AGL Resources (ATG)

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Volatile natural gas costs can make AGL's margins unpredictable, since they allow the company's costs to change while regulations keep prices fixed. The weather also plays a large part in demand for natural gas, which is used for heating, so unseasonable weather patterns can lead to demand fluctuations as well. Fortunately for AGL, the majority of its business occurs in Georgia, a state with a regulatory system that allows the company to charge a monthly rate regardless of gas usage. This insulates the company against the effects of good weather and fluctuating gas use. On the flip side, AGL hasn't been able to negotiate a favorable rate change in the State for over 12 years. AGL Resources doesn't have any real competition in its service areas, thanks to the difficulty of installing infrastructure, but competes on a large scale with other utilities companies like Atmos Energy.

[edit] Business and Financials

AGL Resources, Inc. (NYSE: ATG) is a regulated energy services holding company, which through its subsidiaries and partnerships, is engaged in natural gas distribution and wholesale natural gas asset management. With the acquisition of NUI Corporation, AGL Resources became a leading distributor of natural gas on the East Coast, serving more than 2.27 million customers in six states: Florida, Georgia, Maryland, New Jersey, Tennessee, and Virginia. The company also engages in various non-regulated operations such as telecommunications infrastructure, retail energy marketing and other energy-related services. For the past three years, however, 85% of its EBIT came from its businesses involved in natural gas.

The company sells both to end-use customers and other distribution utilities. The company has relationships with 12 different natural gas marketing firms; these companies peddle the gas to end users, so all AGL is responsible for is delivering it to them. This allows AGL to sell a large amount of gas without the high overhead costs associated with marketing and delivery; it also decreases AGL's debt exposure, as regulations require utilities and marketing companies to exhibit their ability to pay before making the purchase. The only downside is that revenues from sales to marketing firms are lower than with sales to end users, because AGL must sell the gas at a better price if marketing customers are to eventually turn it around and sell it to consumers for profit.

Segment Breakdown for 2007

AGL's four operating segments are Distribution Operations, Retail Energy Operations, Wholesale Services and Energy Investments. Distribution Operations carries out its functions primarily through three local natural gas subsidiaries: Atlanta Gas Light Co. (AGLC), Virginia Natural Gas (VNG), and Chattanooga Gas Company (CGC). Beginning in 2005, ATG added its retail energy segment, which consists of the operations of SouthStar, a retail gas marketer in Georgia with more than 550,000 customers. Wholesale Services are conducted through its Houston-based subsidiary, Sequent Energy Management, which offers wholesale marketing, asset optimization, gas supply and risk management services. The Energy Investments segment includes the company's investment in Jefferson Island and Pivotal Propane of Virginia, Inc. and the telecommunications operations of AGL Networks, a small subsidiary that installs fiber optic infrastructure in metropolitan areas.

For the full year 2007, AGL Resources saw revenues of $2,494 million and EBIT of $463 million. Distribution Operations, Retail Energy Operations, Wholesale Services, and Energy Investments business segments accounted for 72%, 18%, 7%, and 3%, respectively, of total EBIT.

[edit] Modern Gas Utilities Pay Lower Dividends

In the past, utilities paid high dividends because stringent government regulation kept them from having much growth potential. This made them very sensitive to short-term interest rates, as higher interest rates made government bonds more attractive as investments; more people investing in government bonds meant less people buying utilities stock, causing shares to fall. Now, however, the combination of deregulation and the diversification of gas utilities into energy trading, generation, and other businesses mean that the companies have greater growth potential and less exposure to interest rate effects. Now, though utilities still pay dividends, these are lower than in the past - because utilities companies now have a chance for strong share growth, so high dividends are no longer necessary to serve shareholder interests.^[1][2]

[edit] Trends and Forces

[edit] Government Regulation of Gas Distribution Gives the Company Little Control over its Margins

Utilities tend to be highly regulated business in the U.S., with the national government setting transmissions rates and state governments setting electric and gas distribution rates. These rules are designed to ensure both profitability for the company and accessibility for the consumer, but often hold back utilities companies, like AGL, from achieving potential revenues and profitability by preventing them from charging delivery rates that the level of demand would really allow. Regulation can also cause the company's margins to be very volatile, as lobbying the government is the only way the company can control its prices. Unfortunately, natural gas costs fluctuate very rapidly, but it takes a long time for AGL's lobbyists to convince state and regional regulators to raise the price ceiling. For the most part, regulators will only raise rates if the company can show that something, whether rising costs or inflationary pressure, is causing their margins to shrink to unfair levels.

[edit] Regulation Varies Geographically; AGL's Business is Concentrated in Georgia

Utilities regulations vary from state to state and, sometimes, region to region. AGL Resources operates in Florida, Georgia, Maryland, New Jersey, Tennessee, and Virginia. Most regulatory schemes limit the amount a gas company can charge for a unit of gas (such as a cubic foot). In Georgia, however, the regulatory scheme allows AGL Resources to charge a set monthly rate independent of a customer's usage. This means that the company's revenues stay stable in the region no matter what the weather. Of AGL's 2.27 million gas customers, 68.6% percent live in Georgia^[3], meaning that the majority of the company's sales are hedged against the weather and gas-use fluctuations that are the bane of other gas utilities.

[edit] Despite the Company's Georgia Operations, AGL's Revenues Follow Seasonal Patterns; Unusual Seasons Mean Unusual Sales

Natural gas is used most commonly in home heating systems, making its demand partially dependent on the temperature outside. First- and fourth-quarter revenues for AGL Resources tend to be higher than second- and third-quarter revenues because late fall through early spring are much colder than late spring through early fall. AGL Resources' distribution segment saw 2007 revenues of $123 million (1Q)^[4], $64 million (2Q)^[5], $55 million (3Q)^[6], and $96 million (4Q)^[7], effectively illustrating how cold temperatures lead to higher gas revenues. This temperature dependence also means that unusual seasonality has a real effect on the company's operations; warmer winters, a predicted outcome of global climate change, will damage the company's revenues by decreasing demand at a key part of the year.

Incidentally, the gas utilities demand cycle is exactly opposite that of electric utilities, who see higher demand in warmer months because air conditioning units are electrically powered.

[edit] Fluctuating Natural Gas Prices Make AGL's Margins Much Less Predictable

AGL Resources is not a natural gas exploration and production company, so it must purchase the natural gas it sells from other companies. Natural gas prices are extremely volatile, fluctuating between $5/cf and $10/cf several times in the past three years; though AGL tries to hedge against these fluctuations by purchasing long-term supply contracts, most E&P companies are loath to sell at fixed prices natural gas prices are trending upwards. Furthermore, utilities regulations mean that AGL Resources cannot pass rising costs onto consumers, giving the company less control of its margins.

[edit] Competition

AGL Resources operates its gas delivery services in Florida, Georgia, Maryland, New Jersey, Tennessee, and Virginia. In the markets it serves, the company has little real competition thanks to the high cost of infrastructure installation; government regulation, however, keeps the company from charging the rates and turning the profits that would otherwise be expected of a monopolist that sells products with inelastic demand. On a larger scale, AGL competes with other gas utilities like:

• Atmos Energy - Atmos operates in Texas, Kentucky, Louisiana, Mississippi, Colorado, Kansas, Tennessee, Georgia, Illinois, Iowa, Missouri, and Virginia. It is not only a gas utility but also a natural gas marketing, pipeline, and storage company.
• Energen - Energen is an energy holding company that operates in a variety of businesses, from oil exploration and production to natural gas marketing and distribution. Its utilities business is the largest gas distributor in Alabama.
• Equitable Resources - Equitable Resources is a vertically integrated natural gas company that operates from the upstream to natural gas distribution. Its gas utilities operate in Pennsylvania, West Virginia, and Kentucky.
• National Fuel Gas Company - NFG is a diversified natural gas company that does exploration, production, transportation, marketing, and distribution of gas; its utilities segment operates in New York and Pennsylvania.
• ONEOK - ONEOK is a transport and distribution company that acts as a utility in Oklahoma, Kansas, and Texas.
• Sempra Energy - Sempra is a gas and electric utilities company in California.
• Southern Union Company - Southern Union is engaged in the storage, transport, production, and refining of [[natural gas; its utilities business operates in Missouri and Massachusetts.
• National Grid Transco - National Grid is a gas and [[utilities company that operates in the United Kingdom and the United State; in the U.S., it operates in Rhode Island and New York.

[edit] Notes

1. ↑ Business Week: "Utility Stocks With Plenty of Spark"
2. ↑ USA Today: "Utilities funds turn into power players"
3. ↑ ATG 2007 10-K, Page 31
4. ↑ AGL 1Q07 Earnings Release
5. ↑ AGL 2Q07 Earnings Release
6. ↑ AGL 3Q07 Earnings Release
7. ↑ AGL 4Q07 Earnings Release
8. ↑ ATG 2007 10-K
9. ↑ ATO 2007 10-K
10. ↑ EGN 2007 1-K
11. ↑ EQT 2007 10-K
12. ↑ NFG 2007 10-K
13. ↑ OKE 2007 10-K
14. ↑ SUG 2007 10-K
15. ↑ SRE 2007 10-K
16. ↑ Equitable Resources: Equitable Utilities: Equitable Gas
17. ↑ Reuters Full Description: National Fuel Gas Co
18. ↑ Reuters: Full Description: National Grid Transco