Williams Cos Inc (WMB) — Q3 2015 Earnings Call Transcript

Thank you, Michelle. Good morning and thank you for your interest in Williams and Williams Partners. Yesterday afternoon, we released our financial results and posted several important items on our website, williams.com. These items include yesterday's press releases and related investor materials, including the slide deck that our President and CEO, Alan Armstrong, will speak to momentarily. Our CFO, Don Chappel, is available to respond to questions. And we also have the five leaders of Williams' operating areas with us. Walter Bennett leads the West; John Dearborn leads NGL and Petchem Services; Rory Miller leads Atlantic-Gulf; Bob Purgason leads Access Midstream; and Jim Scheel leads Northeast G&P. In our presentation materials, you will find an important disclaimer related to forward-looking statements. This disclaimer is important and integral to all of our remarks and you should review it. Also included in our presentation materials are various non-GAAP measures that we reconcile to Generally Accepted Accounting Principles. These reconciliation schedules appear at the back of the presentation materials. With that, I'll turn it over to Alan Armstrong.

Great. Thank you, John, and good morning everyone. Thanks for being on the call with us early this morning. Before we discuss our third quarter results, I'd like to provide a brief update on the transaction we announced with Energy Transfer on September 28. We are on the path to completion and we expect to file the proxy statement soon. The transaction will then be subject to SEC review and regulatory approval and is expected to close in the first half of 2016. With that, I want to reiterate that the focus of today's call is going to be on our financial and operational results for the third quarter. I ask that you please keep your questions focused on our results, and I want to thank you in advance for your cooperation on that. So we are going to hold tight to that. Now, just some brief thoughts on the fundamentals relevant to the third quarter and the industry in general. Overall, I have to say, it really was a great third quarter for us from an operational performance perspective, a project delivery perspective, and progress towards future growth. We remain very focused on execution, cost management, and taking advantage of the great asset positioning that our strategy has delivered, and I think this focus really showed up here in the third quarter. Importantly, despite the fundamental pressures on our industry from dramatically lower commodity prices, we've continued with very substantial growth in our adjusted EBITDA and DCF, so really, showing the strength as we continue to see prices erode and some dramatically low NGL prices in the quarter, but our strategy of continuing to invest in these big fee-based projects is really starting to overwhelm those lower prices. And so, that's not to say we aren't feeling some of the effects of the low commodity prices directly in our commodity margins and indirectly via the volume shut-in on some of our gathering systems, particularly in the Northeast. However, because of our unique position, we continue to deliver strong results and see strong growth ahead from our projects, especially on the demand side of our business as U.S. industries and international markets look to take advantage of North America's abundant and low-cost natural gas supplies. The North American producers continue to really amaze us and continue to innovate and deliver production at cost levels that no one thought were possible even a year ago. While this has led to painfully over-supplied markets in the short-term, it continues to lead the way towards growing demand and expanding prosperous markets for natural gas and natural gas derivatives. Over the long-term, we think we're really seeing a supply-led expansion, and I know that people are getting impatient about that, but I can assure you, as you look through our backlog of projects, it's very evident to us that that capital is going in place to pave the way for growing demand. The current barrier to the success that we speak of and look forward to really is the low-cost access to these expanding markets, primarily through pipelines, but also other infrastructure required. We are certainly building out this capacity, it is not just important for Williams, but for the industry, and it's also important for the North American economy. We are very excited to be taking on these important challenges at Williams and see it as a critical next role in delivering the tremendous value that North American producers have developed through their innovation and continue the learning process in developing our low-cost resources here in the U.S. So with that, let's move on to slide two. Overall, our strong third quarter results underscore the effectiveness of our strategy to connect the best natural gas supply to the best markets with all this fee-based infrastructure we continue to invest in. This accounted for more than 90% of our gross margin during the quarter and will continue to be that for quite some time, thanks to the tremendous efforts by our teams to deliver the continuous string of large-scale infrastructure projects required to realize the fruits of the strategy. Once again, we showed our ability to deliver substantial growth in EBITDA and DCF despite much lower commodity prices; and in fact, four segments of our five segments realized substantial growth and our fee-based revenue, which was up over $200 million in the quarter, overwhelmed the dramatic drop in commodity margins from the third quarter of 2014. Additionally, our DCF of $754 million delivered a 1.04 coverage, and that's even without recognizing the benefit of the $209 million IDR waiver for the quarter that was associated with the WPZ/WMB merger termination. So let me now drill into the drivers for this 21% improvement in EBITDA for the third quarter of 2015 compared to the third quarter of 2014. First of all, big congratulations to our Atlantic-Gulf team who delivered $414 million for the quarter, up 53%. Even more impressive was that this was in the face of dramatically lower NGL margins in the Gulf Coast. The drivers for this strong performance were many projects continuing that were brought on earlier in the year, things like Gulfstar One, Discovery's Keathley Canyon Connector, but also a full quarter on new Transco projects, including Rockaway Lateral in New York. In addition to that, the team also delivered a new project during the third quarter, which was the first phase of the Virginia Southside lateral, which our team delivered on time; and we were also able to get some early revenues from the mainline services associated with the Leidy Southeast project, and we brought in those revenues well ahead of schedule. Of course, the Leidy Southeast lateral is not yet online, but the mainline portion for gas flowing from that lateral, we were able to bring some of that on early. So great job by both our commercial team and our project teams in continuing to deliver. As you'll see on the next page, you'll see a string of projects that Atlantic-Gulf continues to grow as we provide capacity for the demand side of this growing natural gas market. At the Access level, $351 million of adjusted EBITDA. That was up 9% on this really driven by fee-based revenue growth, and we saw both the mix of volume growth and contractual benefits across multiple areas provide steady growth in EBITDA despite challenging commodity prices in those basins as well. Specifically, the increase in adjusted EBITDA between 2014 and 2015 was driven by higher fee-based volumes and contractual support from the minimum volume commitment agreements, as well as the increased ownership interest in the Utica East Ohio Midstream. As you'll recall, we transacted on that earlier in the year, and so that delivered here for us in the third quarter as we stepped that up. This was despite that area being impacted by very low commodity prices in this basin for both gas and NGLs. And so we did see some shut-ins in that area that were fairly significant in the third quarter, but we've seen a lot of that production return to service now, headed into the fourth quarter. In the Northeast G&P, $87 million, up 28%, also on higher fee-based revenue and this certainly during the quarter – a few things to note here, price-related shut-ins from our producers did dramatically impact the fee-based revenue growth on our gathering volumes, but this – we still managed to grow those volumes by 13% despite some very large shut-ins in the quarter. Our volumes processed grew by over 40%, and NGL production was up 2.5 times last year's production. Thanks to new processing facilities that were installed in the first quarter at OVM. Of course, the NGL & Petchem, I was glad to see a solid quarter of operations from the expanded Geismar plant, and the team hit some impressive production levels during the quarter as they started to learn what they could do with the new facility there, but unfortunately, the ethylene margins that we realized during the quarter were much lower than we had expected earlier. But again, from an operational perspective, some nice performance coming from the team there. Canada also had strong production levels with propylene sales being up 29%, but also suffered weak pricing in the propylene area as well. The NGL services side had a strong operating quarter as well. That's our NGL transportation and storage piece that's in our NGL & Petchem unit. We saw the NGL transport volumes on our Overland Pass Pipeline go up by 59%. So overall, a big step up in adjusted EBITDA from $22 million to up to $85 million for this business unit in the quarter. While the West saw a 28% decline in its adjusted EBITDA to $161 million, really driven by dramatically lower NGL margins, it was still a good operating quarter in terms of the team doing everything they could to deliver the best numbers. We saw that show up in the way of lower operating costs, and the team was able to hold our fee-based service revenues flat compared to the third quarter of 2014. The NGL unit margins that we realized in the West actually were at a 10-year low, as we saw NGL sales fall by over $70 million this year in the 3Q versus the 3Q comparison. Total volumes on Northwest Pipeline were up 14%, which is due to both the increased use of natural gas for power generation in the Northwestern states as well as some basis differential spreads that were existing between prices like ACO and the Western states. So really a good sign. I'll tell you, when we see volumes pick up, even though they're interruptible and people taking use of the capacity, when you see that kind of increase in our throughput volumes on the system, that's always a good sign for long-term firm sales, which is really where we make our money on a pipe like that. Moving on to slide three, here is a picture of the continued delivery of projects and a great job of our team in continuing to put these projects into service. We said back in the first half of the year that the demand side of the natural gas market is driving our capital investments. First of all, the Transco Virginia Southside, as I mentioned earlier, was placed into service in September of 2015, and we look forward in the fourth quarter here to see the benefit of a full quarter there rather than just the one month. I would just note there, really impressive execution by our team who faced difficult obstacles in the construction in that area. The ability to deliver that on schedule, given the obstacles that the team faced, was very impressive, and I want to recognize the great efforts there. On Gulfstar One, we continue to see strong fee-based contributions to EBITDA. We continue to see record volumes on that system, and the team is doing everything they can to maximize throughput because there is a lot of throughput wanting to get through that system right now. We are seeing a lot of exciting growth on the horizon for this investment. On the Northeast G&P, we did execute the Pennant JV. This joint venture allows us to take advantage of some large dedications in the area and increase our capital efficiency. On the dry Utica side, we announced a significant increase in dry Utica acreage from Chesapeake in the quarter. But we are also excited to see some significant dry Utica wells showing up in the OVM area, and really seeing some impressive wells being completed on the same pads that were earlier developed for the Marcellus-rich area. This is a tremendous resource potential up there, and an ability to produce a lot of gas at very low cost. We are anxious to see the new takeaway infrastructure go into service. I would just tell you, there is a lot of growth potential for the future up here, really just dependent on access to those markets on both the gas and NGL side. Moving on to slide four, this is a list of demand-driven projects. Our focus is especially important in the Northeast where we have many producers critical to getting access to those markets, and we take those obligations seriously to get those developed and to work hard to overcome continued regulatory and political hurdles that exist in getting this big infrastructure in place. In the Northeast, while we had quite a bit of gas shut-in in the third quarter, it is a great opportunity for us as we continue to invest. If we focus on the assets in the Northeast, we gather nearly a third of all the gas being produced there. By developing our own infrastructure for takeaway, as well as our peers in the industry, we will see tremendous growth that does not depend on additional drilling rigs. We have a large inventory of drilled and uncompleted wells just waiting for the right price signals. Moving on to slide five, I would reiterate that this quarter's results were a direct reflection of our strategy to position Williams uniquely to connect the very best natural gas supplies to the many markets. We are delivering record quarterly DCF and record adjusted EBITDA through tough headwinds for the industry, which is a testament to the teams at Williams executing our plan. We remain focused on our natural gas strategy and are pleased with our results in the third quarter. Our backlog of projects continues to grow as we see the demand side of the natural gas story develop. Sustainable low-cost reserves will fuel the growth story, and we are excited to be a part of this future. So with that, we'll move to the Q&A session. I remind everyone that today's call is to discuss our operational and financial results for the third quarter, and I ask that you please limit your questions to these topics. Thank you for your understanding and cooperation. I know there's a lot of interest in the transaction, but we'll be limiting our comments today to Williams operations and performance for the third quarter and drivers for the future. So with that, we will turn it over to questions.

Good morning, Alan; everyone.

Good morning.

Let's see here. There is quite a bit. I guess just a little bit of bookkeeping; in terms of project timing in the Northeast, any incremental color on Constitution and getting that kicked off?

Sure. We've gotten through all the work with DEQ with New York and that was kind of our final barrier up there. We are working with the Governor's Office to understand the cause of delay in getting that permit out. We are working to understand that. A lot of great work is ongoing by the teams there to meet the requirements for the New York DEC, but we think we've gotten there. Really just waiting for the Governor's Office to sign off on that and then we'll be in a position to get that done for the fourth quarter of 2016.

And so still on track for that timeline?

Yes.

The new Edmonton PDH facility, any color in terms of just how competitive that market is? Obviously, that's a much-needed project in that region. Are there other folks competing for similar projects there? And across your footprint, do other PDH units make sense, and what's the competitive landscape for those types of projects?

Yeah. Great question. That PDH project is very unique from our perspective, and it takes advantage of very low-cost propylene already in the area as well as the propylene that we would make with the new PDH facility. For quite some time, we’ve wanted to develop polypropylene units and downstream derivatives in the area, because it’s just a logistics game. Today, a lot of that propylene is going into the Gulf Coast, being converted into various derivatives, particularly polypropylene, and then being railed back up into the Midwest market. This project takes advantage of that low-cost propane in the basin and low-cost propylene directly from those big delayed cokers in the oil sands, transporting it into those Midwest markets and having access to international market out of places like Port of Vancouver. This project is exciting for us and we have plenty of product as we continue to expand our upstream oil sands operations.

Awesome. Got it. Thank you. Very interesting.

Thank you very much.

Good morning, everyone.

Good morning.

My first question has to do with CapEx; year-to-date, it's been trending a lot lower than the guidance we got five months ago. I'm guessing most of it is due to lower-than-expected spending in the Northeast and for the Access assets. Is the run rate of spending seen for the first three quarters a good indicator for what to expect in the fourth quarter? How much of the spending would you say has been delayed? Is this more of a timing issue into 2016, or are some of these projects indefinitely postponed until pricing signals improve?

Christine, I would actually say – I'll separate that. The maintenance capital piece, a number of drivers on that, but we still have a lot of maintenance capital work out in front of us. A lot of maintenance capital is invested in the inspection and improvement of our pipeline system. When we don't have as many anomalies show up or as many repairs required, then we don't have as much maintenance capital to spend. We have a lot of work ahead for both the third quarter and into 2016. On the growth capital side, that is somewhat driven by things like we would have hoped to have been started on Constitution by now. But there are a lot of projects where we are actually seeing lower costs come in. The team has been doing a great job up there, bringing in costs lower and enjoying cost savings on significant projects. I would say the delay component is primarily with Constitution, but some substantial savings are coming through in our numbers as well.

Okay, great. And then on the heels of that, it looks like you funded all the CapEx with debt in the third quarter. I'm assuming you couldn't really tap the ATM markets while undergoing a strategic review, but how should we think about CapEx funding between now and closing of the deal at the parent? I realize that IDR waivers are going to help some, but can you tap the ATM markets given the uncertainty around the future? And even if you could, I'm assuming you don't want to when the units are yielding 11% and credit metrics are high. So how should we think about this? I would think that you can't solely lean on the balance sheet for the next six to nine months.

Christine, this is Don. First, I'd say that I think the cost of equity capital is unusually high due to the high level of uncertainty in the energy industry right now. We expect that the market will settle down, and in time, the market will reward the advantaged companies. We have various options ahead of us, and the ATM is one of those. We'll be balancing cost and risk with a combination of debt and equity to finance and keep WPZ at investment grade ratings.

Can you go into further detail about alternatives to the ATM?

I think the alternatives we have are probably the same as other industry participants. I'm not going to delve into the variety of options but we do have a number of them and we'll evaluate all of those to find the lowest-cost solution while balancing risk and maintaining those ratings.

Okay. Last question from me; can you quantify how much gas was shut in in the Northeast for the third quarter and for how long? Additionally, Alan, you mentioned that there are many wells waiting on completion. Can you quantify that behind your acreage as well?

For the third quarter in the dry Northeast, we had a significant amount of volume shut in the Bradford and Susquehanna Counties. We had about 350 million a day in Susquehanna and upwards of 400 million a day in Bradford, so pretty significant. These are all price-related shut-ins. In the OVM area, we had about 150 shut-ins starting in the middle of the quarter. For the Utica, we had shut-ins of about 300 million, but those have come off, and we are now flowing at full rate. Right now, we have about 900 million shut-ins. There are numerous opportunities for us to grow volume besides these shut-in volumes, including uncompleted wells.

Yes. Thank you so much for all the color. Congrats on a good quarter.

Thanks.

Thank you.

Good morning.

Good morning.

I wanted to follow up on the 900 shut-in you talked about. Do you have any visibility to that coming back online with certain price points or regional de-bottlenecks that you think could help get that flowing, or any color there would be great?

Obviously, we've talked about Henry Hub pricing and the basis differential. The basis differentials from the Northeast to market pricing have been significant. Many of our producers have seen realized prices in the $0.70 price range. We have number of opportunities, including Constitution and Atlantic Sunrise projects which will help bring the critical infrastructure we need to unlock the value of these resources. While we are not giving guidance for future volume growth, as we see that basis differential come down, if our producers saw the $2 pricing, we would see tremendous volume growth in the Northeast. Additionally, we need to consider winter pricing and weather-related issues as we move into the winter.

Great. Thanks for that. It sounds like takeaway solutions might be a few quarters off if not longer, but if weather can improve the basis that could potentially be more of a near-term catalyst to help you guys out there?

I would just add, certainly, as Jim mentioned, in the near-term, we have the Leidy Southeast, that's 525 million a day. A lot of that Northeast volume is gathered by our system, and we should expect to see some of that relief parlayed directly to our gathering assets. Additionally, we are in a fairly warm shoulder, and during the winter there will be some relief for both gas prices in the Northeast.

Great. Thanks. That’s it from me. Thank you.

Good morning. Congratulations on a nice quarter.

Good morning. Thank you.

So on Christine's CapEx question, you referenced some cost savings in Susquehanna and Atlantic Sunrise. I'm just wondering if the bulk of that is project-specific with good execution or if we are starting to see industry-wide material and labor cost deflation?

In the case of the Susquehanna Supply Hub, the team has worked hard to take advantage of the scale of installation of our compression and gathering lines. They've worked hard with the Access team to really pull together ideas on the best way to put infill compression. The intense focus on project controls and execution is really starting to pay off up there. On Atlantic Sunrise, the uncertainties in putting these big projects led us to build in quite a bit of contingencies, and as we deliver those projects, we can reduce some of that contingency due to lower costs in materials, particularly pipe, so it's a mix of both.

Okay, great. And where is the current state of Geismar utilization?

Geismar is running at – we sold about 404 million pounds this quarter, and Geismar produced closer to 450 million pounds. On average, we ran about 98%. We are extraordinarily pleased with the Geismar team setting production records. We have two transformers scheduled to be replaced next year which could help us find some increments.

That's great. I know it's been a long road there and it's terrific to hear such a good quarter in terms of execution.

Thank you. We appreciate your comments.

Last question is the PDH project, is it still somewhere in the neighborhood of $1 billion investment? Is there any thought about timing gap for a second PDH project after the first one is online?

We're not going to disclose that until we get our FID on that. We have done a lot to ensure that when we do put in the PDH 2, we have all the planning thought through both on the propylene side and the polypropylene side. Returns for PDH 2 would be very attractive, but we are keeping our focus tightly on the scope of PDH 1 to start with.

Understood. Congratulations again on the quarter.

Thank you.

Hey, guys. Good morning. Alan, just one quick question for you. I realize you're still evaluating that scope of PDH 1, but as we're trying to put some numbers around the profitability of the volume commitments announced, is the biggest influence at arbitrage between the level of currently produced refinery-grade propylene and the demand growth for PGP and derivatives? Or do you see maybe the domestic PGP and derivatives demand significantly increasing, or more margin opportunity internationally?

The party having the lion's share of the exposure will be our partner who will market that product, and they are excited about the markets. From our perspective, we’ll focus on producing propylene at a low cost and into a fee-based contract. Our focus will be on driving volumes and low-cost sales.

Thank you.

Thanks. I would love to ask about the Appalachian Connector project. You mentioned the fact that producers are really interested in getting their gas transported, and it seems like a good solution, but there are some competing projects along the same lines. What are your thoughts on that?

I would say we’ve been looking at a number of alternatives. The demand for natural gas in Southeast power generation markets is significant. This is a valuable opportunity for us, particularly given Transco's ability to expand cheaply out of Station 165 to the South. It provides an ability to enter into the best project but we want to maximize value after other investments have been made. The volumes from the dry Utica continue to impress us, and those are the key drivers. We think the need for this project will be out there.

Okay. Thank you for that. And then some housekeeping; now that we have Geismar up and running, are the operating costs in the NGL & Petchem Services reflective of the run rate we saw in the quarter, or will there be other puts and takes?

John, you want to take that, please?

As we look at earnings absent commodity price volatility, the earnings would be a reasonable run rate for the business. Geismar is contributing. NGL services have had a reasonably good quarter for NGL services in Canada. We experienced some costs this quarter slightly higher than we would have expected for the Geismar unit, but that would be on the order of just a few million dollars. So I wouldn't expect costs to be hugely different going forward.

Perfect. That's it from me. Thank you.

Thank you.

Good morning, guys.

Good morning, Becca.

On Chesapeake recent negotiation on the Haynesville MVCs, can you talk about what happens in a low gas price environment? Do they have an option for an out, or do they need to continue to drill into that agreement?

For 2016 and 2017, as we mentioned earlier, our cash flow from the MVC has not changed, so there is no change on that. Relative to the obligation to drill, that is a firm obligation.

Okay.

Those MVCs end under the contract in 2017.

Thank you. Can you talk about discussions with them? Are discussions continuing to renegotiate some of these contracts?

I would just say we think those were the bulk of the opportunities, but we'll continue to look at opportunities if there are growth prospects. Great relationship with them; we think they're a great operator and we'll continue to look for opportunities.

Thank you.

Thank you.

Hey, Alan. How are you?

Good morning. How are you?

I'm great, thanks. A lot of this has been hit already, but I have two questions. The Gulf Connector project looks like the proposed capacity there came down quite a bit. Just wondering if you could offer any color on that project, costing-wise or counterparty-wise, and your thoughts on initial versus potential future expansion?

Sure. Rory, would you take that question, please?

Sure. Good eye there, Christopher. Those numbers did change a little bit quarter-to-quarter. When we had that open season, we had requests for greater capacity than we could handle. So we moved forward with two parties, and one party has stepped out and decided they are not going to pursue signing the agreements. We've reduced the size of the project, but, on the good side, one of the other players that wanted to get in that couldn't, now will have an opportunity to come into the project. It will be a smaller project, but the returns actually go up.

Okay. Thanks for the color on that. Switching gears, the West performance was solid mostly on the pricing front this quarter. Can you share your thoughts on producer activities and potential volume movements as we move into 2016?

The producers are finding ways to bring in additional production with very few rigs running. They're being very efficient with that, and we're seeing interesting new developments. The good news in the West is that there's ample takeaway capacity and low gathering and processing costs. We don't expect a whole lot of change out there, but there are lots of known reserves. If we see a price signal, producers are ready to act.

Great. Thanks a lot, Alan. Thanks for the color this morning. Appreciate it.

Hi. Good morning.

Good morning.

I wanted to get your thoughts on the pace of additional capital spending for gathering and processing assets in the Northeast, given the current environment. Specifically, can you talk about the investments tied to the Utica with Chesapeake and how you see the capital ramping up over the years?

We are excited about the acreage dedication. Once the infrastructure constraints are lifted and the clients can take advantage of the dedicated capacity, it will pay off. We are not obligated to spend that money in front of production evidence, so we will be thoughtful about expenditures.

Thank you.

Thank you.

Hey, good morning. This is Bhavesh instead of John. Most of my questions are answered. Just a question on Geismar. Given where ethylene prices are, can you share your views on prices going ahead for the next few quarters and whether there are opportunities for pricing-based contracts?

John, you want to take that, please?

As we brought Geismar back on, the market was served well; there were very few unexpected shutdowns. Looking ahead, the second quarter of next year may see a positive shift due to a high turnaround season. Inventories are relatively low, which should bode well for supply and demand balance in our favor. We are always looking to secure the best value for our ethylene and have been in conversations about entering contracts.

Great. Thank you, and congrats on a great quarter.

Thank you.

Thank you everybody for joining us this morning. We appreciate the interest and appreciate you respecting the scope of our discussion this morning. A big thanks to the team here at Williams for great execution and focus. Thank you for joining us this morning and have a good day.