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Sempra Eyes Growth; RBS Deal Closes

Sempra Energy hopes to better navigate roiling global financial markets now that its trading joint venture with the Royal Bank of Scotland (RBS) received final regulatory approval from the U.S. Federal Reserve Bank to complete the formation of their commodities/marketing joint venture, RBS Sempra Commodities. Sempra CEO Donald Felsinger said he would like to boost the San Diego-based energy company's stock price.

Felsinger expects to experience faster earnings growth and more diversity in Sempra's operations over the next five years, he said during the company's annual analyst meeting in New York City last Thursday. The announcement on the Fed approval came shortly after the analyst meeting.

"The next five years look a lot different than the last five years, and I am as confident as I have ever been that we will meet our earnings targets through 2012," Felsinger said. Sempra said it should average 11% earnings growth annually over the next five years, targeting earnings-per-share guidance for next year in the $4.35-4.60 range and for 2012 in the $5.50-5.80 range.

With less risk and more upside potential in the energy and metals trading in which it has thrived for a number of years, Sempra can use the joint venture to remain relatively aloof of the global credit crunch now plaguing the financial sector, Felsinger said. The Fed approved the two firms merging their physical trading of commodities -- the last remaining approval needed. The deal is expected to close Tuesday (April 1).

The joint venture received approvals last year from the UK Financial Services Authority and the Federal Energy Regulatory Commission (FERC).

While analysts probed senior Sempra officials for more details on various merchant businesses, such as power generation and importing liquefied natural gas (LNG) at the company's two new receiving terminals -- North Baja California's Costa Azul and Cameron on the Louisiana Gulf -- Felsinger painted a picture of growing earnings from a number of natural gas infrastructure projects, which include pipelines and storage projects in addition to LNG, and a growing presence in the renewable energy sector in the Southwest and northwestern Mexico.

While recording record earnings of a little more than $1.1 billion last year, Felsinger said Sempra took a "giant step forward on natural gas infrastructure" and many of those projects will be commercialized this year. By 2012, he expects earnings to be in the range of $1.3-1.5 billion.

Felsinger and the rest of the Sempra senior executives expressed confidence that the current delays and uncertainty related to how much LNG growth there is going to be in the United States should not adversely affect their projects. There may be a lot of unused capacity at first at Costa Azul and Cameron, but from what is firmly committed -- not counting supplies that can be diverted -- Sempra will stay profitable on its LNG operations, the executives said.

In fact, over the next 20 years, just with the four long-term contracts it now has in place for LNG supplies, Sempra is looking toward returns on its investment in the 8-8.5 % range, said Felsinger, noting that even when LNG cargoes may be diverted to higher priced markets, Sempra is paid its margin.

"Our terminals make money whether gas flows or not," he said.

Even though revenues streams will not be jeopardized by its partially filled new LNG terminals scheduled to start commercial operations later this year, Sempra is fairly confident that Merill Lynch will now opt out of its contract to bring 500 MMcf/d through the new Sempra Cameron LNG terminal in Louisiana, according to the CEO of Sempra's LNG unit, Darcel Hulse, who spoke at the analysts' meeting.

Merrill's expected supply from Papua New Guinea has slipped and therefore it doesn't want to "go live" yet, Hulse said, adding that eventually, "they'll probably be back with us." So he doesn't see the supply longer term as a "total loss," it can't be counted on in the near term of the next three to five years, though.

Sempra two years ago inked a 500 MMcf/d deal for a portion of the Cameron plant capacity with Merrill Lynch -- a 15-year, full-service deal, giving the company the capability of importing 3.7 million metric tons of LNG annually. The deal was contingent upon Merrill finalizing its LNG supply arrangements.

"Depending on the timing of Merrill Lynch Commodities' arrangements, Sempra LNG would have the flexibility to service the capacity agreement from either the first [1.5 Bcf/d] phase of Cameron's development, to be completed this year, or its proposed [1.15 Bcf/d] expansion, which could be completed in 2010," a Sempra spokesperson said at the time the contract was announced.

For now there is a loss in the LNG unit carried from quarter-to-quarter related to the Merrill contract, according to Sempra COO Neal Schmale. Hulse said that Sempra is doing "everything it can" to replace those volumes, and "there are a lot of potential things teed up. The next thing we need to see is a new liquefaction facility with some of the parties we have been negotiating with," he said.

Overall, with four assured contracts for LNG supplies that will begin at the Costa Azul facility in North Baja California, Mexico, and Cameron, Sempra has a locked in single-digit return on investment. When the other supplies fill out those two terminals -- such as the replacements for Merrill's 500 MMcf/d -- Sempra will be drawing double-digit returns, Hulse said.

In 2008, Sempra will still show a loss of $40-60 million for its LNG operations, Hulse said because of pipeline charges and other upfront costs that kick in once commercial operations begin. He expects the first modest profit in the unit for 2009 ($20-40 million), and the real profits to begin rolling in about 2012 ($140-170 million).

It is 2012 in which Sempra estimates there will be 12.5 Bcf/d of new LNG capacity coming online worldwide.

Following the Fed's approval, Sempra said that RBS Sempra Commodities LLP will purchase Sempra Commodities, which at times in the past two or three years has contributed as much as half of Sempra's profits. During the next five years, trading's proportional profit contribution will drop some, Felsinger said, as the company diversifies more and some of its major gas infrastructure projects reach full commercialization. In 2012, he estimated Sempra profits from trading will represent a little more than one-third of its overall net income.

As outlined last July when the deal was announced, the Sempra-RBS trading joint venture was valued at $2.65 billion with Royal Bank of Scotland assuming the day-to-day operations and capitalization of the San Diego-based energy company's trading operations. Sempra officials described the transaction as the best of both worlds, allowing Sempra to use RBS's financial heft to realize upside growth while at the same time lowering its risk.

At the time Felsinger described Sempra's prospects for greater trading profits with lower risk as being akin to "clipping coupons" for well heeled bondholders.

Now that the deal is about to close, a key for Sempra is the fact that RBS is the world's leading project finance bank, and it is the leading lender to the renewable energy sector, an area that Sempra intends to expand into in a big way in the years ahead, according to what senior company officials told analysts last Thursday.

Sempra Commodities was built up over the past 10 years to become an international marketing and trading company combining financial risk management with physical expertise in natural gas, power, petroleum and base metals, as well as natural gas liquids, coal, emissions credits and ethanol.

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