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Williams Income Spikes on NGL Margins, Gas Production

Tulsa-based Williams net income for the third quarter was $106.2 million (18 cents/diluted share), more than 24 times the $4.4 million (1 cent/diluted share) net income of 3Q2005. The spike came from a 112% increase in natural gas liquids (NGL) sales margins, 22% higher gas production, and significantly reduced forward unrealized mark-to-market losses. These benefits were partially offset by higher operating and maintenance costs.

The latest results are a sharp improvement from the second quarter, when the company was hindered by litigation costs (see Daily GPI, Aug. 4).

Year-to-date through Sept. 30, Williams reported net income of $162.1 million (27 cents/diluted share), compared with net income of $246.8 million (42 cents/share) for the same period in 2005. Results for the first nine months of 2006 are significantly reduced by the after-tax impact of legacy litigation charges recorded in the second quarter totaling $175 million.

During a call with analysts, Williams CEO Steve Malcolm commented on last month's action at the Federal Energy Regulatory Commission that rejected an administrative law judge's recommendation for a single-digit return on equity allowance for Kern River Gas Transmission (see Daily GPI, Oct. 21). While the FERC raised Kern's ROE to 11.2%, Williams's Malcolm said that wasn't sufficient.

"Certainly, the FERC's order on this issue was a significant improvement over the administrative law judge's recommendation, Malcolm said. "Nevertheless, we remain committed to pursuing higher return levels in our rate cases. The FERC has recognized the importance of continued infrastructure development in this industry and we believe that authorized returns need to be higher than 11.2% in order to encourage that development."

Malcolm also spoke briefly about plans by Williams to drop down some of its assets to master limited partnership (MLP) Williams Partners.

"As previously announced, we continue to have a goal of completing additional transactions of approximately $1 billion to $1 and a half billion involving gathering and processing assets between us and Williams Partners within the next three months," he said. "It is important to remember with respect to our MLP strategy that dropdown transactions are subject to approval by the board of directors of both Williams and the general partner of Williams Partners. As well, the terms of certain transactions may be subject to approval by the conflicts committee of the board of directors of the general partner of Williams Partners."

Williams raised guidance for 2006 based on the strong performance through three quarters, anticipated increases in gas production, and its outlook for energy commodity prices -- key factors that have driven higher sales margins for natural gas liquids. The company now expects $1.05-1.20 for diluted earnings per share in 2006 on a recurring basis adjusted to remove the effect of mark-to-market accounting, compared with the previous expectation of 95 cents to $1.20. Williams also is raising its expectations for 2006 consolidated segment profit on a recurring basis adjusted to remove the effect of mark-to-market accounting. The company now expects approximately $1.8-2.02 billion for this measure. Williams previously expected $1.69-2.01 billion.

Williams also modified its expected capital budget for 2006 through 2008, increasing spending on midstream growth projects, mainly in the western deepwater Gulf of Mexico.

"This is the second time we've raised our earnings guidance this year," said Malcolm. "And we like the momentum we have going into 2007 and beyond. Our outlook is based on the fact that our natural gas production continues to rapidly climb, our older below-market hedges for that production are beginning to roll off, we see sustained strength in NGL sales margins, and our midstream business has sizable opportunities on the horizon...

"Our midstream business has provided a natural hedge to the price exposure we have in exploration and production. So while natural gas prices have been lower, the NGL margins in midstream have been higher -- significantly higher."

Williams said it continues to rapidly increase its gas production in the western United States. Production in the Piceance Basin -- the company's cornerstone property for growth -- increased 31% year-over-year in the third quarter.

Consolidated results include segment profit for Williams' primary businesses: exploration and production, midstream gas and liquids, gas pipelines, power, and other. The businesses reported consolidated segment profit of $395.8 million in the third-quarter, 94% greater than $204.5 million a year ago. For the first three quarters of 2006, Williams' businesses reported consolidated segment profit of $1.1 billion, an increase of 13% compared with $970.6 million for the same period in 2005. Results for the first nine months of 2005 benefited from $102.1 million of forward unrealized mark-to-market gains in power, compared with a forward unrealized loss of $11.1 million for the same period in 2006. The 2006 period also includes $70 million in litigation accruals associated with the Gulf Liquids verdict earlier this year.

For the first three quarters of 2006, net cash provided by operating activities was $1.3 billion, compared with $1.1 billion for the same period in 2005. Net cash generated this year is primarily being reinvested in capital expenditures. Williams invested $1.8 billion in capital expenditures in the first nine months this year, essentially doubling investments of $886 million in the same period a year ago.

Exploration and production volumes were up 22% from a year ago. This includes natural gas production and development in the U.S. Rocky Mountains, San Juan Basin and Mid-Continent, and oil and natural gas operations in South America. This business reported third-quarter 2006 segment profit of $144.5 million, compared with segment profit of $158.8 million a year ago. The third quarter of 2005 included the benefit of a $21.7 million gain on the sale of certain properties in the Powder River Basin.

Average daily production from domestic and international interests in third-quarter 2006 totaled 831 MMcfe, an increase of 22% compared with volumes of 682 MMcfe in third-quarter 2005. Third-quarter 2006 average daily production in the Piceance Basin was 430 MMcfe, up 31% compared with 329 MMcfe in third-quarter 2005. Production in the Powder River Basin also increased, up 23% to 147 MMcfe, compared with 120 MMcfe a year ago. Increased production in the Powder River primarily is coming from volumes in the Big George area.

Increased production was partially offset by 10% lower domestic net realized average prices; increased lease operating expenses; higher depreciation, depletion and amortization; and higher general and administrative expenses due to increased business activities and generally higher industry costs. However, 3Q 2006 included a $5 million unrealized gain from hedge ineffectiveness and certain basis swaps not designated as hedges, compared with a $16 million unrealized loss for 3Q 2005.

For the first nine months of 2006, exploration and production reported segment profit of $411.9 million, an increase of 8% compared with $380.8 million for the first three quarters of 2005. The improvement in the first three quarters of 2006 primarily reflects increased production volumes. The first nine months of 2006 also include a $21 million unrealized gain from hedge ineffectiveness and certain basis swaps not designated as hedges, compared with a $16 million unrealized loss for the same period in 2005.

Williams now has 24 rigs operating in the Piceance Basin of western Colorado, nine more than it had a year ago (see Daily GPI, March 24). The rig count includes eight new-generation drilling rigs that are purpose-built for conditions in the tight-sands development. Two more of the new rigs are scheduled for delivery later this year. Williams said it is on track to invest $1.15-1.25 billion in exploration and production this year with spending primarily focused on natural gas.

The company narrowed the range of segment profit it expects from exploration and production in 2006 based on lower domestic net realized prices and higher lease operating expenses in the third quarter. The company now expects $550-600 million in segment profit for this business. Prior guidance was $550-650 million.

In the midstream gas and liquids business segment, third quarter profit rose 75% to $212.2 million from $121.1 million a year ago. The increase came primarily from better NGL margins. Per-unit margins were 112% higher than margins in the same period a year ago. Williams markets gas liquids via equity volumes the company retains as payment-in-kind under certain processing contracts.

In addition, Williams experienced strong growth in production handling volumes and revenues in the deepwater Gulf of Mexico, and higher fee-based gathering and processing revenues. The 2006 quarter also benefited from $7.9 million in gains on asset sales. These benefits were partially offset by higher operating expenses, a $10.6 million adjustment to increase accrued accounts payable and a $5.2 million loss associated with an asset abandonment.

In third-quarter 2006, the midstream segment sold 334 million gallons of NGL equity volumes, 21% percent more than equity sales of 276.4 million gallons in third-quarter 2005. For the first nine months of 2006, midstream reported segment profit of $494.4 million, 38% greater than $358.8 million for the first three quarters of 2005.

Greater NGL margins during the first three quarters of 2006 are primarily the result of the difference between higher liquids prices - which typically track closely with crude oil prices - and lower natural gas prices.

The Cameron Meadows natural gas processing plant in Louisiana's Cameron Parish is returning to its full design capacity after being damaged by Hurricane Rita in September 2005 (see Daily GPI, Feb. 15). The plant is expected to be available to process up to 500 MMcf/d in early November as crews finalize the startup procedures on the plant's second processing unit. Cameron Meadows had been operating at about half of its design capacity since February.

Williams now expects $675-750 million in profit for the midstream segment in 2006 based on its performance in the first three quarters and Williams' outlook for strong NGL prices. The company's prior guidance in August was $550-675 million in segment profit.

In the gas pipeline segment, results for the third quarter were cut by about $22 million, mainly from higher business costs. New rates for both of Williams' wholly owned interstate transmission systems -- Transco and Northwest Pipeline -- will be effective, subject to refund, in first-quarter 2007. Northwest Pipeline filed its rate case with the Federal Energy Regulatory Commission on June 30. Transco filed its rate case Aug. 31. The filings reflect, among other things, current levels of operating costs and rate base.

For the first nine months of 2006, the gas pipeline segment reported profit of $366.4 million, down 26% compared with $493 million for the same period in 2005. The reduction for the first three quarters of 2006 is attributable to higher operating and maintenance costs; higher selling, general and administrative costs, including the absence of a $34.8 million benefit in prior-period adjustments recorded in 2005; and the absence of the $14 million benefit of the 2005 fuel tracker settlement.

In July, Transco filed an application with the FERC to provide additional capacity to the greater Washington, DC and Baltimore metropolitan areas (see Daily GPI, July 19). The proposal, known as the Potomac Expansion, is designed to increase firm transportation capacity by 165,000 Dth/d beginning in November 2007. In August, the Commission also issued a certificate enabling Northwest Pipeline to proceed with a 37-mile expansion in Colorado known as the Parachute Lateral project (see Daily GPI, Aug. 18). The 450,000 Dth expansion is scheduled to be completed by January 2007.

Northwest Pipeline expects to have its Capacity Replacement project between Sumas, WA and Washougal, WA in service by December (see Daily GPI, Oct. 17). The company abandoned 268-miles of 26-inch diameter pipeline and replaced its 360,000 Dth of capacity with 80-miles of 36-inch diameter pipeline in four sections along the same corridor. Startup operations on the new pipeline sections began the week of Oct. 23.

Williams has narrowed the range of segment profit it expects from the gas pipeline segment. The company now expects $475-500 million in 2006. Williams previously expected $475-520 million.

Williams power business unit manages a portfolio of more than 7,000 MW and provides services that support Williams' natural gas businesses. Power reported a third-quarter 2006 segment loss of $69.7 million, compared with a segment loss of $226.4 million for third-quarter 2005. Results include the effect of forward noncash unrealized mark-to-market gains and losses.

The improved results in third-quarter 2006 are primarily the result of lower noncash unrealized mark-to-market losses, higher accrual portfolio earnings and the benefit of a $12.7 million reduction in contingent obligations associated with a former business. The improvement was partially offset by a $3.5 million litigation accrual. On a basis adjusted for the effect of mark-to-market accounting, Power reported recurring segment profit of $16.6 million in third-quarter 2006, compared with a recurring segment loss of $13 million in the 2005 period.

The improvement in third-quarter 2006 recurring segment profit adjusted to remove the effect of mark-to-accounting reflects the benefit of having additional megawatts economically hedged on the segment's tolling positions. Third quarter 2006 adjusted results include $13 million of losses related to the write-down of natural gas storage inventory due to falling prices and $7 million of certain related realized hedge losses. These losses -- on a basis adjusted for mark-to-market accounting -- are timing-related only. The company expects to recover these losses since the inventory is hedged at fixed prices.

For the first nine months of 2006, Power reported a segment loss of $171.8 million, compared with a segment loss of $187.3 million for the first three quarters of 2005. The improved results in 2006 are primarily the result of higher accrual portfolio earnings and a $24.8 million gain on the sale of certain third-party receivables in first-quarter 2006, offset by lower noncash unrealized mark-to-market earnings.

For 2006, Williams now expects a segment loss of $190-240 million from the power business, which includes year-to-date unrealized mark-to-market losses on derivative contracts but assumes no future change in fair value on these contracts. Williams previously expected a segment loss of $150-200 million. Williams said it continues to expect the power business to generate 2006 recurring segment profit of $75-125 million after removing the effect of mark-to-market accounting.

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