understood. I strip those out generally as I did the figures here. I’m just trying to get an idea for normalized going forward and comparative purposes. Secondly, in Washington, you have some things are going but can you talk about, obviously we’re not sure where things are going to end up, but given where weather was and it seems like you have a pretty good argument for the decoupling from this quarter, I would think it strengthens the argument. Can you talk a little bit about where you saw margins go given the weather in this past quarter from Washington in particular?

David Hugo Anderson

Margins were higher. I don’t know if I have those at my fingertips. Weather for Washington it was a little bit higher and we only have 10% of our customers there. I’m sorry, I don’t have those numbers at my fingertips.

Mark S. Dodson

But Eric you’re correct. The argument against weather normalization is it’s always kind of a takeaway and certainly this year it was a big giveback to the customer so this is an excellent time to make that argument.

David Hugo Anderson

Just to kind of back into it, again we can get you some Washington numbers, but Oregon rate pairs overall saved over $15 million for the year-to-date period based on weather and decoupling. So I give you a number that’s representative of 90% of our company to help extrapolate to that 10%. I’m sorry I don’t have the Washington numbers.

Mark S. Dodson

And Eric, on the guidance I just want to make sure you understand with the airplane, we’re not moving guidance because of the airplane. We originally did our guidance and did not assume the sale of the airplane. So it’s just a positive that’s helped offset some of the losses we’ve incurred to date on the WACOG.

Eric Beaumont - Kopia Capital

In going forward, as I think about some movement [inaudible], you have the compressors and when Palomar comes in, how should I be thinking about the cost pieces? Is it all capitalized and should I be thinking about any interest bits while things are going forward or how will things be booked with [inaudible] or kind of equipped during construction phase, how should I consider those cash flows and earnings pieces?

David Hugo Anderson

Both of those will be capitalized, both Palomar and Gill Ranch. Gill Ranch is obviously the one that’s on a more accelerated timeframe with most of the capital expenditures occurring in 09 and 10 because we’re targeting a late summer start-up of Gill Ranch. And during that period of time full AFUDC will be booked and accrued to help offset some of the capital costs. Palomar, Gregg just kind of gave you an update on the open season. Right now we’re in the permitting stages. All of the costs of those will be capitalized and again AFUDC will be booked on those also.

Eric Beaumont - Kopia Capital

Can you just so we can do kind of a better job next quarter let us know A) what’s in the current PGA as far as WACOG and what is the bogey you guys are shooting for even given where gas has moved?

Mark S. Dodson

I’ll give you a little bit. The first question really comes down to the hedge position and as I indicated our overall hedge position is roughly for the year around 75% or so and as you would anticipate Eric, we would hit more in the winter months and a little bit less in the summer months so that’s where most of the exposure is. But we probably have 1 million to 1.5 million therms that are exposed right now in the unhedged position and so prices in the PGA are a little bit on a rough number above $7.00 or right around $7.00 and change. So we have a little bit of exposure right now but gas prices continue to come down. The good thing is in July, August and September there’s very little volume. The only thing I’ll caution you on is October. October in this part of the country can be very warm or it can be a little bit cold so we have a little bit of variability there. But I think where we’re at with current gas prices, I still think we’ll be within our guidance range barring obviously holding other things in neutral on the operations when I make that statement. Is that responsive:

Eric Beaumont - Kopia Capital

Yes, that’s helpful.

Mark S. Dodson

It doesn’t sound like we have any other people in the queue. I want to thank everybody for joining us this morning. Everybody have a good weekend. Thank you guys.

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Source: Northwest Natural Gas Company Q2 2008 Earnings Call Transcript
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