Dominion, whose diversified portfolio includes about 6.6 Tcfe of proved natural gas reserves, announced Wednesday it will sell nearly all of its highly profitable North American exploration and production (E&P) assets to focus on its less risky utility businesses. Only the company's Appalachian Basin properties, with 17% of Dominion's total proved reserves and 8% of average daily production, will be retained.
The Richmond, VA-based company's E&P business segment now accounts for about 36% of the company's total earnings; in 1997, E&P accounted for 3%. After the bulk of the E&P assets are sold, the Appalachian properties will account for less than 5% of Dominion's total earnings.
Dominion did not put a purchase price on the E&P assets, and it does not expect to have one until a year-end audit is completed. Dominion's unaudited estimate on Sept. 30 of the proved reserves to be sold totaled 5.5 Tcfe, with average daily production of 1,175 MMcfe/d. The reserves to be sold are 76% natural gas and 76% developed.
A review of comparable E&P sales transactions by energy consultant John S. Herold puts the value of the Dominion assets to be sold at $10.5 billion. Merrill Lynch energy analyst Jonathan Arnold calculated the gross proceeds "would be well over $10 billion."
Included in the package are proved reserves and daily production in Canada (220 Bcfe, 55 MMcfe/d); the Gulf Coast (475 Bcfe, 158 MMcfe/d); the Gulf of Mexico (986 Bcfe, 106 MMcfe/d); Midcontinent (703 Bcfe, 108 MMcfe/d); Permian Basin (2,096 Bcfe, 168 MMcfe/d); Rocky Mountains/other (533 Bcfe, 100 MMcfe/d); and Michigan (250 Bcfe, 24 MMcfe/d).
"It is rare that a business of this size and quality becomes available," CEO Thomas F. Farrell II told financial analysts during a conference call. The decision to sell the profitable unit was not a "precipitous or easy one," and Farrell stressed that the E&P assets are profitable and are forecast to remain profitable going forward.
"This announcement is not about retrenchment," said Farrell. "We are doing this from a point of strength to move to a point of strength." Dominion's integrated business model, he said, was difficult for investors to understand, and its broad diversification has limited its growth relative to its peers. "The E&P segment exceeds the comfort level of those investing in the utility sector, and we've earned a discount to our peer group."
Dominion's E&P assets are managed by subsidiary Dominion Exploration & Production Inc., based in Houston. The subsidiary has been one of the most active drillers in the United States over the past four years, with just under 4,000 net wells. The subsidiary was formed in 2000 when the company restructured following a merger with Consolidated Natural Gas Co. (see Daily GPI, March 6, 2000).
The sale "is about refocused growth," said Farrell. "We have our sights set on other opportunities, and there are many positives on the horizon...With our strategy more clear to investors, we will position ourselves to review opportunities. It is a new way of looking at the business. Earnings are important, but so is maximizing the ratio."
Dominion executives undertook a strategic review of the company more than a year ago, and a final decision to sell the E&P business was made at the end of the third quarter. Farrell told analysts two months ago that the company was considering selling or spinning off the E&P business (see Daily GPI, Sept. 7). A formal sales process will begin in mid-February after the reserve audit for 2006 is completed. "A lot of work" still needs to be done before the sale is under way.
"Our strategic review has determined that the best long-term course for Dominion is to place greater emphasis on our traditional utility businesses, which will account for about 64% of our income this year," said Farrell. The utility businesses "provide the balance of risk and reward with which our traditional shareholder base appears to be most comfortable. By redeploying net cash proceeds to debt reduction, stock buybacks and expansion of our remaining businesses, we believe that shareholders would see solid, reliable growth from a complementary set of assets."
Farrell said that even before Wednesday's announcement, "there has been a lot of industry interest in all of the E&P assets..." Dominion's "first choice" is to sell the properties as a package to ensure their full value and to try and keep the Houston-based employees together. However, if the "right offer" was made, the CEO said the company would consider breaking up the assets.
Asked what Dominion would do if an offer was made below the company's expectations, Farrell said there is "very little likelihood we won't get the value we're looking for. We have expert advisers, and they say this is the best set of assets offered for sale in the last 10 years. If we don't get the levels we're looking for, we night reconsider the idea of spinning [the unit off] as an option. There are other alternatives as well. We don't expect to get to that spot."
With the proceeds, Dominion plans to reduce its debt, repurchase shares and/or acquire complementary assets for its remaining businesses, Farrell said. The remaining businesses are expected to grow consolidated operating earnings at a rate of 4-6% annually.
Dominion's new focus will be centered on its utility and natural gas transportation, manufacturing and retail businesses -- all located east of the Mississippi River. The transportation segment will include 7,800 miles of gas pipeline, 6,000 miles of electric transmission, nearly 1 Tcf of gas storage, and the liquefied natural gas (LNG) regasification facility, Cove Point LNG.
The manufacturing segment will include Appalachian Basin's 1.1 Tcfe of proved gas reserves, 100 MMcfe/d of production and 28,000 MW of electric generation. The retail segment will include 4 million franchise gas and electric delivery customers in five states and 1.5 million unregulated retail energy customer accounts in 11 states.
Dominion's Appalachian reserves, estimated to total about 1.1 Tcfe, "fit well geographically and operationally with our natural gas pipeline, storage and gathering businesses," said Farrell. They are located "in the middle" of Dominion's gas pipeline and storage assets, which puts their risk profile more in line with the risk profile of Dominion's utility business. The "growing costs per well are relatively low. We've had a 98% success rate in the region over a long period of time, and the location of production provides a positive basis differential compared to other areas."
"The new profile will be one of the strongest electric franchise areas in country, with a successful and growing retail program, diversified portfolio, active LNG facilities, and plenty of room to expand," Farrell noted. "We'll have one of the largest natural gas storage systems, a pipeline business that is geographically advantaged, and a low-risk oil and gas operation."
With the sales announcement, Farrell said, "I want to make it clear that our strategic review process is complete and that we intend to keep the resulting business profile for the foreseeable future. However, our review of individual assets in each business unit will continue. We will work to improve the return on invested capital across the company."
Dominion engaged the investment banking firms of JP Morgan, Lehman Brothers and Juniper Advisory LP for the potential sale. Merrill Lynch is advising Dominion on market perception of existing and future activities. BakerBotts LLP and McGuireWoods LLP are the company's legal advisers for the potential sale.
Also Wednesday Dominion reported quarterly earnings rose to $654 million ($1.85/share) from $15 million (4 cents) in 3Q2005. Last year's quarterly earnings were impacted by several charges, the most significant being a $375 million charge related to Hurricanes Katrina and Rita. Excluding nonrecurring items, earnings were $662 million ($1.87/share), up from $373 million ($1.08) a year ago. Revenue fell to $4.03 billion from $4.56 billion.
Increased earnings were attributed to the receipt of business interruption insurance proceeds, lower unrecovered Virginia fuel expenses, higher contributions from the company's merchant generation and producer services businesses, as well as increased gas and oil production revenue. Profits were partially offset by the impact of comparatively milder temperatures in the electric utility service area, lower sales of emissions allowances, and restoration expenses following Tropical Storm Ernesto.
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