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  • 1. Spectra Energy Corp Q1 2008 Earnings Call Transcript May 6, 2008 Operator Good morning. My name is Molly, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2008 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to John Arensdorf, Vice President of Investor Relations. You may begin your conference. John Arensdorf, Vice President of Investor Relations Good morning, everyone, and welcome to Spectra Energy's first quarter 2008 earnings review. We are very pleased that you've joined us today. Leading our discussion today will be Fred Fowler, our President and Chief Executive Officer and Greg Ebel, our Chief Financial Officer. Also available to take your questions at the end of the call are Martha Wyrsch, President and CEO of Spectra Energy Transmission and Sabra Harrington, our Vice President and Controller. First, Fred and Greg will discuss our quarterly results and provide more color around our strategic plans to enhance the value Spectra Energy delivers to its shareholders. We will then open the lines for your questions. Before we begin, let me take a moment to remind you that some of the things we will discuss today concern future Company performance and include forward-looking statements within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements. You should refer to the additional information contained in Spectra Energy's Form 10-K and in our other SEC filings concerning factors that could cause these results to be different from those contemplated in today's discussion. Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 1
  • 2. In addition, today's discussion includes certain non-GAAP financial measures as defined by SEC Reg G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our Investor Relations website at spectraenergy.com. With that, I will turn the call over to Fred. Fred J. Fowler, President and Chief Executive Officer Well, thanks, John, and good morning, all. As you have seen from our earnings release this morning, we delivered exceptional first quarter results. Greg is going to take you through the numbers here shortly, but the key takeaway is we reported ongoing earnings per share of $0.58, which is more than 50% higher than the first quarter of 2007. As you know, we enjoyed the benefits of robust commodity prices this quarter and a stronger Canadian dollar, but we also experienced continued growth in our underlying businesses. These exceptionally strong first quarter results and our very positive outlook for the rest of the year provide us with a good opportunity to enhance Spectra Energy's value proposition, and an opportunity to reward our investors. You saw that we intend to take advantage of that opportunity on your behalf. This morning, we announced two significant value enhancing initiatives. First, our Board of Directors has approved a share repurchase plan of up to $600 million. We anticipate the buyback to be a combination of an open market purchase program and other transactions such as an accelerated stock repurchase program. The execution of these plans will, of course, depend on market conditions and our stock price over the next several months. Thanks to our strong financial and cash standing, we expect to execute the announced buyback without any additional leverage. Today's actions send a clear message, I think, to financial markets. Spectra Energy's stock represents a great buying opportunity. We also announced that management has recommended to our Board of Directors, an increase in our quarterly dividend from $0.23 to $0.25 effective in the third quarter of 2008. That would make our annualized dividend -- it would take it from $0.92 a share to $1 per share. We would expect to announce the Board's action on this recommendation in early July. When formally approved, this increase together with the $0.04 annual addition in January will represent an increase in the dividend this year alone of close to 14%. We are making these moves from a position of financial strength, driven by profitable growth, strong cash flows, as well as Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 2
  • 3. confidence in our long-term outlook. We will continue to execute on our impressive slate of expansion projects that we have underway as well as those on the drawing board. We have an exceptionally strong balance sheet from which to grow and take advantage of the opportunities that will inevitably arise, and we have the management will to take the kind of value enhancing actions that you are seeing today. Let me turn now to our first quarter earnings. Our first quarter earnings growth and ability to deliver on plan paired with the outlook for continued robust commodity pricing gives us confidence that we will exceed, and perhaps significantly, our $1.56 employee incentive target for the year. As I previously mentioned, all of our segments did perform very well and consistent with our growth expectations. US Transmission is realizing EBIT from the projects that were placed into service last year. These include Northeast Gateway and the Time 2, just to name a couple of them. Distribution continues to enjoy strong growth in its storage and its transportation business, driven by both market dynamics and its mainline expansions on its gas transmission system. Western Canada has a much healthier outlook than we were facing last year. Today, we expect to capture value associated with an improving production and drilling landscape that we're seeing in Northeast British Columbia. And, Field Services made significant progress toward improving both plant efficiencies and increasing volumes. We delivered our strong results in a period of unprecedented industry growth, and as you know, that level of activity has put significant pressure on material, labor and overall project costs. So, before I do turn things over to Greg, I did want to update you on our overall growth portfolio, and specifically the Southeast Supply Header project, which has faced a number of cost challenges. Most recently, we've had above normal rainy weather, as well as a number of workarounds that were related to delayed right-of-way acquisition. They have driven up our costs. We now expect our half of SESH to exceed our previous capital estimate of $500 million. We're finalizing the estimates, but they could be higher by as much as 15 to 20%. As a result of this changing cost environment, we have made several organizational and process adjustments, just to be certain that we're giving this the level of attention that it deserves. Excluding SESH, I think we've done a very good job of cost containment. Since we've shared our 2008 plan with you in January, we've seen projected cost increases of slightly more than 2% on all of our other projects that we have in execution. And, I want to be sure that Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 3
  • 4. you know that we continue to expect returns on all of our projects in the aggregate to be at the mid to upper end of the 10 to 12% range. So overall, our capital expansion plan is well on track. I know that you're anxious for the details around both our earnings and our value enhancements, so I'm going to turn things over to Greg. Gregory L. Ebel, Chief Financial Officer and Group Executive Thanks, Fred, and good morning, everyone. Since Fred has already covered our quarterly highlights, I'm going to drive right into our segment results, beginning with US Transmission. US Transmission reported first quarter EBIT of $226 million compared with $220 million in the first quarter of 2007. The increase reflects earnings from expansion projects, higher gas processing associated with pipeline operations and higher earnings resulting from capitalized interest on construction projects. These increases are partially offset by higher capitalization of project costs in the prior-year quarter versus this year's quarter. Now let me turn to our Distribution business. Distribution reported first quarter EBIT of $165 million compared with $144 million in the first quarter of 2007. Distribution benefited from higher storage and transportation revenues from the completion of expansion projects and higher usage due to colder weather. But, the biggest driver of the variance was the stronger Canadian dollar. These increases are partially offset by higher operating costs including advanced spending for routine integrity work conducted earlier in 2008 than in 2007, higher benefit costs and an increase in the customer energy conservation program, which are ultimately recovered in rates. Now let me move to Western Canada. Western Canada reported first-quarter EBIT of $131 million compared with $74 million in the first quarter of 2007. The increase is primarily due to an improved frac spread that benefited our Empress operations, as well as a stronger Canadian dollar. The Empress frac spread for the quarter averaged $8.13 compared with $4.20 during last year's quarter. Base processing and transportation revenues also remain solid. This quarter we saw relatively stable volumes compared with a year ago. Last year at this time you might recall we were looking at the prospects of reduced volumes in drilling in our western Canadian gathering and processing business. Today, based on strong land sales, the current outlook Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 4
  • 5. is more favorable, and we now expect increased future drilling in the areas of Northeast British Columbia, where our facilities are located. Now let me turn to Field Services. Our Field Services segment, which represents Spectra Energy's 50% interest in DCP Midstream, had a strong first quarter, reporting ongoing EBIT of $192 million, more than double the $85 million in the first quarter of 2007. This increase in earnings primarily resulted from favorable natural gas liquids prices, which are closely correlated to crude oil. Crude oil prices averaged $98 per barrel this quarter versus $58 per barrel during first quarter 2007, but this quarter's results also reflect improved operating efficiencies, higher volumes and growth from acquisition. These non-commodity-related earnings by themselves represent more than 10% of the earnings improvement over last year. You may recall that first-quarter 2007 operating results were negatively affected by severe winter storms. Fortunately, severe weather was not a key factor in this year's quarter. DCP Midstream is a significant source of cash for Spectra Energy, and first quarter was no exception. Field Services paid normal distributions of $112 million to Spectra Energy this quarter, and in April, DCP paid an additional $250 million special dividend to Spectra Energy from the proceeds of debt they were able to issue, given their very strong financial position. Now let me turn to other, which is primarily comprised of our corporate costs. For the first quarter, other reported ongoing net costs of $20 million compared with ongoing net costs of $12 million in the previous year's quarter. This quarter's costs are in line with our projected corporate cost goal of $85 million for the year. The next slide shows several important additional items, and I'll cover a few of the more significant ones. As of March 31st, our debt to total capitalization stood at 54.6%, slightly below our 55% to 60% targeted range, and we had available liquidity of almost $2 billion. The Canadian currency change had a positive after-tax effect on earnings for the first quarter of about $18 million compared with the first quarter 2007. On May 1st, we repurchased the publicly held shares of Spectra Energy Income Fund in Canada for approximately $275 million. We have given you an overview of our first-quarter results, and you can see we had a strong quarter. Now let's turn to our planned share buyback and Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 5
  • 6. dividend increase, which we believe will add value for both our shareholders and our bondholders. As Fred noted earlier, we announced two strategic actions today. First, our Board of Directors has approved a plan to repurchase up to $600 million of Spectra Energy shares, which would involve a combination of open market purchases and other transactions such as an accelerated stock repurchase. The components and execution of this plan will be determined based on our assessment of market conditions. We're in an excellent position to fund this stock repurchase without adversely affecting our balance sheet or credit metrics. In fact, a substantial part of the $600 million has been pre-funded with our first-quarter earnings and the $250 million special distribution from DCP Midstream. We expect the remaining amount to be funded with a combination of internally generated cash from earnings and some relatively minor asset rationalization. We're confident that the buyback can be completed with virtually no incremental debt. The second leg of our value enhancement plan involves a recommendation to our Board of Directors to increase our annual dividend from $0.92 per share to $1 per share, beginning in the third quarter of this year. As Fred mentioned, this action will represent an almost 14% increase in our dividend this year. The dividend increase is also very much in line with our stated 60% dividend payout policy. After the effect of the share repurchase, the cost of this dividend increase is expected to be less than $20 million in 2008. We believe these two strategic moves serve to illustrate the underlying value, earnings and cash generation potential of Spectra Energy, and they reward our investors for their confidence in our company, a confidence we certainly share. Despite, a current realized and forward curve that would indicate oil at $110 per barrel for all of 2008, we have assumed a $90 per barrel price and have also assumed that level will remain flat through 2010. Using those assumptions coupled with the earnings from the successful completion of our capital expansion projects, we expect to deliver EPS growth of about 8%. That, together with a dividend yield of 3% to 3.5%, takes our expected total shareholder return to north of 10%. These are very positive moves enabled by our first-quarter earnings, stronger than expected cash distributions from DCP and our positive outlook for the balance of the year. And, we'll execute on all these plans, while maintaining our solid investment-grade credit metrics. I'll show you how that's possible by taking Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 6
  • 7. you through a revised projection of our cash flow for the year and the effect of today's announcement on our credit metrics. This slide starts with the 2008 cash flow forecast we rolled out in January. We've added the incremental cash flow from stronger earnings, the additional DCP dividend and the proceeds from asset rationalization. We then subtracted the cash requirements of the share repurchase, the Spectra Energy Income Fund acquisition and the incremental dividends. All of this brings us to an external funding requirement for the year of about $1.7 billion. This is about $200 million higher than our forecast at the start of the year, due to the $275 million acquisition of the Spectra Energy Income Fund. As you can see, after subtracting the $700 million of debt we have already successfully issued this year, we are left with borrowing requirements of less than $1 billion. Given that Spectra Energy Partners borrows on their own behalf, we exclude their needs here, and as such, we have only $600 million to finance for the remainder of the year, a very doable amount. With the outlook for commodity markets for the rest of the year, we will likely not need to even borrow at this level. It's also important to note that we currently have about $2 billion in unused liquidity. Our financial strength is a real competitive advantage, and we intend to use that advantage when appropriate. Looking now at the oil curve for all of 2008, you see that the current settled and forward prices are about $20 a barrel above the revised $90 assumption, we talked about earlier. Should the forward curve settle substantially higher than our assumption, we would realize a substantially higher level of cash and earnings. As a reminder, for every $1 increase in the crude oil price, we realize $12 million in additional pre-tax earnings. So, what does all this do for our credit metrics? Well, utilizing our revised assumption for crude oil, our 2008 FFO to interest and FFO to debt coverage ratios are stronger than those set forth in our 2008 outlook, we shared with you in January. Those credit metrics are consistent with a strong BBB/Baa balance sheet, and will improve if oil prices average above $90 this year. We also indicate here our expected year-end debt balance to be approximately $11 billion, about $400 million lower than we forecasted in January. We finished 2007 stronger than expected, and we continue to perform. We're extremely excited about executing on this plan and returning real value to both our debt and equity holders. Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 7
  • 8. With that I'll turn things back over to Fred. Fred J. Fowler, President and Chief Executive Officer Well. Thanks, Greg. As you've heard, we delivered an impressive quarter, driven by great operational and expansion performance as well as favorable market dynamics and we're taking some decisive steps to realize value for our investors. We believe strongly in our ability to execute on our plan and drive out the operational, the growth and financial return targets that we've set for ourselves, and then some. Simply put, 2008 is shaping up to be an excellent year for Spectra Energy and our investors. With that we'll be happy to take your questions. Q&A Operator [Operator Instructions] Your first question comes from the line of John Kiani with Deutsche Bank. <Q - John Kiani>: Good morning, Fred, Greg. <A>: Good morning, John. <Q - John Kiani>: I know you talked a little bit in your opening remarks and also in your press release about your expectation to exceed the annual employee incentive target for 2008. Can you give us a little bit of additional color on, based on the fact that commodity prices and specifically crude oil prices are at levels that are obviously meaningfully higher than what you have included in your guidance, kind of coupled with the positive effect of the buybacks, and also the beneficial NGL/crude oil relationship, what level that might be relative to the employee incentive target you laid out at the beginning of the year? <A - Fred Fowler>: Well, maybe a couple of different ways to look at it, John. One, I think the sensitivities we gave at the beginning of the year are extremely helpful. So, depending on what your view is where oil is going to be, on average, that dollar increase in crude should result in about $12 million of pre-tax earnings. Every $10 million in EBIT equates to about a penny. So that's one. Maybe the other thing to consider as well is, the dividend increase we are proposing is very much consistent with our 60% payout. So those are two things that might give you some bookends around where we are seeing the year come out. Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 8
  • 9. <Q - John Kiani>: That's helpful. And then, as far as the -- the growth rate is concerned, I think you mentioned 8%. Can you remind us of what your original growth rate was? <A - Greg Ebel>: We were originally speaking of 5% to 7% compound annual growth rate. But again, with – as projects come in and as we see some commodity forecasts looking higher than our original $83, that gives us the view that it could be 8% compound annual growth over the three-year period. <Q - John Kiani>: Okay. That's very helpful, and then final question is on Empress. Obviously that asset has been performing very well, even up until very recently. What's your view on how core Empress is, longer-term, to the Spectra portfolio? <A - Fred Fowler>: It's like any other asset, John. We continually look at assets and have what we believe is a whole value. If we find people that are willing to monetize things at values higher than we see as a whole value, we'll consider it. And I would put that in the same class as all -- as virtually most of our assets. <Q - John Kiani>: Okay. Thanks, Fred. Thanks, Greg. <A>: All right, John. Operator Your next question comes from the line of Lasan Johong with RBC Capital Markets. <Q - Lasan Johong>: Good morning. Nice results. A couple of questions. First, on the drilling in British Columbia, can you give us a little bit more color on what kind of volume increase are you expecting, how long do you think this will last? Is there any chance of the Alberta tax burden affecting British Columbia? <A - Greg Ebel>: Well, I don't think we're prepared today to give you some views on volumes. But I guess some – if you look at the Horn River Basin and the Montney region, we're seeing some very significant land purchases. I think over the last little while, you are looking at -- probably over the last -- it has accelerated into this year and last year, we are starting to push $1 billion in land purchases. And for a lot of money for players like the EOGs and Devons and Apaches, EnCana's of the world to put dollars in. So that gives us a lot of confidence. With respect to the tax in British Columbia, we would expect that that would flow through, that that would just be a cost of operations, if you will, which would then flow through to the end users or producers, if you will. Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 9
  • 10. <Q - Lasan Johong>: But that does definitely have a dampening effect on exploration programs and exploitation programs anywhere? <A - Greg Ebel>: Yeah... <Q - Lasan Johong>: Alberta? <A - Greg Ebel>: Well, and as you know, in Alberta you've got two. In Alberta, you've got the royalty issues, which has probably pushed more activity into British Columbia, which fortunately, is where the bulk of our assets are. And then the carbon tax in British Columbia has an impact as well. But still, as we are seeing robust prices, new technologies and some of the promise of some of these plays in Western Canada, that does bode well for us, in our view. <Q - Lasan Johong>: True, true. Why do a $600 million a share repurchase program when you are in the need for $600 million of additional funding? <A - Greg Ebel>: Well, I guess we look at it a couple of ways. One, we started out the year with debt balances below where we thought we would be. We're currently below our target in terms of what we thought our credit metrics and balance sheet would be. And, since we didn't feel a need that in fact we had to pay down debt, paying down debt right now would be CP, which would be about a 2% after-tax return. And then, we also have great confidence in the earnings and cash generations of the Company. And as such, we think it sends that signal and represents a very good investment opportunity for us at this point in time. <Q - Lasan Johong>: Then why not borrow money to invest in more projects? <A - Greg Ebel>: Well, remember, a project takes 18 to 24 months to actually bring to fruition and bring on earnings. So an impact, if we started a project today, we might not see that impact for 12 to 24 months. We can see the impact of this $600 million repurchase much quicker once it's executed. So, again, that seems to be the better choice of dollars. As you see, earnings impacted by the projects coming on this year -- recall, we'll bring on $1.5 billion this year in new projects that will produce, next year, $200 million in earnings. I would expect you'd continue to see the balance sheet actually strengthen. And as such, I don't see that limiting our ability to go out, access capital markets and invest in more opportunities that come along. <A - Fred Fowler>: Yeah, Lasan, then for me, it was -- in my opinion, we had excess cash sitting on the balance sheet and if we would view what we are doing here as a third-party acquisition, we would be all over it. So why not do it on your own? <Q - Lasan Johong>: True. So what you're suggesting is that this is not a signal to us that you don't have projects to invest. You are saying you do Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 10
  • 11. have a lot of projects to invest, but circumstances on your balance sheet would make this a much more immediate impact to shareholders? <A - Fred Fowler>: Exactly. <A - Gregory Ebel>: And not restricting our ability to invest in additional projects, which we're constantly looking at. <Q - Lasan Johong>: Good, good. One last question -- effect of Canadian dollars on your numbers for the quarter, and kind of what your assumptions, are going forward on the dollar -- Canadian dollar/US dollar relationship? <A - Gregory Ebel>: The impact was about $18 million after-tax in the first quarter versus last quarter and our assumption is just parity. And I think, if you'd look, you'd see the Canadian dollar seems to have settled into it, just about that range. <Q - Lasan Johong>: Thank you. <A - Fred Fowler>: If you recall, Lasan, first quarter last year the Canadian dollar was under a little pressure. <Q - Lasan Johong>: Yes, yes. Great. Thank you very much. <A - Fred Fowler>: Thank you. Operator Your next question comes from the line of Ross Payne with Wachovia. <A>: Ross? <Q - Ross Payne>: Can you hear me? <A>: Yes. <Q - Ross Payne>: Okay. <A>: We're not hearing you now, Ross. Operator Okay. His question was withdrawn. Your next question comes from the line of Scott Engstrom with Blenheim Capital Management. <Q - Scott Engstrom>: Good morning. <A>: Good morning. <Q - Scott Engstrom>: I'm trying to remember that line about patience being a virtue, and I feel very virtuous today. A question about -- at Field Services, on the volume growth. How much of that was organic? How much was, say, from the momentum acquisition? How should we thinking about the volume growth there? And, I know there were some weather issues last year as well. <A - Fred Fowler>: Yes, it's a combination of all three of those. Probably, order of magnitude, a third, a third and a third. Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 11
  • 12. <Q - Scott Engstrom>: Okay, roughly split. Okay great. Then, just thinking about again the commodity exposure, the slide you guys gave in January, and now you talked about, Greg, $1 change in crude and $12 million of EBIT. Just trying to think of how to use that over the course of the year. I mean year-over-year, we saw a $40 rise in crude, which would have implied a $480 million increase in EBIT at Field Services. I know there's been restructuring of the contracts, etcetera. But, is that sensitivity useful on a quarter-over-quarter basis, or does it only apply relative to the forecast of $83? I mean how they -- how can I use that sort of between -- throughout the year? <A - Gregory Ebel>: It's not great through quarter-over-quarter. I would suggest you work off the $83 and change price that we gave you, and take whatever your assumption is on oil and use the $12 million associated with that. As you point out, there's contractual changes that occur year-over-year, some correlation changes. So we've focused on $83 and 60% correlation. And I would suggest that's probably, your best -- the best way for you to look at that. <Q - Scott Engstrom>: Then, thinking about the sensitivity at Empress, the $0.50 per change in frac is $16 million of EBIT. You had almost a $4 year- over-year change there, implying an uplift -- I'll use round numbers – of about $125 million. But we didn't see that in Western Canada, either. So -- <A - Fred Fowler>: That would be on an annual basis, not a quarterly basis. You'd have to divide by 4. <Q - Scott Engstrom>: Okay, thank you. But that is more applicable year- over-year. I could see that, or is that just against the 7.25? <A - Gregory Ebel>: I'd encourage you to use it against the 7.25, our original forecast, because, remember, you also have a change in currency that we talked about as well. I think you are better off, looking against the 7.25. And think about it on an annualized basis. Volumes change quarter-to- quarter. But I think, as you look forward for the rest of the year, you want to think about the full year and think off our base assumptions, would be my suggestion. <Q - Scott Engstrom>: And then one question at distribution. How much of the -- what was kind of the year-over-year weather impact in EBIT terms? Do you have that? <A - Gregory Ebel>: About $5 million. <Q - Scott Engstrom>: Okay. And, do you have the EBIT for Canadian dollar, just in distribution, not sort of net for the whole Company? Do you have it EBIT at distribution? Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 12
  • 13. <A - Gregory Ebel>: That was about $20 million, as I recall, is what you would see. So you've got some pluses and minuses, but currency ran around $20 million on the EBIT basis, at least in terms of earnings. <Q - Scott Engstrom>: And that's just that Distribution, or does that include -- <A - Gregory Ebel>: No, that's just that distribution. <Q - Scott Engstrom>: Okay, so $5 million of weather, $20 million of Canadian dollar. So you would have had some other on the cost side offsetting that? Is that -- <A - Greg Ebel>: Yes. Maybe the way to look at it is, in terms of upsides, you've got some currency around $20 million, you've got transportation, revenue and weather around $10 million, and then you have about $10 million of cost changes to get you around that $20 million increase? <Q - Scott Engstrom>: Was there any uplift in storage or -- <A - Greg Ebel>: Yes; we -- the benefits of bringing on the Dawn-Trafalgar expansions and the first phase of the storage that was coming into -- not just market-based rates, but benefiting the Corporation. Those also helped earnings this year versus last year. <Q - Scott Engstrom>: So, as I think about all those pluses and minuses, there's a big uplift in your guidance for distribution this year, year over year. Was this within plan, excluding kind of weather and the Canadian dollar? <A - Greg Ebel>: Very much. I think you'll -- you start to see, as we indicated, a nice a substantial increase in distribution driven by those expansion, which, as you may recall -- that's a 5 Bcf plus pipeline, and we're seeing a 20% expansion between last year and the next couple of years as well as some storage coming in. So all of that's been taken into account. <Q - Scott Engstrom>: All right, great. Thanks guys. <A - Greg Ebel>: And remember, we assumed the Canadian dollar would be at parity. <Q - Scott Engstrom>: Okay. Operator Your next question comes from the line of Ross Payne with Wachovia. <Q - Ross Payne>: Can you guys hear me better than... <A>: Yes. <Q - Ross Payne>: Okay. Thank you. It seems like your cost inflation is somewhat isolated to the Southeast Supply Header. Can you talk about -- you obviously had weather issues, other issues with labor and any other inefficiencies relative to your earlier expectations? Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 13
  • 14. <A - Fred Fowler>: Not at this point. It's primarily being driven, again, by the fact -- that's virtually a cost-plus contract, so we're at risk for any kind of delays and primarily these weather and these -- and this right-of-way. We had -- as a result of right-of-way acquisitions taking longer than anticipated, what we would have to do was breakdown the equipment and crews and move them around to where we had right-of-way secured. But each time that you do that, it cost you a day to break it down, it cost you a day to set it back up. So it just pass data cost. And therefore, your efficiency drops. <Q - Ross Payne>: Sure. Okay. <A - Fred Fowler>: That's the two primary drivers. <Q - Ross Payne>: Okay. In general, given the amount of CapEx you guys have going into '09, do you have any expectations there on what kind of cost creep you may see? <A - Fred Fowler>: I would -- to me, I think it would be somewhere along the lines of what we've experienced here on our other projects, ex-SESH. <Q - Ross Payne>: Okay. Great, guys.. <A - Fred Fowler>: SESH was a project that was just during that period where we saw the huge cost fly-up, and it was one where, because of competitive pressures, we had to assume a lot of that risk. Most of the later projects were not in that set of circumstances. <Q - Ross Payne>: Okay. All right. That's helpful. Thank you. Operator Your next question comes from the line of Matthew Akman with Macquarie. <Q - Matthew Akman>: Thanks very much. On US Transmission, the quarter was up year over year. I think your guidance at the beginning of the year was for that business to be slightly down, mostly because of one-time items from last year. Is that still applicable, or is that improving? <A - Fred Fowler>: Well actually, Matt, it has improved, and driven a lot by -- we still have a little bit of gas processing that gets done in the regulated transmission part of our business, some of the old legacy stuff from the old model. And that is what has got us above plan at this point. Everything else is on plan. <Q - Matthew Akman>: Is that a frac spread-sensitive business? <A - Fred Fowler>: No. <Q - Matthew Akman>: Okay. Is it sustainable? <A - Fred Fowler>: It basically, it's a long gas liquids position -- <Q - Matthew Akman>: Okay. <A - Fred Fowler>: On like a percent-of-proceeds type contract, but it's all liquids. Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 14
  • 15. <Q - Matthew Akman>: Okay, thanks for that. And then, I wanted to shift to Western Canada. We're seeing, really, kind of a sea shift in activity there, here in Canada and you guys have assets that seem to be very well positioned. Can you please just maybe talk for a minute about the kinds of opportunities you probably have underutilized assets there that can fill up? And also, you bought in the fund, so there are other consolidation opportunities there for you. <A - Greg Ebel>: Sure, we could speak to that, and Martha is on the line, too. She may want to chime in as well. But you look at our plants, and I think you're right; we are well-positioned, particularly in the Northeast British Columbia. We really see that area bucking the trend of what you see in the rest of the Western Canadian Sedimentary Basin. So our -- the big plants, Fort Nelson, the capacity there -- we haven't fully filled that capacity there right now. But the opportunities look quite good and much better than they were a year ago. Plants like McMahon were running full out, which is over 600 million cubic feet a day plant. That's very positive. That's in the Fort St. John/Peace River Arch area. And again, the Grizzly Valley -- very positive what we're seeing going on there. And we've got the big Pine River plant there, which is about 400, 450 million cubic feet a day. So all those plants, I would agree, are extremely well-positioned. As I mentioned earlier, when you see things like the Horn River Basin being compared to the Barnett Shale, I'll let the producers decide that, but that's obviously very positive. And then the Montney play that's being discussed is also attracting really strong producer interest. So there's a lot of work left to be done. It's early days, obviously. But I would agree with your assessment that things look a lot more favorable than they did a year ago. <A - Fred Fowler>: We currently have two plant expansions ongoing in the BC. <Q - Matthew Akman>: Okay. <A - Martha Wyrsch>: Matthew, The only thing I would add is that, we have both sweet and sour gas processing capability in those areas, which is a real plus for us as well because not all of this new gas is sour. But we also have sweet processing. So I think we're well-positioned. <Q - Matthew Akman>: Okay. Thanks for that. And then my last question is just kind of on the bottom line. Greg, you talked about 8% growth. Can you just clarify -- is that 8% over last year's number? And then, is that based on $90 oil? <A - Gregory Ebel>: Yeah. I'm looking not one year to the next, so to speak. I'm looking, obviously, the way numbers are looking maybe a little better than that, than where we ended up versus last year. I'm looking, really, Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 15
  • 16. at over the next three years compound annual growth, on average, to range about 8%, and that is looking at $90 oil. <Q - Matthew Akman>: Okay. Okay. Thanks very much. <A - Gregory Ebel>: Thank you Matt. Operator Your next question comes from the line of Paul Patterson with Glenrock Associates. <Q - Paul Patterson>: Good morning guys. <A>: Good morning. <A>: Good morning, Paul. <Q - Paul Patterson>: Most of my questions have been answered, but I just wanted to make sure I didn't miss something here. It looks like you guys are being conservative with the price of oil here. Just in general, assuming that the prices were stayed higher what would you guys use the extra cash for? I mean how should we think about the potential for extra cash above your projections being deployed? You guys have lots of opportunities, it seems. On the other hand, you guys are buying back stock and stuff. <A - Gregory Ebel>: I think we would look at it based on the situation and time, and we've got the same principles we came to this decision. We could look at additional investment opportunities, of which we think there are numerous. We could -- if we felt it was a wise investment decision, you could avoid issuing debt. And obviously, depending on our Board's views, you can look at dividends as well, and buybacks and acquisitions. So I don't think we'd take any off the table... <A - Fred Fowler>: I think it's whichever opportunity is available at the time. <Q - Paul Patterson>: Okay, well I guess that's a good problem to have. Okay great, thanks. <A - Gregory Ebel>: Thank you. Operator Your next question comes from the line of Rick Gross with Lehman Brothers. <A - Gregory Ebel>: Hi, Rick. <Q - Rick Gross>: Good morning. My question is in and around maybe the forward-looking dividend policy at DCP. You've got a special dividend in a pretty robust commodity environment and that's been, at least in our estimation, an asset that's been fairly heavily equity capitalized. It generates a lot of free cash. And I'm just curious as to whether or not this, we'll call it Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 16
  • 17. nonrecurring dividend, could become more recurring and serves as more of a periodic cash injection to buy in more stock over time. <A - Fred Fowler>: Yeah. Again, Rick, I think it depends on what we see as opportunities. Clearly, in recent times, we have felt that asset values got way too pricey in that particular part of the business and we made a conscious decision that we weren't going to play in that market as a result. The fact that we built our position at the low end of the commodity cycle, obviously our assets are throwing off tremendous cash flow at this point. And we just feel that the opportunities that we've seen recently in our gas transmission business have been better. But going forward, if you see an adjustment -- and I would tell you that Greg and I just were at a Board meeting last week. They had a couple of fairly compelling investment opportunities still within their kind of their ongoing annual capital spend level that we use for them. But if we start seeing very good returns in that business, better than we're seeing here, it could go the other way as well. <A - Gregory Ebel>: Yeah. I think the key is -- our key and the focus, the policy is sort of about 90% of net income and cash would be redistributed out. And you pointed out that DCP has strong metrics. Indeed, it does. If you look at their debt to EBITDA numbers today versus other peers – and frankly, we look at it as a privately held MLP, if you will. They are very well-positioned to either provide more distributions to the parents or to use that cash for investments. What we don't see is any requirement from cash from the parents, which both to Conoco and ourselves, is very important. <Q - Rick Gross>: Okay. Thank you. <A>: Thanks Rick. Operator Your next question comes from the line of Mark Caruso with Millennium. <Q - Mark Caruso>: Yes, great quarter. I just wanted to -- you had updated the sensitivity for oil and raised the assumption to 90. I was curious your thoughts on gas, since gas has moved a lot. I remember the original EBIT was a $0.10 change in gas, it's around $2 million in EBIT. I just wanted to start there and then ask about the buyback second. <A - Fred Fowler>: Yeah, I think, I'm probably the last person in the world you should ask about prices because I'm so lousy at predicting them. I think it has finally dawned on some of the financial players that if crude oil is going to sustain at this level, gas really has been selling at too much of a discount. It looks like you have seen some of the investment type money move over into gas. And to me, it's just hard -- as long as we're seeing these kind of crude oil values, to see any big downward pressure on natural gas, Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 17
  • 18. although I would say that I think gas in the US trades much more on fundamentals than crude oil does. <Q - Mark Caruso>: Have you guys factored in higher gas prices? Is that all part of the 8% that you mentioned earlier? <A - Greg Ebel>: Well, that sensitivity still holds true, I think for simplicity. Now you've seen a slight drop in the correlations from 60 to around 58, and you'd see the increase in gas to what we gave you to -- what's the current price today, 10, 10.25? So, those are a bit of an offset, but indeed that sensitivity is still alive and well, and something that is appropriate for you to consider. <A - Fred Fowler>: But we don't fine-tune it quite to that level. The big impact that we have is on the gas liquids. That's our big position. <Q - Mark Caruso>: Thanks. And then as far as the buyback goes, you had mentioned it's partially pre-funded. Any limitations for, I guess, as soon as you could -- as far as how soon you could start it up? It's just a matter of market conditions, or I mean, there is no other limitations beyond that? <A - Greg Ebel>: That would be correct. <Q - Mark Caruso>: Got you, perfect. Thanks so much. <A - Greg Ebel>: Thank you. Operator [Operator Instructions]. Your next question comes from the line of Dennis Coleman of Banc of America Securities. <Q - Dennis Coleman>: Thanks. Good morning. <A>: Good morning. <A>: Good morning. <Q - Dennis Coleman>: I wonder -- I just – if you can just help me with the numbers on slide 13 and a couple of things you said there. We're showing a financing need increased by $245 million. And then you made the comment that your target is $11 billion of debt at year end. <A>: Correct. <Q - Dennis Coleman>: About $400 million lower. And I guess I'm missing how we are getting a higher financing need and a lower debt balance. <A - Greg Ebel>: Well, it's actually, where we ended up the year was much stronger. When we came out in January, we were telling you approximately $11.4 billion, where we would be in 2008. And in fact, that was before, obviously -- it was very early January, before we've had actually closed the book. So we finished the year stronger. So if you look at December -- the Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 18
  • 19. easy way to look at December I am sorry, March 31st, you're talking about a $9.3 billion in debt. Add the 1.7 billion because we really hadn't issued any debt through March 31st, and you get approximately $11 billion. <Q - Dennis Coleman>: Perfect. Okay. And then, so that the remaining $600 million need you had talked about doing as much as 500 million in Canada. And you said something about maybe no borrowing at some level, and I wasn't quite sure which level you were referring to, and maybe that's it? <A - Gregory Ebel>: Yes. What I'm saying, we've issued 200 million in Canada and $500 million from Spectra Capital, currently. And as such, what we're saying is that $600 million -- that could be in Canada and the United States. But I think what I was saying was that, if we continue to see the commodity prices where they are right now, you could see that we not even borrow this amount of money. That sort of depends on cash generation, and as we have indicated, at $90 oil this is the number you would see. Obviously, I think the current forward curve is around $110 per barrel. That would produce both earnings and cash that would lower our borrowing requirement. <Q - Dennis Coleman>: Okay. So obviously, a lot of other people have asked those questions, trying to get at that cash flow number, and that's pretty clear. So it's conceivable that there isn't any additional capital markets needs at the Spectra Capital level? <A - Gregory Ebel>: That's conceivable. And again, we will look at market conditions, and you can see where things are going for next year. So it's really a timing issue, but your assumption is correct. <Q - Dennis Coleman>: Okay. And when do you look at that? What is... <A - Gregory Ebel>: What I think right now -- right now I think, yes, we'd look to the last half of the year and figure out where we go from there. <Q - Dennis Coleman>: Very good. That's what I had. Thanks. <A - Gregory Ebel>: Thank you. Operator [Operator Instructions]. <A – John Arensdorf>: Molly, it appears there are no more questions? Operator There are no further questions at this time. John Arensdorf, Vice President of Investor Relations Thanks, everyone, for joining us today. We appreciate your being on the call. As always, if you have any additional questions after the call, you can Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 19
  • 20. feel free to call either Patti Fitzpatrick or me; this is John Arensdorf. Just a reminder, that on Monday, May 19th, we're going to be in New York for a breakfast, and then we're going to go onto Boston for a lunch, so we've sent out invitations to that. If you haven't already done so, please let us know whether you will be able to attend, and we look forward to seeing you at that time. Thanks again, everyone. Operator This concludes today's conference call. You may now disconnect. Spectra Energy Corp Q1 2008 Earnings Call May 6, 2008 20