Dominion Resources Inc. CEO Tom Farrell said last week the planned sale of the exploration and production (E&P) unit is on track to close in 2Q2007, and the company expects to show more stable and steady earnings and growth from its core utilities businesses. Dominion E&P, one of the largest exploration businesses in North America, is rumored to be drawing the interest of private equity players, global oil and gas majors and several U.S.-based independents.

For Dominion Resources, which is ready to shore up its earnings performance through the more solid and steady utilities businesses, the sale its E&P business could not come soon enough. Dominion Resources’ net income in 4Q2006 plunged 88% from a year ago, with the E&P segment posting an 83.6% drop in earnings compared with a year earlier.

The Richmond, VA-based company reported net income of $31 million (9 cents/share) from $257 million (74 cents) for 4Q2005. The company’s 4Q2006 operating earnings totaled 78 cents/share, well below $1.02 recorded in 4Q2005 but still in line with analysts’ expectations.

The decline was blamed on warmer-than-normal weather in the electric and gas utility areas Dominion serves, lower average realized prices for natural gas and oil sales, and the absence of a mark-to-market benefit from hedges that were in place following hurricanes Katrina and Rita. The negatives were partially offset by increased natural gas and oil production, lower unrecovered Virginia fuel expenses and higher contributions from the company’s merchant generation and nonregulated retail energy marketing businesses.

The E&P unit reported operating earnings of $37 million (10 cents/share), compared with $226 million (65 cents) for 4Q2005. For the year, E&P earned $680 million ($1.93/share), ahead of $565 million ($1.64) in 2005.

Dominion E&P produced 74.1 Bcf in the United States and 3.9 Bcf in Canada in 4Q2006, ahead of 4Q2005’s 64.5 Bcf in the United States and 3.7 Bcf in Canada. Total equivalent production reached 114.2 Bcfe, up from 92.2 Bcfe in 4Q2005. Averaged realized gas prices without hedging results in 4Q2006 were $6.00/Mcf, versus $11.18/Mcf for the same period of 2005.

“Each of our business units performed well,” Farrell said. “Exploration & Production drilled a record number of wells, with 13% more drilling than in 2005. Production was up 22% from a year ago.” But 2006 was a “pivotal year strategically” for the company, one in which management turned its eye toward long-term investment capital growth for shareholders and fewer surprises in earnings.

“This is what led us [in 2006] to sell our gas distribution and peaking units…and the November announcement to sell our E&P unit,” said Farrell. The sale of three of its peaking power plants is anticipated by the end of 1Q2007; the sale of local distribution companies is expected by June. “The sale of E&P gives us the opportunity to sharpen our focus.” Dominion’s “commodity-price position following the E&P sale will have only one-third of the sensitivity it has now.”

Although several financial analysts asked, Farrell did not tip his hand on the E&P sale, but the rumor mill is taking care of most of those details for him. Two weeks ago, Goldman Sachs Group Inc. and Morgan Stanley led a list of likely bidders for Dominion’s E&P business (see NGI, Jan. 29). According to reports, the two banks and several other equity consortiums are working on deals to buy the unit for as much as $18 billion.

Since the initial report in The Wall Street Journal, word on the street is that most of the majors and several U.S.-based independents are trying to get a piece of the action. The data room will open in the next two weeks, Farrell said, but he offered few other details. However, to perhaps entice a few more buyers, Farrell tossed out a few tidbits to whet the appetite for anyone interested in buying the gas-heavy reserves.

According to an audit by Ryder Scott, total proved reserves at year-end 2006 were 6,530 Tcfe — a 4% increase over year-end 2005. Excluding the Appalachian Basin assets, which Dominion plans to keep, total proved reserves were 5,524 Tcfe. Unaudited total proved, probable and possible (3P) reserves at the end of 2006 were 12,312, excluding 1,286 Tcfe in the Appalachian Basin. Minus the Appalachian assets, Dominion’s unaudited probable reserves totaled 3,056 Tcfe; possible reserves totaled 3,732 Tcfe. Unaudited reserve replacement, net of sales, was more than 150%.

In a research note following Dominion’s earnings announcement, Merrill Lynch analysts projected three scenarios for the E&P sale values and use of proceeds.

“Our core scenario on which our estimates are based involves gross proceeds a little under $15 billion, implying a sale price of $2.70/Mcfe on proven reserves only,” Merrill analysts noted. “This embeds a base sale price of $2.65/Mcfe, plus an adder for the expected 338H10 tax basis adjustment less negative value associated with hedges. We currently show about $480 million of net below-market hedge and [volumetric production payment] VPP costs — on the assumption that 50% of 2007 hedges remain in place by the time of sale. We estimate net proceeds in the $11 billion range, with a core tax rate of 37% on the taxable gain offset by about $300 million of shield from other tax losses.”

Going forward, Farrell said Dominion will be continuing its proactive approach to prepare for the inevitable crackdown on carbon dioxide (CO2) emissions. Dominion, he said, will be focused on building up its electric and gas utility businesses. He also assured investors and analysts that the company will take the lead for new generation and for emission controls.

“The need for new generation is one we need to address now with the proper regulatory framework,” Farrell said. “I’m not going to spend time internally debating global warming. The possibility of addressing emissions is an important factor in our planning. However, with the recent changes in California and Massachusetts, the expected presidential candidates [in 2008], it is increasingly likely that we will be facing some kind of restraints on CO2 emissions.”

Farrell cautioned that the “expense to the economy to address CO2 will be enormous. There is no viable CO2 technology on the market, and it could take decades to develop. Climate change is an issue that requires cooperation. And the United States needs a policy that is national in scope, and not one that singles out the power industry. The power industry is only responsible for about one-third of the [CO2] emissions.”

Nevertheless, he said, Dominion took the “possibility of regulations into account” when it established its power prices in the Northeast. “The greenhouse gas emission initiative is something we will be actively engaged in on a regional process, and we will consider this on a fleet-wide basis,” said Farrell. “This topic is an important one to address, and it needs to be addressed properly. We intend to be prepared early. This will only benefit Dominion in the long-term.”

©Copyright 2007Intelligence Press Inc. All rights reserved. The preceding news reportmay not be republished or redistributed, in whole or in part, in anyform, without prior written consent of Intelligence Press, Inc.