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Williams Slumps on Low Natural Gas Prices, NGL Frac Spreads

Williams, whose natural gas midstream and pipeline infrastructure stretches from Canada into the deepwater Gulf of Mexico, is tweaking its earnings forecasts lower for the next two years based on conversations with customers that indicate activity will be slower in the short term.

The updated guidance mostly reflects "the impact of lower gas prices" on gathering volumes at Williams Partners Ltd. (WPZ), which Williams controls. WPZ owns Transcontinental Gas Pipeline Ltd., the Transco system, as well as Gulfstream, Northwest Pipeline, Pine Needle, Black Marlin and Discovery Gas Transmission LLC. Earnings adjustments for WPZ were made after sifting through "a lot of the input from a lot of our producers around our systems," said CEO Alan Armstrong. Williams projections are based on a $3.25 gas price in 2013.

Lower revenue growth rates are expected for the next two years "across most of our operating areas that are exposed to natural gas prices...And although we have some fairly low natural gas price assumptions in place for '13 and '14, you really should not misconstrue that we have a lack of confidence in the natural gas market," Armstrong told analysts during a conference call Thursday.

"In fact, we're fairly bullish about the long-term demand that we continue to see build for natural gas. But we also have been impressed with the capabilities of natural gas producers here in the U.S. to continue to lower their cost of production, and so we're balancing that. We do think it will take some time for a lot of the big capital that's coming on to build that demand. But long term, I would tell you we're very bullish on seeing this natural gas market continue to expand..."

"But we continue to see supplies grow. And, in fact, our forecast of lower volume rates is not showing up currently in our growth rates. It's continuing to grow." Gas demand "picked up over the summer," Armstrong said, but "a lot of it...was very price-dependent growth, and you can argue whether that price is $3.50 or $3.75 or $3.25. You can argue as to where that price that kicks coal out and brings gas in, but it's certainly not $4 from our vantage point."

If the management team "thought gas prices were going to be $4.50 or $5 in '13, then we probably would have had a different perspective on that. But with our assumption of gas prices being at $3.25 for '13, with that assumption embedded, we'd have a hard time being more bullish than the producers in terms of their capital plans. And so we really basically took the capital plans from producers."

Many of the near-term plans by producers that Williams serves "were formed over the summer when gas prices were even softer," Armstrong said. "So if we do see gas prices rebound, we probably would see some more activity and more rigs picked up. But, of course, then we would have to raise our natural gas price if we believed that...But in general, I would tell you that we gather a lot of gas. And there's just a lot of areas that are exposed to the natural gas price, and we're seeing drops in really all of our regions from what we had forecasted earlier in the year, based on producers' forecasts..."

Onshore producers served by Williams and WPZ "are heavily impacted by the gas prices," Armstrong said. And they "are not enjoying any of the uplift" from natural gas liquids (NGL).

"We continue to be impressed with the kind of drilling and growth around our systems as we sit here today. But we think, eventually, that's got to moderate, and obviously, that's our reaction to it. On the ethylene price, what we continue to see is really a response between crude oil and ethane. As you get into '14, we're actually almost completely neutral to ethane prices and, in fact, a little bit short ethane. So if our ethane price is wrong, that will just show up in ethylene price...That's the best intelligence that we have based on the markets that we're seeing out there."

There is "good news" in the Northeast, boosted by the Marcellus Shale activity, he said. "For the most part, activities, particularly in the Ohio Valley Midstream area, really have nothing to do with either prices or with the drilling results from the resources. Actually, those are coming in a little better than we thought. It's really just a delay in terms of the activity and our ability to get infrastructure into place there quickly." The Ohio Valley Midstream unit was created earlier this year after the company acquired Caiman Energy's midstream arm (see NGI, March 26).

"All in all, I would say the environment's pretty good," said Armstrong. "But..we do expect continued reduction in areas that are totally dependent on just the natural gas price."

Producers in some of the unconventional U.S. basins are able to get a respectable return on $4/Mcf gas. However, many have moved from dry gas to focus on more liquids-rich areas.

"Certainly, not all these basins are created equal," said Armstrong. "There's quite a bit differentiation from one -- even in Susquehanna County [PA] there's a pretty big spread in one part of the county versus others. And as well, some producers are better than others at getting their costs down and there's a major variability in terms of what their other options might be and what they're invested in."

The market is "not perfectly efficient in that regard..But on the producer side, not everybody has the same number of options about where they might take the rigs, and some are more invested in others in getting their cost structure down in an area. We certainly see that in the Marcellus, with some players having a much lower cost structure and lower cash costs than others...I think it's hard to draw it with a broad brush..."

Williams has been forecasting that its Marcellus gas hub processing and transporting capacity would reach 3 Bcf/d or more by 2015, about triple current levels (see NGI, Feb. 27). Armstrong was asked if that plan would have to be adjusted.

"It certainly could [be adjusted] in some areas," he said. "I would tell you the areas that are the drier gas are most likely to be the larger part of that impact." However, he said the company remained optimistic about Marcellus production, "in terms of the producers' economics and their activities and the resource there."

The fractionation, or frac spread, basically is the difference between the value of natural gas and the value of NGLs. The wider the spread, the more favorable the market for natural gas processors. In the latest quarter Williams' NGL frac spreads "were about 18% lower, on average, than the already low 2Q2012 amounts and the impact of Hurricane Isaac," said Armstrong. "We saw about a 9% lower average NGL composite price, but an even higher impact from natural gas Street prices that were up about 26%, on average...We were not expecting that degree of decline into the third quarter. And again, a lot of that was impacted by gas prices moving up."

Williams net income in 3Q2012 was $155 million (25 cents/share), versus year-ago profits of $272 million (46 cents). Lower NGL margins at WPZ drove the decline in net income, which was partially offset by higher fee-based revenues. Adjusted income from continuing operations fell to $161 million (25 cents/share) versus $179 million (30 cents). Sequentially, adjusted income was 17% higher in 3Q2012 than in 2Q2012.

Separately WPZ agreed to pay $2.36 billion for Williams' 83.3% stake in the Geismar, LA, olefins production facility, as well as a refinery-grade propylene splitter and pipelines in the Gulf Coast region. WPZ, which would own 88% of Geismar, would be responsible for completing an ongoing expansion.

Williams also disclosed that it is buying 12 of ExxonMobil Corp.'s idle pipelines in the Gulf Coast region, which are to be combined with an organic build-out of several projects to expand petrochemical services in the region. The Gulf Coast projects, which are scheduled to be placed into service beginning in late 2014, include a significant expansion of an existing ethylene hub, as well as establishment of a propylene hub to connect customers with Mont Belvieu, TX, and an isobutane network to connect to single-sourced or undersupplied customers. Additional projects are planned to use unused portions of the acquired pipelines.

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