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Uncertainties Lessen, Future Clearer, Sempra CEO Says

With some key uncertainties now resolved in its utilities and commodities businesses, San Diego-based Sempra Energy is raising its confidence level and profit guidance for the rest of the year, CEO Donald Felsinger told financial analysts during an earnings conference call last Thursday. Still, regulatory, economic and contractual challenges lie ahead for interstate pipeline/storage plays and Sempra's growing liquefied natural gas (LNG) terminal assets.

Profits for the quarter, year-over-year, were down overall -- $244 million (98 cents/share), compared with $277 million ($1.05) -- for the second quarter in 2007.

While its results from its California utilities, pipelines, storage and independent generation businesses were all improved from the second quarter last year, this was the first earnings report under Sempra's new $3.3 billion joint-venture commodities business -- RBS Sempra Commodities. Under the RBS partnership, Sempra has reduced ownership in its energy trading unit, but has less risk and more access to a greater number of global deals due to the worldwide reach of the Royal Bank of Scotland (RBS), the company said.

Closing the energy trading joint venture was one of several "uncertainties" hanging over Sempra at the beginning of 2008 that have now been resolved, said Felsinger. He listed additional milestones as the general rate case decision for the California utilities that came July 31 from the state regulatory commission and the extension of the Rockies Express Pipeline (REX), which is now flowing 1.5 Bcf/d east.

"The strong results we saw this quarter were driven primarily by natural gas and power," Felsinger said. "But another key result we are seeing is increased 'deal-flow' [due to the RBS joint venture], coming from both new customers and new areas of business. At the moment we have a pipeline to about 50 large deals pending, many of which combine customer needs for financing with their need to hedge some form of commodity risk exposure. These are exactly the types of deals we were targeting by partnering with RBS."

On the recently announced pending $510 million Gulf of Mexico-based gas storage/utility acquisition of EnergySouth, Felsinger indicated that at least 40 Bcf of the potential 57 Bcf storage capacity in separate Alabama and Mississippi gas storage developments will be commercially available by the end of 2011. For the two fields -- Bay Gas Storage and Mississippi Hub -- there is about 20 Bcf of capacity already under contract.

The Bay Gas Storage facility plans to expand to 27 Bcf of total capacity; it currently has 11.4 Bcf of working capacity that is fully contracted, and another 5 Bcf is 92% contracted and under construction with a scheduled start date in the first quarter of 2010. Mississippi Hub eventually will grow to 30 Bcf capacity, and its first 6 Bcf phase is under construction with 4 Bcf of that capacity already under contract.

Felsinger said that Sempra's share of the cost of ultimately building out both storage projects will be $475-525 million, and he reiterated the company's strong belief that natural gas storage will increase in value through a combination of what he called "high prices and continued volatility in commodity markets.

"Along with our current LNG, pipeline and storage development in the region, we believe the EnergySouth acquisition helps lay the foundation for a highly profitable natural gas business in the Gulf."

Sempra plans to operate the 93,000-customer gas distribution utility in Alabama, Mobile Gas Service Corp., that it acquired with the storage field deal, said Felsinger. He did not say when Sempra might consider either selling or adding to the utility assets in the Gulf region.

"The distribution utility came with the transaction, and it is a good utility, with good regulation," Felsinger said. "For the current time, we plan to keep it." On the question of whether Sempra intends to acquire other utilities to add to it, he said, "The Southeast is a growing area of the United States from an economic standpoint, so we look at it as something we plan to make even a better utility out of. This is a key area for growth and for natural gas infrastructure. Having pipelines, storage, LNG terminals and a distribution utility give us a base to built on."

Noting that Sempra intends to expand its footprint in the Gulf region, Felsinger said the EnergySouth deal "allows [it] to better serve key markets in the Southeast where gas demand outpaces the national average, and the new assets complement existing assets in the region and position us for growth."

Felsinger talked about some continuing uncertainties amidst ongoing successes in Sempra's investments in REX and various liquefied natural gas (LNG) projects, including rising costs (estimated at $5.6 billion overall) for REX with all of its expansions and uncontracted for capacity at its Cameron (LA) LNG terminal that is nearing the end of construction and ready for commercial operations next year (see related story).

"There have been a number of things that have gone well with this [REX] project, but the challenge of late has been cost increases on the eastern-most segments of the pipeline due primarily to labor cost escalations and changes in the preferred route," Felsinger said. "Even with the cost increases, when REX is fully operational, we'll have around $650 million of equity and will be receiving dividends each year of about $70-80 million.

"There are always the regulatory uncertainties, and we have had quite a few conditions from the Federal Energy Regulatory Commission [FERC] that we have to meet," Felsinger said. "As we look at the environmental and routing conditions, there is always the chance that costs can change, but we think that the $5.6 billion is a good number with what we know at this time."

While noting "a lot of progress" in recent months in getting gas flowing on REX, Felsinger said the project still faces the challenge severe cost increases on the eastern-most segments of the proposed pipeline. He attributed the increased cost pressures to labor escalations and changes in the preferred route.

Felsinger said that the current "high-cost environment" makes it harder for new pipeline projects to compete with REX. "Early on, we were able to lock-in certain costs, such as steel and labor, for the first half of the pipeline," he said. "That type of hedging is not available in the current cost environment. REX or any other new pipeline could not be duplicated today at the same price."

In this environment, building the last, so-called northeast expansion of REX into New England is not a sure thing, according to Felsinger, and a smaller competitor may end up moving into that market.

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