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Sempra Bullish on RBS Trading Joint Venture

With the Royal Bank of Scotland (RBS) spewing red ink and heavily propped up by the British government, the high-profile, highly profitable joint venture trading operation between a unit of the bank and San Diego-based Sempra Energy has become the subject of much speculation and questioning.

However in an earnings conference call Feb. 24, Sempra senior officials said the joint venture remains profitable, and at worst Sempra would take back its $1.6 billion investment and look for another partner with global heft if the RBS partnership craters.

Profits were down in the fourth quarter compared to the previous year's last quarter ($164 million vs. $186 million in the 2007 fourth quarter), but they were still strong, particularly considering the global financial crisis, Sempra CEO Donald Felsinger said. Senior bank officials in the RBS Sempra Commodities joint venture have indicated to Felsinger that they have no intention of breaking up the trading combine.

Sempra CFO Mark Snell said the joint venture agreement calls for an initial four-year period in which neither side unilaterally can leave the partnership. Sempra has $1.6 billion invested, and RBS was looked to for additional capital in the years ahead. The joint venture is approaching its first-year anniversary.

"We've been in constant contact with our partners and I can't speak for them, but I will tell you what they have told us, and that is if there was to be any change in the joint venture status, they would have let us know by now, and I can say they have not done so," said Snell, who reiterated Felsinger's assurance that there is no prospect for the joint venture being dissolved.

"We feel very comfortable at this stage that we will stick together. Nevertheless, if down the road [RBS] decided to change its mind, the first hurdle is that the agreement itself has a contractual obligation that neither party would try to sell or get out of the agreement for four years, and we're not quite a year into the agreement yet. Contractually they are bound to do that.

"We also think the support [RBS] is getting from the United Kingdom government would completely eliminate the possibility of any kind of fire sale, if they had to do anything very quickly without any planning or thought. I think we are in a stable position now with RBS, and the [UK] government influence on the bank has stabilized them to the extent that if we were to do something, we would have a negotiation and we'd figure out what the right thing to do is.

"Our worst possible downside would be that we'd get our capital back at book value [$1.6 billion]. There's now about $6/share from trading in our business, and as we look at this business going forward, the opportunities for growth to really capture a market with not very much competition right now is so good and our results for the fourth quarter are so positive that I think this is a very valuable asset in the long run. I think both the bank and we certainly recognize it, and we'd like to stay in it for awhile."

In essence, Sempra feels it is making a lot of money in broad trading (electric, gas and metals) and in the worst case it would have a chance to get its trading business back if RBS was forced out by the global financial woes. If that is the case, Snell said Sempra would probably seek another partner.

"It would be hard to run this business [unilaterally] in the size that it is currently on our balance sheet," Snell said. "That is why we looked for a partner in the first place. I think what we would do is work out something over time with the bank [taking a smaller piece of it back]."

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