Duke Energy Buys Westcoast for US$8.5 Billion
While much of the gas industry is busy preparing for a period of low prices and declining demand due to the weakening economy, Duke Energy is showing great confidence in future gas market growth and the potential of Canadian supply basins. The company announced plans last week to buy Westcoast Energy in a cash and stock transaction valued at US$8.5 billion, including $4 billion in debt assumption. The move greatly expands Duke's North American natural gas pipeline holdings and positions it for a strong role in future gas infrastructure expansions.
"This is the first large cross-border infrastructure transaction, and it reflects an economic reality," said Westcoast CEO Michael Phelps, who will become a member of Duke Energy's board and chairman of an advisory board for DEGT's Canadian operations. "In North America today we have the most dynamic economy in the world. It's obviously going to have its degree of short-term pressures, but it is the most dynamic economy...and energy is what fuels that. Gas is really the most important part of that energy growth... In the North American context, two of the most prospective new supply sources around the continent are on the Scotian Shelf off the East Coast and in the new areas of western Canada and the far north. Westcoast is the only pipeline that serves those new basins and connects them to the market.
"When you marry that to the existing well-established Duke infrastructure and our joint market presence in a lot of key markets, it is the most powerful combination in our infrastructure business today," said Phelps. "Size is very important in terms of efficient access to capital and this transaction will certainly help us there."
The transaction increases Duke control over Canadian gas transportation from 3% to 30% and puts Duke in a much better position to transport gas from the more rapidly growing supply basins in Canada to growing markets in the United States. It also grows Duke's natural gas storage capacity by 140%, and improves its ability to serve the rapidly growing needs of gas-fired power generators.
The combined natural gas-related assets will include about 18,900 miles of transmission pipeline, 241 Bcf of gas storage, 58,700 miles of gathering, 84 processing facilities, and 16,500 miles of distribution pipeline. The combination puts under one roof Duke Energy Gas Transmission's interstate pipelines, including Texas Eastern Transmission, Algonquin Gas Transmission and East Tennessee Natural Gas, and Westcoast's BC Pipeline, Empire State Pipeline and Union Gas Transmission. The company also will have a large ownership interests in Maritimes & Northeast Pipeline (75%), Gulfstream Natural Gas System (50%), Foothills Pipe Lines (50%), Vector Pipeline (30%) and Alliance Pipeline/Aux Sable (23.6%).
Duke will buy all outstanding common shares of Westcoast in exchange for a combination of cash, Duke Energy common shares and exchangeable shares of a Canadian subsidiary of Duke Energy such that 50% of the consideration will be paid in cash and 50% will be paid in stock. The deal will provide Westcoast shareholders with C$43.80 per share in value, subject to a collar. Duke believes that the acquisition can be completed during first quarter 2002.
"Since the company was created from the evolution of the combination of Duke Power and PanEnergy some four and a half years ago, we've been firmly focused on executing our strategy, growing a world-leading integrated energy business," said Duke CEO Richard Priory. "This greatly improves the balance and diversity of our energy assets. We see a tremendous need to expand the natural gas infrastructure across North America. Much of this will be to simply move incremental gas supply from expanding sources in Canada to fast growing markets in both Canada and the United States. We're convinced that this combination...will position us to take a lead role in development of that infrastructure."
Priory said the transaction would be "immediately accretive upon closing. "It is an important investment in our competitive energy businesses, expected to provide the opportunity for increased earnings growth from our gas transmission business, while also providing new growth opportunities for our other businesses." Duke expects the deal to boost its earnings per share by about 4.5 cents next year and by 10.4 cents in 2004. Phelps said Duke continues to expect earnings per share (EPS) growth of 10-15% per year from a base of $2.10 EPS in 2000. Fred J. Fowler, group president of Duke's energy transmission business, said the deal would increase DEGT's projected annual growth earnings before interest and taxes (EBIT) from 5-7% to 7-9%.
The deal shows the confidence the companies have in the growth of the gas market. "We just came off some pretty high gas prices last winter, which drove off a good deal of demand, we think, temporarily," said Priory. "There are a dramatic amount of new gas facilities to convert gas to electricity being installed around the country. Those will be installed. They are being connected to the grid now. The rapid development of gas fired power unquestionably is going to require us to expand our infrastructure to supply that fuel... We are very confident that this market will continue to grow. We may see 1 Bcf/year [of growth] for the next 10 years or so."
Phelps said the companies have "billions of dollars of assets tied up in the bet that gas is going to find an appropriate equilibrium [price] level, and it's somewhere higher than today's price and lower than the prices that we saw this winter. I'm very confident that's what we will see."
And as that recovery takes place, the increases in supply over the next decade undoubtedly will come mainly from Atlantic and western Canada and the far north, including Alaska and the Northwester Territories, Fowler said during a conference call with analysts on Friday. He said 70% of the forecasted production growth between now and 2010 will come from Canadian sources. About 75% of the increase in North American gas deliverability last year came from the Lady Fern play behind Westcoast's system in British Columbia. The Scotian Shelf currently holds about 6 Tcf of proven reserves, but Phelps said that could easily grow to 10 times that amount, all of which will be headed to market down the Maritimes and Northeast pipeline, which Westcoast expects to expand to 2 Bcf/d by 2010 from about 500 MMcf/d today.
This transaction in large part reflects Duke's belief that a shift is taking place in the North American gas market. Gas production from the Gulf of Mexico is being displaced by growing Canadian supply and that is expected to continue, said Fowler. Northeastern markets increasingly will be served by Canadian gas coming down the Maritimes and Northeast Pipeline and down Alliance pipeline and through Vector to the Dawn Hub in Ontario, all of which are owned in whole or in part by Westcoast. Fowler said Gulf gas increasingly will be devoted to serving the Southeast, the fastest growing gas demand region in the country, while Canadian gas will fill the Northeast's growing hunger for the commodity.
Another important strategic component of the deal is Duke's belief that gas storage is becoming much more important. The deal makes Duke the third largest storage operator in the country. Westcoast's 140 Bcf Dawn storage facility boost's Dukes storage holdings by 140%. Last year Duke bought Market Hub Partners, the nation's biggest operator of high deliverability salt cavern storage. "Increasingly we see gas customers requiring the ability to ramp up their gas supply not only during the day but on an hourly peak," said Fowler. "Much of that results from all the gas-fired electric generation we have on our systems. It has put a strain on pipeline systems. They weren't built to handle that load. And storage and hub related services are increasingly important ways of meeting that need." He added that Westcoast expects to expand Dawn's working storage capacity by 5-7 Bcf per year. "We believe that storage is going to have to increase" to serve growing gas demand from power generation.
Despite the apparent strategic values behind the deal, it didn't draw a favorable response from the bear market on Wall Street. Duke's stock was down 5% Friday afternoon. One analyst said he expected the traditionally slower growing Canadian assets to slow down Duke's projected 15%/year earnings growth to closer to 10-11%. Westcoast shares rose sharply over a 52-week high on the Toronto stock exchange to $39.79 as of 2:30 EDT Friday.
Another Wall Street analyst said the deal easily could have been delayed because of last week's attacks and the impact on the economy, which may have even jeopardized the transaction. Westcoast's board was wary of going through with it under such dire continental economic circumstances. However, the strategy behind the deal was so compelling and in line with current national energy policy, the analyst said, that the companies felt the need to move forward and make the announcement.
"If you look at what is being created by Duke and Westcoast in the North American natural gas business and you overlay that on the president's national energy policy document, it really is a very powerful combination," said the analyst, who asked to remain anonymous. "One of the things that I believe very firmly is that all of us in this industry if we do have a quiet moment when we could tear ourselves away from the terrible things being reported on CNN should reread the national energy policy. It was written for something we call 'the crisis.' But that was a crisis written with a small 'c' compared to where we are right now. But what was written in that national energy policy...provides a good reason why the Westcoast-Duke deal makes sense." It also makes sense given that the "new chairman of the Federal Energy Regulatory Commission, Pat Wood, is likely to come out next week "with guns blazing for the construction of new infrastructure," he said.
"I'm hearing things -- I don't know if you are -- about Sen. [Jeff] Bingaman and others promoting legislation that will have something in it about reducing reliance on imported oil. All these policy initiatives are coming back. Somehow I think our country feels differently now about its resolve to do stuff like that." Energy policy has become a national security issue, he added, and transactions that are designed to boost energy infrastructure development fit very well with our national needs.
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