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Enterprise Products Partners L.P. (NYSE:EPD)

Q2 2008 Earnings Call

July 24, 2008 10:00 am ET

Executives

Randy Burkholter – Vice President, Investor Relations

Michael Creel – President, CEO

Randall Fowler – Chief Financial Officer

Richard Bachmann – CEO, Duncan Energy Partners

James Lytal – Executive Vice President

James Cisarik – Senior Vice President

Jim Guy

Dan L. Duncan - Chairman

A. J. Teague – Executive Vice President, Chief Commercial Officer

[Chris Goode]

William Ordeman – Executive Vice President, Chief Operating Officer

Analysts

Mark Reichman – Sanders, Morris and Harris

Michael Bloom – Wachovia

Darren Horowitz – Raymond James

Sharon Lui – Wachovia

Brian Zeran – Lehman Brothers

Xin Liu – J.P. Morgan

John Edwards - Morgan, Keegan

Louis Shamie – Zimmer Lucas

Operator

Welcome to the Enterprise Products conference call to discuss earnings for the second quarter of 2008. (Operator Instructions) I would now like to introduce your first speaker, Mr. Randy Burkholter, Vice President of Investor Relations.

Randy Burkholter

Mike Creel, Enterprise's President and CEO will lead the call today followed by Randy Fowler, the company's Executive Vice President and CFO. Also included on the call today from Enterprise is Dan Duncan, our Chairman and Founder, as well as other members of our senior management team. Also, Hank Bachman will lead a discussion on our Duncan Energy Partners earnings today. Afterward we will open the call up for your questions.

During this call we will make forward-looking statements within the meaning of section 21-E of the Securities and Exchange Act of 1934 based on the beliefs of the company as well as assumptions made by and information currently available to Enterprise's management. Although management believes that the expectations reflected in such forward-looking statements are reasonable, they can give no assurance that such expectations will prove to be correct.

Please refer to our latest filings with the Securities and Exchange Commission for a list of factors that may cause actual results to differ materially from those in the forward-looking statements made during this call. And with that, I'll turn the call over to Mike Creel.

Michael Creel

We had another quarter of record operating and financial results supported by a strong performance by each of our business segments. As we noted in the press release, this is the third consecutive quarter for our pipeline to transport in excess of 2 million barrels per day of natural gas liquids and 8.5 trillion btu's per day of natural gas. Also for the third quarter in a row, we fractionated more than 400,000 barrels per day of natural gas liquids.

We benefited this quarter from volume in cash flows related to new assets and expansions we completed in the last 12 months. The Meeker and Pioneer gas processing facilities which were completed in the fourth quarter of last year and the first quarter of this year respectively, contributed about $75 million to gross operating margin this quarter and the Hobbs and GL fractionator completed in the third quarter of last year generated $9 million in gross operating margin this quarter.

Gross operating margins from the Mid America/Seminole NGL pipelines was $77 million this quarter, a 61% increase over the second quarter last year, driven in part by the 50,000 barrel per day expansion of the Rocky Mountain leg in the Mid America pipeline which was completed late last year. Despite being down, our operating had reduced volumes for 66 days during the quarter due to repairs, Independence Hub and Trail contributed $12 million of gross operating margin this quarter.

These strong operating results underscore the benefit of our geographic and business diversification especially since gross operating margins this quarter was $52 million lower than it otherwise would have been due to lost opportunity from the down time and repair expenses associated with the Independence project and the Pioneer gas processing plant.

About $43 million of this was related to Independence which was taken out of service for repairs on April 8 and then returned to partial service on June 3, and full service on June 14. Pioneer was out of service for 24 days in April for repairs.

Nevertheless, this was our second consecutive quarter of record gross operating margin and record net income and our third consecutive quarter of record EBITDA. We have $535 million of gross operating margin and for the first time, exceeded $500 million of quarterly EBITDA at $506 million. Adjusting for earnings and distributions from unconsolidated affiliates EBITDA was $515 million for the second quarter.

Distributable cash flow totaled $375 million this quarter after excluding gains and losses associated with interest rate hedging activities. Even with the loss on these hedges, distributable cash flow produced 1.4 times coverage of the $0.515 distribution we declared with respect to the second quarter this year. We retained approximately $86 million or $25% of our distributable cash flow this quarter, while still increasing the quarterly distribution rate by 6.7% year over year.

For the first six months of 2008 we've retained $212 million of distributable cash flow which provides us with flexibility to reinvest in growth capital projects and reduce debt and further reduces our need to access the capital markets. We believe this is very important with our limited partners, given the current volatility in the capital markets.

Turning to our business segments, each of our four business segments reported higher gross operating margins this quarter compared to the same quarter of last year. Our NGL pipelines and services segment benefited from strong overall demand for NGL's from the petrochemical and refining industries, reporting a 52% increase in gross operating margin in the second quarter to $318 million. Each of the businesses in this segment reported higher gross operating margins this quarter compared to the same quarter of last year.

NGL demand for petrochemical production was strong in the second quarter despite annual turn around's in several methane tracking facilities, ethylene steam crackers produced an annual rate of 54 billion pounds or an operating rate of approximately 88% and in June, the operating increased to 89%. This high operating rate coupled with natural gas currently priced at approximately 47% of crude oil on a btu basis, resulted in ethane, propane and butane continuing to be the preferred B stocks.

According to the Hodson report, ethane B stock consumption by the U.S. ethylene industry increased at the highest levels this year, averaging 812,000 barrels per day in the second quarter of 2008 compared to 749,000 barrels per day in the second quarter of last year.

Our natural gas processing business posted a 92% increase in gross operating margin of $196 million in the second quarter of 2008 as a result of strong processing margins and increased volumes. About $74 million of the increase was from the Meeker and Pioneer processing plants. If Pioneer had operated for the full quarter, gross operating margin would have been higher by approximately $9 million.

This month, Meeker has been extracting an average of 30,000 to 31,000 barrels a day of NGL's on gas volumes of about 600 million cubic feet a day while Pioneer is averaging 29,000 to 30,000 barrels per day of NGL's on volumes of about 650 million cubic feet a day. Construction is well under way on Meeker 2 which should double the inland capacity at the Meeker complex to 1.5 billion cubic feet a day and should increase the liquid extraction capability to approximately 70,000 barrels per day. We expect this expansion to be completed in the fourth quarter of this year.

Our processing business benefited from strong gas processing margins this quarter. We have taken steps to preserve the attractive margins we've had by hedging approximately 80% of the NGL's we expect to extract from our Rocky Mountains plants during the remainder of this year, and about 58% from our expected 2009 NGL production from these plants.

We also had increased gross operating margins in this quarter from our South Texas and [Chacho] plants due to improved gas processing margins and higher volumes. Increased drilling activity in South Texas has resulted in more natural gas being processed by our plants in that region.

We've completed several expansions and are in the process of expanding other plants in South Texas that in the aggregate will increase our gas processing capacity by about 15% over what it was a year ago, adding an additional 250 million cubic feet a day of gas processing capacity. We've also renegotiated roughly one third of our contracts that extended the terms for approximately 550 million cubic feet a day with major producers through 2012 to 2014.

Gross operating margin from our NGL pipelines and storage business increased to $94 million in the second quarter of 2008 and that's a 42% increase over the $66 million reported in the second quarter of last year. This increase was due primarily to a $29 million increase in gross operating margin from the Mid America and Seminole pipelines. Mid America pipeline benefited from 114,000 barrel per day increase and NGL volumes and higher revenues due to a system wide tariff increase.

Gross operating margin from the NGL fractionation business was $27 million this quarter compared with $21 million reported in the second quarter of last year. This business benefited from the addition of the Hobbs NGL fractionator which began service in the third quarter of last year.

Our onshore natural gas pipeline and services business reported a 48% increase in gross operating margin to $123 million for the quarter, compared with $83 million for the second quarter of last year. Most of our natural gas pipelines recorded improved results this year.

Gross operating margin for the San Juan system increased $18 million this quarter, primarily due to higher transportation fees that are indexed to natural gas prices as well as from NGL and common state sales. The Texas intra system was up $9 million due to increased volumes and higher average transportation and reservation fees.

The Acadian gas system in Louisiana reported a $5 million increase and our share of the Jonah Gas gathering system was up almost $4 million. In addition, natural gas storage reported an increase of $2 million, primarily from new capacity and pipeline fees at [Pedal].

Gross operating margins for the off shore pipelines and services segment was $35 million in the second quarter of 2008 compared with $31 million in the second quarter of last year. Independence contributed a net $12 million to gross operating margin this quarter, consisting of about $19.5 million from the Hub platform offset by a loss of $7.7 million from the pipeline which includes $14 million of repair expense. As I mentioned earlier, the pipeline and the platform were out of service for about two months in the quarter for repairs.

Gross operating margin from the oil pipelines was up $16 million quarter to quarter primarily due to Enterprise's 50% ownership interest in the Cameron highway oil pipeline which benefited from 119% increase in transportation volumes and the retirement of project debt in the second quarter of last year.

Our petrochemical services segment turned in another solid quarter with 16% increase in gross operating margins at $58 million. The butane [inaudible] business continues to perform well benefiting from strong demands for high purity butane and the increased value of byproducts.

We're very pleased with our performance this quarter, setting new operational and financial milestones as well as retaining a significant amount of distributable cash flow to provide us with additional financial flexibility. Our latest distribution increase was our 16th consecutive quarterly increase and the 25th increase we've had since our IPO of 10 years ago.

The outlook for the remainder of 2008 continues to look favorable with the Meeker Phase 2 expansion, the Sherman extension still on schedule to be complete and to begin operations during the remainder of this year. We expect the Exxon central treating facility to be completed the fourth quarter this year and to begin operations in the first quarter of 2009 along with our [Senzioa] pipeline.

We're also pursuing a number of other opportunities to develop additional growth projects that would be completed and begin operations in 2009, 2010 and beyond. With that I'll turn the call over to Randy Fowler for a financial review of the quarter.

Randall Fowler

I'll pick up where Mike stopped and briefly discuss the income statement items below gross operating margin. Depreciation and amortization expense increased to $136 million in the second quarter of 2008 from $121 million for the second quarter of 2007 primarily due to increased property, plant and equipment from the additions of Independence, Meeker, Hobbs, the [Maple] expansion, Pioneer and the propylene fractionater that we put in service last year.

G&A expense decreased to $24 million this quarter from $31 million in the second quarter of last year. If you recall the G&A expense for the second quarter 2007 included approximately $10.5 million of executive severance costs.

Interest expense, in looking at that we reported $96 million of interest expense this quarter compared to $71 million for the second quarter of last year basically on higher average debt balance, average debt outstanding including 100% of our hybrid securities was $7.6 billion this quarter compared to $5.9 billion for the second quarter of last year.

At the same time capitalized interest decreased $2.8 million this quarter compared to last year due to a decrease in construction work in progress as these new projects have come on line.

The provision for income taxes was $7 million for the second quarter of 2008 versus a credit of $2 million for the second quarter of 2007. This increase was due to higher Texas margin tax accruals and higher corporate taxes at the Fort Dixie pipeline company.

Turning to capital expenditures, we invested $425 million in growth capital projects and spent $44 million in sustaining capital expenditures in the second quarter of 2008. The majority of the capital spent during the second quarter of 2008 was attributable to the Sherman extension pipeline, the Meeker [inaudible] plant, the Exxon central treating facility and the [Shindsey] oil pipeline.

Through the first six months of 2008, we've invested approximately $1 billion in growth capital expenditures and spent $69 million in maintenance capital expenditures. Based on our current slate of projects, we are still on tract to invest approximately $1.6 billion to $1.7 billion on growth capital projects this year and between $175 million and $200 million in maintenance capital for the year.

At June 30, 2008 we had $7.7 billion of debt including 100% of our $1.25 billion of junior subordinated hybrid securities and $218 million for DEP's debt. DEP had liquidity at June 30 of approximately $1.3 billion. Our floating interest rate exposure was approximately 15% at the end of the quarter and the average life of our debt was 17 years with an effective average cost of debt of approximately 5.8%.

A key credit metric for Enterprise is our consolidated leverage ratio of debt to last 12 months EBITDA. Consolidated debt includes DEP's debt and is adjusted to exclude 58% of our hybrid debt principal to recognize the average equity content credit given by the rating agencies.

At June 30 our consolidated debt was $7.12 billion. EBITDA for the last 12 months after adjusting for equity earnings and actual cash distributions received from unconsolidated affiliates was $1.77 billion resulting in a consolidated leverage ratio at June 30 of 4.0 times. We've improved this ratio from 4.3 times at the end of 2007 and from 4.5 times at its peak at September 30 of last year. As I mentioned in last quarter's call, we expect for this ratio to continue to improve as we realize a full 12 months of cash flow from our new major growth projects.

Before I finish the call today I'd like to turn it over to Hank Bachmann, President and CEO of Duncan Energy Partners to briefly DEP's discuss the second quarter results.

Richard Bachmann

Duncan Energy Partners had another quarter of solid operating results, reporting a 45% increase in net income to $6.6 million or $0.32 per common unit for the second quarter of 2008, compared to $.45 million or $0.22 per common unit for the second quarter of 2007.

Distributable cash flow for the second quarter of 2008 increased 65% to a record $10.8 million from $6.6 million in the second quarter of 2007. In recognition of DEP's improving businesses, the Board of Directors of DEP's general partner, increased the quarterly cash distribution rate to $0.42 per common unit, a 5% increase from the $0.40 quarterly distribution rate per common unit paid for the second quarter of last year.

The $4.2 million increase in distributable cash flow was primarily a result of higher sales volumes and improved sales margins on the Acadia natural gas pipeline system, including a decrease in losses from lost and unaccounted for gas, increased NGL storage fees and volumes at our Mount Bellevue NGL storage facilities, and lower standing capital expenditures.

As we discussed in our annual report last year, in connection with pipeline integrity work on our Acadian pipeline system, we encountered significant losses arising from lost and unaccounted for gas which had historically not been experienced by the pipeline system. As a result of a great deal of effort over the past year, we've been able to correct the situation and have alleviated these losses.

This quarter, the partnership recorded its highest net income in distributable cash flow since its initial public offering in February 2007. I believe we can continue to post solid results given the attractive markets we serve, our efficient operating system and our affiliation with Enterprise Products and its comprehensive network of integrated assets.

Randy Burkholter

We're ready now to take questions both on Enterprise and Duncan Energy Partners.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Reichman – Sanders, Morris and Harris.

Mark Reichman – Sanders, Morris and Harris

With regard to the three large capital projects that will go into service in the second half, are all three of those slated to go into service in the fourth quarter? Are you able to provide any guidance in terms of what the expected gross operating margin contribution should be in the fourth quarter or address it in volumes context?

Randy Burkholter

As typical for Enterprise, we haven't given guidance on the company in general, we don't give guidance on specific assets. We do talk about the margins in the area, the volumes that are there.

James Lytal

We expect within a couple of months of Meeker 2 coming up, we'll have a couple hundred million a day in Meeker. We expect that we will improve our ethane recoveries by virtue of the fact that we'll be able to run both plants together in the interim at an optimum level and we expect the volume to ramp up as we've got a number of projects within the [Beyonce] basin that's going to enhance the flow of gas to that Meeker plant.

In terms of margins, if you look in the fourth quarter of '08, in the Rocky Mountain area you're seeing margins in the [inaudible] and the Rockies on a composite perspective in the fourth quarter anywhere from $0.75 to $0.95 a gallon gross processing spread, so we expect pretty strong margins to continue through the year.

Randy Burkholter

We've got James Cisarik to talk a little bit about Sherman extension. You want to just talk a little bit about what you're seeing in the Barnett Shale and what you think the ramp up might look like for Sherman?

James Cisarik

Actually with the Sherman extension we are scheduled sometime next week to put a portion of the Sherman extension in service, so we'll put it in interim service and flow it back into our traditional Enterprise Texas pipeline. As of this time, the full service, we are thinking it'll be in late 4Q when the Gulf Crossing project becomes in service as well. At that time, we're projecting that our capacity will be full and flowing approximately a bcf or slightly more.

Randy Burkholter

And finally, the Exxon central treating facility we expect to have that completed by the end of the year but the volume won't be ready to start flowing until the first quarter of '09.

Mark Reichman – Sanders, Morris and Harris

On the offshore natural gas pipeline business, I noted there were some producers that had shut in wells for work over's, what would the volumes have been at more normal levels, and do you expect that most of that activity is complete?

Randy Burkholter

I'm not sure we can speak to what volumes would have been on more normal times. These aren't exactly normal times. We're parsing new production coming on which is always a good thing but there's always ups and downs out there. We've got Jim Guy on, do you want to talk about any production times that might have been offshore.

Jim Guy

I think most of the production down times that we've seen are due strictly to maintenance that they've performed on their wells, and due to the current prices, I doubt that they'll go ahead and have any gas, but they won't put on as quickly as they can. A lot of the maintenance work is probably going to be curtailed until we see what happens in the winter months or gas prices.

Dan L. Duncan

Let me ask a question to either one of the Jim's. I thought that one of the BP dealers is now flowing and is tied into the first quarter and will keep ramping up either the Atlantis or the big BP fields out there.

Randy Burkholter

The Atlantis field for BP has ramped up. They currently have I think six wells flowing which is currently what they anticipate flowing and so we've seen that on the volumes through Cameron highway, and we're not seeing a great deal of gas but they [inaudible].

Operator

Your next question comes from Michael Bloom – Wachovia.

Michael Bloom – Wachovia

Can you just give us your outlook going forward on what for what the [Peckham] market looks like in terms of demand both domestically and internationally?

A. J. Teague

I think as you heard in Mike's comments as he was reporting on our second quarter earnings, you saw extremely strong petro chemical demand for natural gas liquids in particular for ethane. What we're seeing today is the products we produce overwhelmingly being preferred by petro chemical plants. If you look at cash cost of producing ethylene, producing ethylene on a cash cost basis from heavy liquids like naphtha and gas oil you've lost money relative to the ethylene market price.

The only products that you make money on from a cash cost perspective producing ethylene through the second quarter and continuing today is ethane, propane and normal butane and so we see not only strong demand from those crackers that have had the flexibility to consumer our products, we see increasing demand from those crackers that have traditionally used very little NGL's as they have tweaked their operations to use it, and are making capital expenditures to increase their ability to use it.

Dan L. Duncan

Jim let me ask you a question, and I think they can understand it better if you're dealing cents per gallon rather than cents per pound. The difference on [inaudible]. I think it's probably [ianduble] that goes out every week and shows the differential between the heavy end of the market and the gas hogs and the naphtha versus the light end. Is that $0.20 or $0.80 to $0.90 a gallon?

A. J. Teague

With my petrochemical background, I think pounds I'm thinking ethylene but to convert it to gallons, cents per gallon, Dan's right. You're probably producing ethylene at about $0.80 a gallon cheaper using ethane than you are naphtha or gas oil.

Michael Bloom – Wachovia

Has the overall production of ethylene stayed steady? I guess what I'm trying to get at is are you seeing any reduction in overall demand for the end product given the slow down in the economy.

Randy Burkholter

No. What you've seen in reality with the weak dollar is you've seen quite a lot of as I understand it, a pretty strong export market for ethylene derivative producers.

Michael Bloom – Wachovia

You talked about the potential for a lot of additional growth CapEx projects for '09 through 2011. I wonder if you could just comment about that both in terms of the magnitude of capital you're looking at, what areas or what types of projects you're considering? What level of capital spending do you think you could have in 2009?

Randy Burkholter

We haven't laid out anything specific for 2009, but if you look at the capital expense for the last several years and we have stated publicly that we see $1.5 billion a year easily for the next three to five years. In terms of specific projects we rarely roll out any projects until they're pretty firm. We are working on a number of pipeline projects in the U.S. We've got a number of opportunities that we're looking at in the Gulf of Mexico.

We've got, if you look at the production in the Rocky Mountains, you can see that there's plenty of opportunities left there for further expansion of our facilities. We're continuing to work on our storage assets. It really is across our entire value chain. There's no one specific area that we're really concentrated in.

Operator

Your next question comes from Darren Horowitz – Raymond James.

Darren Horowitz – Raymond James

My first question is on the second Meeker plant. If memory serves correct, I thought that the initial expectation was for the completion date to be somewhere are the third quarter or the end of the third quarter and now it looks like it's going to be in the fourth quarter. Could you give us an update as well in terms of the scale of the cost to complete that plant? If it is pushed back, is there any incremental cost associated with it?

Randy Burkholter

We had really looked at that as a third quarter project but it was late third quarter, now it's early fourth, so it's slipped a little bit.

Darren Horowitz – Raymond James

When you were discussing natural gas storage and you're looking at your asset footprint, can you give us a little more insight into the ultimate goal for your natural gas storage, the type of optionallity or flexibility it could provide and the costs associated with that?

Randy Burkholter

Obviously as we look at natural gas storage we're also looking at the storage market itself and we have some opportunity that we've worked on. We had considered converting some of our caverns at Mount Bellevue but the economics today don't really make sense. It might be something we look at in the future.

From a marketing standpoint, and I'll let [Chris Goode] talk to that a little bit, he looks at storage assets whether we own them or not where it makes sense for us.

[Chris Goode]

We're looking at storage all over the country right now. We're starting to build this marketing company. We like the upper Midwest. We like being closer to the market place. We think there's going to be ample storage here along the Gulf, and that's kind of why we held off in the Mount Bellevue for right now. It looks like there's an over built situation coming on. With the imports of LNG it looks like there could be constraints here to get the gas north and east out of the Gulf Coast. We're looking more that direction, upper Midwest.

Darren Horowitz – Raymond James

One final question, as it relates to Duncan, and you mentioned this is the prepared commentary discussing pipeline integrity issues on the Acadian line, when you're looking more broad based throughout the entire NGL pipeline storage business, are there any integrity issues that you see could be popping up in the third quarter here that we should be aware of?

Randy Burkholter

We really haven't seen a lot of surprises. As we've gone though this it's been a multi-year program that we've been going through and we've gotten smarter each quarter. Let me let Bill Ordemann talk to it.

William Ordemann

I don't see surprises coming up right now. In fact everything this year seems to be going pretty well. We're right on track to what we were going to spend or slightly below and really no surprises that we've come across at all.

Randy Burkholter

I think one of the things that we have done recently is some hydro testing on the Dixie pipeline and that actually came out better than we expected with fewer costs.

Unidentified Corporate Participant

Chris, let me ask you a question on natural gas. From the time that you came up with your business plan last year, Jim Teague had talked about this when we made the decision last year to bring experienced people on to the deal, and give us a quick update on the amount of the number of people that you brought into your group, also, how much total intrastate marketing gas are we handling now relative to the total United States. Do you have that off the top of your head?

[Chris Goode]

In the relative terms we've built the marketing company up to where we're handling about a million cubic feet of gas a day as Enterprise now up from where we were about 500 million to 600 million cubic feet second half of last year. I don't have it in relative terms to the national market, but 58 BCF supplies on a daily basis at this time of year we're running at 1% or 2%. We're rapidly growing. We're focused on mostly working with producers and with the end user direct. We're not in the trading business. We're in the physical merchant business of handling gas, handling it physically, putting it and out of storage and meeting the end needs market.

Unidentified Corporate Participant

We're up to 32 people for me down to through all the scheduling and commercial folks I think there's about eight commercial traders right now, four schedulers, and then the rest are contract admin folks.

Darren Horowitz – Raymond James

And of the 32, how many are new additions versus how many people have you just pulled in from other parts of the organization?

[Chris Goode]

About 20 people have come in from internally and about 12 new people from the outside.

Unidentified Corporate Participant

How much gas touches the Enterprise sales force right now?

[Chris Goode]

I think 8 bcf to 10 bcf a day is what between all of our gathering transmission. That does not include our processing. Our gathering and transmission pipelines, I think we're at 8 bcf to 10 bcf a day.

Unidentified Corporate Participant

We quoted 8.5. I think the main thing we brought this up is that we have developed natural gas as planned type of a business unit just like we do the NGL business plan. We only market gas basically around our own facilities. We're not out taking positions of hedging gas other than to the extent that we do buy gas now. We sell it December. We're really what we call flat foot on natural gas relative the same as natural gas liquids. There's no gambles that we're taking.

That's a hot issue in Tulsa, Oklahoma right now, but we are staying clean. We're not having no type of problems or we're not having those types of problems, and we're building a natural gas, and Chris is doing a super job coming in and moving the natural gas in the same type of format that Jim Teague has always done in the natural gas liquids.

We only trade or we build natural gas around assets which also gives us more transportation volume to our pipeline. That was one of the reasons Duncan Energy and the Acadian guys moved up this year, because he did a lot of business not making actual large margins on his pocket, but he was moving gas through that system.

That was the main reason that Acadia has moved up this year over and above last year. He came in here a year ago. I was just throwing those things forward to make sure you all understand where we're trying to go in natural gas. And we'll go to the next question.

Operator

Your next question comes from Sharon Lui – Wachovia.

Sharon Lui – Wachovia

My question relates to DEP. Acadian's results have been quite strong year to date. I was wondering if you could comment on the incentive margins that you received and whether this is sustainable.

Unidentified Corporate Participant

James Cisarik

The incentive margin on one of our contracts I think average for the last seven years is about $1.8 to $2 million a year of gross profit that's attributable to that. But with that, it ranges from zero to perhaps 3 1/2 or 4. This year that's accounting for $2 million or will by the end of the year. But again, we never really know until the end of the year for the next year if we're going to have any incentive margin, but this year that will attribute $2 million.

Randy Burkholter

Jim it's a pretty high level. You might want to explain what gives rise to that incentive margin.

James Cisarik

Actually what happens on that is under a long term utility contract we have. We're basically graded each month during the year, and that grade is how our weighted average cost of gas is under that contract compared to certain postings in the market place. With that, we do have a grade each month and those 12 grades during that calendar year, our weighted average and that results in a computation of the incentive margin for the subsequent year.

Sharon Lui – Wachovia

Is the benefit for the second quarter from these incentive margins?

James Cisarik

Actually, the benefit in the second quarter compared to last year really included three to four items, one of which Hank mentioned, the alleviation of the LAUF is a pretty significant item. Secondly, we've had opportunities for spot sales in the second quarter. We've positioned ourselves in the gas supply area in order to make those sales to traditional customers that have needed more load during 2Q.

And actually, we're actually starting to see the full result of an initiative we started about 18 months ago where the transportation and sales margins have been increasing. About a year and a half ago we really started initiating those increases and I think you're seeing the full results of those now in 2Q as well.

Randy Burkholter

You might want to touch just a little bit on the initiative you've had looking at your ability to expand Acadia in certain areas and capture additional markets.

James Cissarik

We put a team together about eight months ago and that team has initiated several projects not only expansion and some of the other end users along our system but really even more geared to the expansion of acquisition of supply bases and through puts through the system. We have initiated several new interconnects with some of the interstate pipelines and we're working on several end user locations now to which we're not connected and I think probably in the next six to seven months you'll see the results of those efforts as well.

Sharon Lui – Wachovia

Moving on to potential drop downs, I was wondering if there was any update on your outlook for drop downs to DEP?

Randy Burkholter

From Enterprise's standpoint we are kind of in an enviable position amount MLP's. The business is going great. We've got a very solid balance sheet. As Randy showed you, our financial ratios are in line and improving. We really don't have a need to go back to the capital markets, either that or equity this year.

Obviously we continue to look at our assets as Hank looks at opportunities. No definite time line in place, but as we've stated before it certainly wasn't – the objective was not to do a one off transaction when we took DEP public. The plan was for DEP among other things to help facilitate the growth of Enterprise. So while you may not see anything near term, certainly stay tuned.

Dan L. Duncan

Basically under that particular deal we're probably looking long range and this was our plan before we went into it. It's probably 40% to 60% drop down, probably 40% to 60% including organic and actually buying assets from other type of companies in DEP. We're looking at several different directions for DEP to go, even working with [Tepco] too, we're working both [Tepco] EPD, and DEP. So we feel long range, the business plan that we've formed when we did DEP and we the vote show on it, is very much intact and we plan on staying with that business plan.

Operator

Your next question comes from [Brian Zeran – Lehman Brothers].

[Brian Zeran – Lehman Brothers]

Can you comment on how the cost escalation for construction is impacting your future capital expense plan?

William Ordeman

I don't know at this point if I would say it's impacting our future capital expansion plans. When we look at the economics on these projects, and they're good projects, we're proceeding with them. The cost escalation right now is a little bit volatile. We see steel prices go up, come back down, go back up again. So I think we've seen a moderation of what's going on. We understand some new capacity will be coming on in the steel markets. I think our general expectation is that the rate of increase at least is going to slow if not flatten out on steel.

Labor has been very regional. We've had a few areas where labor costs continue to go up, and others where we don't see that happening and don't see problem getting labor. So it's been kind of volatile. But I guess overall, right now I see it kind of moderating compared to what it's done for the last two years.

Randy Burkholter

For better or worse, we did have a big slug of construction work in progress beginning probably late 2005 and just starting to go into commercial operation in late 2007 so we're past that big slug. Our biggest areas of cost overruns were in the Rocky Mountains with Meek 1 and Pioneer and the returns on those projects far exceeded what we ever thought we'd see, so it's kind of a good news, bad news.

We did have higher costs but the economics are much, much better than we'd expected and all that's starting to show up now in the results that you've seen in the last several quarters.

Dan L. Duncan

I think the industry as a whole, we will not see the missed cost increases as we did from the late 2005, 2006 time frame. I think now we're all up to speed on what our costs are. I think from the industry as a whole right now, we won't see those big misses that we've had for the last couple of years. I think anything we started in the past year, we've stayed on top of, and we've not had cost increases in the last 15 months that we didn't anticipate. So we're not mis-applying our costs relative to the revenue going forward now, like everybody was for about a two year time frame there.

[Brian Zeran – Lehman Brothers]

Can you remind us on your drip, what that contributes to your reinvestment in the business on an annual basis?

A. J. Teague

On an annual basis it's about $75 million to $80 million a year.

[Brian Zeran – Lehman Brothers]

Can you also provide what the cash distribution paid to the GP was in the second quarter?

Randy Burkholter

At the beginning of August it's $36.6 million.

[Brian Zeran – Lehman Brothers]

But the second quarter payment that was made.

Randy Burkholter

It hasn't been paid yet. We pay in August with respect to the second quarter. The payment that was made in May was about $35 million.

Operator

Your next question comes from Xin Liu – J.P. Morgan.

Xin Liu – J.P. Morgan

In terms of your distribution coverage, can you give us your thoughts on how you decide how much cash to be returned?

Randy Burkholter

There's no formula, but as we said before, we do have a fair amount of capital to spend. This is not a time where you want to be going to the equity or debt capital markets if you don't need to, and so our view is that it makes a whole lot more sense for our unit holders and our debt holders if we retain a certain portion of our cash flow to reinvest in the company rather than distributing out and having to back out the next quarter and raise additional equity.

So we think this is a smart thing not only for the debt but also for the equity. We think it provides a better long term return.

Xin Liu – J.P. Morgan

If the capital markets get better will we see that function in terms of your growth?

Randy Burkholter

I think that it's a combination of things. As we get more comfortable with our new assets, as we see how they're going to perform longer term over a longer cycle, as the capital markets get a little more favorable, we probably wouldn't see a need to have a 1.4, 1.5 distribution coverage, but we also wouldn't go down to a 1.05 or 1.0 times. We take a lot of different factors into consideration in determining what the appropriate distribution increase is.

Xin Liu – J.P. Morgan

Can you give us an update on the hedges for your [inaudible] exposure in Meekers and Pioneer for the second half of this year and '09?

Randy Burkholter

For the balance of the year I think in the Rockies if I'm not mistaken we're about 80% hedge and 2009 in the Rockies, we're between 55% and 60% hedged for the year.

Xin Liu – J.P. Morgan

And the price?

Randy Burkholter

In 2009 we're in the neighborhood of $0.75 to $0.80 a gallon but that's driven by the fact that we primarily did our propane plus. The ethane we have done less of. You can go out and look at the forward curve and kind of figure out what the spread ought to be.

Dan L. Duncan

I don't know that Enterprise's hedge is directly to cents per gallon type of deal. We hedge more to natural gas liquids relative to natural gas so how much natural gas liquid we get out of natural gas. So we hedge on what we call the differential between natural gas itself and natural gas liquids, and it doesn't come into play on cents per gallon of actually selling the natural gas liquids. And that's the only true hedge that we have figured out in the natural gas liquid world where you're not doing what we call dirty hedges.

I think all of us in the past have tried to hedge natural gas liquids for crude oil, and we tried to hedge with motor gasoline. The only true hedge we've come up with is the natural gas liquid relative to natural gas which is your cost of all your natural gas liquids. That's the base cost that you start off with.

Xin Liu – J.P. Morgan

How much gross margin contribution is from the gas marketing and which segment do you report the earnings?

Randy Burkholter

We include that in our natural gas segment. We don't break it out separately because frankly it's hard to do that. As Jim Cisarik mentioned, the reason that the Acadian system saw an improvement was because of some marketing effort around that system. They also do some things around our Texas system to improve the transportation volumes. So the marketing gets spread among a long of different segments so we don't try to re-create that in the aggregate.

Operator

Your next question comes from John Edwards - Morgan, Keegan.

John Edwards - Morgan, Keegan

How are you doing relative to the plan?

[Chris Goode]

We're ahead of plan and like I said, we're focused and Dan and Mike have both alluded to, we're focused about physically marketing around this system to make sure we increase through put. This is a physically marketing shot. We physically handle the gas. We do supplement financial hedging with our storage when we don't buy and sell on the open market on a daily basis.

We don't have a sale today, we put it in storage. If we need to make an extra sale today, we pull it from storage and we use appropriate financial tools to make work. This isn't a speculative shot. We currently have around four billion cubic feet of gas in the ground right now with a possible [inaudible] of total capacity that we have leased right now.

Dan L. Duncan

What Chris and what Jim Teague are going for, and Jim is overseeing that department, it's a value chain deal the same as we have in natural gas liquid. Most of Chris' margin that flows back into the Enterprise family is through the value chain and it goes back into the pipeline. So you will continue to see the pipeline groups from all of our different assets, intrastate Texas, intrastate Louisiana and also the other state markets that we're getting involved in. That's where the value is going to show up more so there than it is actually profit and loss as a marketing tool.

He makes two ways. He makes a value chain through those assets, and he also makes profit back end, but it's all vented into that value chain of natural gas just like we do natural gas liquids.

John Edwards - Morgan, Keegan

Any update you can provide on progress with Pathfinder?

Randy Burkholter

We had the open season. We're pretty pleased with the results we've seen in that. We're continuing to work on the proceeding agreements but beyond that we don't have a whole lot that we're prepared to report on.

John Edwards - Morgan, Keegan

Since you've already met your goal for cash vis a vis your target, you're talking about $200 million by the end of the year, you're already above that. Do you have a revised goal now that you've already met the original budgeted target?

Randy Burkholter

No, but it's in a constant state of revision so we'll let you know next quarter what it is. The good news is that it continues to move up.

Just for clarification, our objective this year was $200 million plus.

Operator

Your next question comes from Louis Shammie – Zimmer Lucas

Louis Shamie – Zimmer Lucas

I wanted to drill a little bit more into the margin that you achieved on the Meeker and Pioneer plants in the second quarter. Can you give me the hedged and unhedged margin per gallon that you saw there?

Randy Burkholter

I think what we try to do is break it out in sufficient detail in our earnings release and in our Q but we aren't prepared to go into a long division on specific hedges, specific plants.

Louis Shamie – Zimmer Lucas

In terms of the number that you tossed out, the $0.75 to $0.95 for Q4?

Randy Burkholter

That's on the forward hedges, right.

Louis Shamie – Zimmer Lucas

How does that compare to what you realized in this quarter?

Dan L. Duncan

Around 50 to 60 ball park on our hedges for second quarter.

Louis Shamie – Zimmer Lucas

In terms of hedging for '09 when you quote these $0.75 to $0.85 that you lost on 58% on the volume, first off, are you willing to provide what that volume number is that you used to come up with that 58%?

Randy Burkholter

No.

Louis Shamie – Zimmer Lucas

I think you mentioned you hedged methane a little bit less than the other NGL's.

Randy Burkholter

Obviously when we're looking to hedge, we're looking at the more liquid markets. We're looking at the ones where we think we can lock in the best rates. It's not to say later in the year we might not do something more with ethane.

James Cisarik

The thing is, methane is so backward dated, we just don't believe the backwaration.

Louis Shamie – Zimmer Lucas

I guess the question is when you're quoting $0.75 to $0.85, is that including the proportion of the amount of ethane compared to your production?

Randy Burkholter

We have some of that hedged, and I think what Jim's talking about is in the aggregate, that's kind of the ball park.

Operator

At this time there are no further questions.

Randy Burkholter

Thank you for joining us on our call today. Have a good day.

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Source: Enterprise Products Partners L.P. Q2 2008 Earnings Call Transcript
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