Soaring fuel prices, which slashed the value of unwinding energy trading contracts collapsed Williams' 3Q earnings by 96%, the company reported Thursday. However, the Tulsa-based company raised its profit forecast for the year on the continued strong performances of its other three major business units: exploration and production (E&P), natural gas pipelines and midstream processing.

Net income fell to $4.4 million (1 cent/share), from $98.6 million (19 cents) in 3Q2004. Revenue dropped 8.9% to $3.08 billion as the company continued to unwind its energy trading business, which forced a $141.1 million cut to energy contract valuations. Excluding the energy contract valuation adjustments, 3Q2005 income was $125.3 million (22 cents/share), just below Wall Street estimates. Earnings in its E&P unit more than doubled to $158.8 million, with average oil and natural gas output increasing 18% from a year ago. Gas pipeline profits climbed 8.3% to $162.1 million, and midstream profits also jumped 15% from a year ago.

CEO Steve Malcolm, who presided over a conference call with financial analysts on Thursday, said the company is "obviously delighted with the results of our restructuring." He noted Williams' debt now stands at $9 billion, versus $15 billion in mid-2002. Another sign of momentum is the elimination this week of the "chief restructuring officer" position created in late 2002 to help the company complete asset sales and reduce costs.

"Our asset sales are essentially completed, and we're much more about looking at growth opportunities," said Malcolm. "We are gaining traction in production growth plan and we are focused on expanding on gas production and processing businesses to capitalize on growing energy demands...The benefit of having diversity in our businesses and our revenue streams was evident in the third quarter."

Natural gas will continue to be the "focal point of our strategy," Malcolm said. Now that the company is on more solid financial footing, the "scale and scope of investments in our primary gas businesses could ramp up in 2005 to 2007. It's all about exploiting our exploration and production portfolio." He declined to elaborate on possible future investments -- other than growth in its E&P portfolio.

"As we emerge from restructuring, we're going to ramp up our investments in a disciplined manner," Malcolm said. "We expect to capture our share of the deepwater [Gulf of Mexico], and enter new basins consistent with tight sands gas and coal seams gas," building on its success in the Piceance Basin. Williams is spending $675-725 million on drilling projects in the Rockies this year, up from a previous budget of $605-680 million. Accelerated drilling is trained on the Piceance, where production has jumped 53% from a year ago --15% sequentially from the second quarter.

Since the beginning of 2005, Williams has grown its domestic oil and gas output by 18%, said Ralph Hill, senior vice president of E&P. "The Piceance Basin continues to produce strong production growth," he said, and Williams now is capitalizing on the success by entering into new areas of the basin. The Piceance is now the focus of about 40% of Williams' E&P. By 2007, Hill said the Piceance will be the focus of about 50% of the drilling, with Powder River drilling at about 15-20%, and the San Juan Basin with about 20%.

Williams suffered $12 million in damage on and offshore during the three hurricanes in the third quarter -- Dennis, Katrina and Rita -- but the only significant damage onshore was at the Cameron Meadows natural gas processing plant, near Johnson Bayou, LA. Alan Armstrong, who directs the midstream unit, said the plant, which took an almost direct hit from Hurricane Rita, is expected to return to partial operations by the end of this year. The plant should return to full service by 2Q2006, he added.

The Gulf Coast damage also failed to stop the gas gathering and processing unit from posting a strong quarter, Armstrong said. Midstream profit rose to $121.1 million from $105.4 million in 3Q2004, partly from a $22 million increase in fee-based revenue in the western United States, which was offset by lower fee-based revenue in the deepwater Gulf.

Citing the increased demand for processing capacity, Williams on Thursday announced plans to expand its Opal, WY facility by adding a fifth cryogenic processing train. The project is designed to boost the overall processing capacity of Williams' Opal facility from more than 1.1 Bcf/d to 1.45 Bcf/d, with the ability to recover 68,000 bbl/d of natural gas liquids. Work on the project is scheduled to be completed in 2Q2007.

Gas Pipeline, which primarily delivers natural gas to markets along the Eastern Seaboard, in Florida and in the Northwest, reported segment profit of $161.1 million, up from $148.8 million from 3Q2004. The increased profits were attributed to the benefit of a $14.2 million favorable adjustment from the resolution of litigation associated with its fuel tracker filings and an increase in equity earnings from Gulfstream Natural Gas System LLC, in which Williams owns a 50% stake. These items were partially offset by the termination of a firm transportation agreement related to the Gray's Harbor lateral on the Northwest system, effective January 2005.

Offshore, the Devils Tower deepwater spar at Mississippi Canyon block 773 is preparing to resume commercial operations, with startup expected to begin within the next few days. The facility has been available for service since shortly after Hurricane Katrina struck, but production was shut in until a downstream third-party oil terminal near Venice, LA, reopened for business.

Williams also has announced a $177 million offshore expansion to gather oil and gas from the Blind Faith Field in the deepwater Gulf. To accommodate this anticipated production, Williams has agreed to extend its Canyon Chief and Mountaineer pipelines by 37 miles each. The project is scheduled for completion in 3Q2007.

Williams raised the low end of its 2005 capital spending range for Gas Pipeline by $20 million to reflect higher activity through the third quarter. The company now plans to spend $390-420 million in capital expenditures for Gas Pipeline in 2005. The company also is increasing its expectation for 2005 segment profit, and now expects the unit to earn between $630-645 million, compared with a previous estimate of $590-615 million.

To provide an added level of disclosure and transparency, Williams provided an analysis of recurring earnings adjusted for all mark-to-market effects from its Power business unit. Recurring earnings exclude items of income or loss that the company characterizes as unrepresentative of its ongoing operations. Recurring income from continuing operations -- after adjusting for the mark-to-market impact to reflect income as though mark-to-market accounting had never been applied to Power's designated hedges and other derivatives -- was $125.3 million (22 cents/share), compared with adjusted recurring income from continuing operations of $49.0 million (9 cents) on a restated basis in 3Q2004.

Power, which Williams had planned to sell until it reversed the decision earlier this year, reported a segment loss of $226.4 million, significantly down from the profit of $109.3 million in 3Q2004. The reduction is primarily the result of unfavorable year-over-year changes from forward unrealized mark-to-market results, consisting of $141.1 million in forward unrealized mark-to-market losses in 3Q2005 versus $187.9 million in forward unrealized mark-to-market gains in 3Q2004.

As a result of the unexpectedly mild weather in California and the other factors, including Hurricane Katrina, Williams changed its 2005 expectation for cash flow from operations in Power to a range of $25-75 million on a basis that excludes future changes in working capital used in commodity risk management activity on behalf of all of Williams' commodity businesses. Williams previously expected to generate cash flow from operations of $50-150 million in 2005. Because of the large mark-to-market losses, coupled with the effects of higher natural gas prices and milder summer weather in California, Williams now expects a revised segment loss of between $175-225 million from Power on a basis that excludes future mark-to-market changes. Williams previously expected a segment profit range of a $50 million loss to a $50 million profit.

Also in the quarter, Williams Partners LP completed its initial public offering. Williams Cos. and some of its affiliates own 60% of the new master limited partnership (MLP), which primarily gathers, transports and processes natural gas and fractionates and stores natural gas liquids. In addition to Williams Partners' initial asset portfolio, Williams plans to sell 25% interest in its existing gathering and processing assets in the Four Corners area to the MLP. The transaction is expected to be completed in 2Q2006.

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