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Evan Schladow

SE AT A GLANCE

P/E ► 14.5 AVG EV/EBITDA ► 8.09 AVG ROA ► 6.1% AVG ROE ► 12.2% AVG Debt to Equity ► 2.45 AVG Current Ratio ► 0.677 LOW Interest Coverage Ratio ► 2.85 AVG

 

 

 

 

 

 

Spectra Energy (NYSE:SE), a 2007 spin-off of the natural gas division of utilities giant Duke Energy (NYSE:DUK), controls a natural gas processing and distribution network stretching across the United States and Canada. Spectra uses its 18,000 miles of transmission pipeline and 265 billion cubic feet of storage capacity both for its own supplies of natural gas products and for long-term contractual leases to other suppliers.^[1] The recent rise in oil prices, more than doubling between May 2007 and May 2008, has increased demand for natural gas as an alternative energy source, thus increasing demand for Spectra's pipeline and processing services. However, proposed pipeline projects by competitors like El Paso (EP), SEMPRA ENERGY (SRE), and Williams Companies (WMB) threaten the strong position of Spectra's pipeline network.

Business Overview

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Business Financials

Although Spectra Energy was spun off from Duke Energy in 2007, Spectra offers financial data from 2005 and 2006 for the business segments that became Spectra Energy. EBIT, earnings before interest and tax, is a preferred metric in the utilities sector, as it provides information on the company's profits without the added complexity of its more complex financial and tax activities. As EBIT ignores the company's individual financial structure and tax rates, it provides a clearer basis for comparison between utilities companies.

Key Segments

U.S. Transmission: 32.5% of Revenues, 42.3% of Earnings

Natural Gas pipeline and storage facilities primarily in the U.S. from Texas and Florida to Nova Scotia in Southeastern Canada. Spectra Energy's controls more than 13,500 miles of pipeline, consisting of both wholly owned pipelines and jointly owned pipelines. The primary source of revenue for Spectra's U.S. Transmission segment is long-term leasing of pipeline capacity. Revenues in these contracts come both from fixed fees for a constant amount of pipeline capacity (regardless of how much natural gas actually passes through the pipeline) and from variable fees for the actual quantity of natural gas that travels through the pipeline. As a result, Spectra's revenues are effected significantly by seasonal changes in the demand for natural gas, with demand highest in the first and fourth quarters, when cold weather increases the demand for natural gas as a heating fuel. Between 2006 and 2007, throughput in Spectra's pipelines increased 14% from 1,930 TBtu to 2202 TBtu. ^[7]

Gas Distribution: 40% of Revenues, 15.2% of Earnings

Spectra operates one of Canada's largest local distribution companies, Union Gas, and is also one of North America's largest storage providers. Union Gas supplies natural gas to approximately 1.3 million residential, commercial, and industrial customers in Ontario, Canada. Much of Union Gas' business is regulated, so the rates it can charge customers are set by government of Ontario and there is little or no competition within the natural gas industry in the area Union Gas supplies, although the company does compete with the suppliers of other forms of energy. Union Gas also generates revenue by providing natural gas storage and transportation services to other utility companies throughout the region, much of it through contracts with an average term of five years. ^[8]

Western Gas Transmission and Processing: 27.5% of Revenues, 17.3% of Earnings

A pipeline and processing business in Western Canada. Much of the revenue for this segment comes from the processing of raw natural gas into various products (butane, ethane, propane, etc.), either for other producers on a fee basis or to to be sold wholesale by Spectra Energy itself. The other source of revenue for this segment is fee-based transportation services through Spectra's Canadian pipeline system. ^[9]

Field Services: 25.2% of Earnings

Exploration and production operated through DCP Midstream, LLC, a 50/50 joint venture with ConocoPhillips. DCP Midstream operates in 25 US states, gathering raw natural gas, processing it into various products (butane, ethane, propane, etc.), and selling these products wholesale. Earnings from these operations are dependent on the market prices of both natural gas products and crude oil, which increased approximately 18% and 10%, respectively, in 2007 compared to 2006 prices.^[10]

Spin-off from Duke Energy

On January 2, 2007, Duke Energy Corporation (DUK) completed a spin-off of its natural gas transmission and storage business, creating Spectra Energy. By separating Duke Energy's electricity and natural gas divisions, management hopes to increase the efficiency as each division focuses solely on its own part of the utilities sector. Among Duke's major holdings that were spun off with Spectra were DCP Midstream, a 50/50 joint venture with ConocoPhillips previously known as Duke Energy Field Services, and Union Gas, acquired by Duke Energy in 2006.

Key Trends and Forces

Rising oil prices are increase revenues but decrease competiveness

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Proposed pipeline projects are a major test for Spectra

Spectra is currently in the initial stages of developing the Bronco pipeline, a new pipeline system from Rocky Mountains to Oregon, connecting the major natural gas supplies, including those of DCP Mainstream, to markets in the Western U.S.^[13] As current production in the Rocky Mountain region significantly outstrips pipeline capacity, Spectra stands to profit significantly from the completion of this pipeline. However, the Ruby pipeline, a proposed joint project along the same route as the Bronco pipeline by El Paso (EP) and PG&E (PCG), and the Sunstone pipeline, a proposed joint project between Williams Companies (WMB), TransCanada Pipelines (TRP), and Sempra Energy (SRE), also hope to carry natural gas westward from the Rockies. June 25th, 2008 analysis from Morningstar (MORN) favors the Ruby and Sunstone pipelines to see completion over Spectra's Bronco pipeline, although maintained confidence that none of the three pipeline projects would be completed.^[14]

Weather conditions influence the demand for natural gas

Demand for natural gas is heavily dependent on the severity of winter weather conditions, effecting all revenues in all of Spectra's business segments. For example, Spectra attributes a $114 million increase in its natural gas sales in 2007 to "winter weather that was approximately 9% colder than the previous year."^[15]

Spectra's greenhouse gas emissions effected by increased concern with global warming

Amidst continued international efforts to curb emissions of greenhouse gases, the pollutants held responsible for global warming, the risk of Spectra's high emissions levels conflicting with changing regulations increases. As "the single largest private-sector source of greenhouse gases" in the Canadian province of British Columbia, Spectra is preparing itself to operate under an anticipated "cap-and-trade" emissions regulation policy in Canada, in which high-emissions businesses like Spectra would have to buy allowances to continue emitting at its current rate.^[16] In the U.S., Spectra's joint venture DCP Midstream's emissions record in Oklahoma allegedly fits into the Environmental Protection Agency's category of high priority violators.^[17] Changes to Spectra's policies and processes to meet current and future regulations would require capital investments by Spectra, although the likelihood of U.S. or Canadian government intervention is unknown.

References

1. ↑ Spectra Energy - What We Do
2. ↑ SE's 2007 10-K, Item 7: Management Discussion (Page 39)
3. ↑ SE's 2007 10-K, Item 7: Management Discussion (Page 39)
4. ↑ SE's 2007 10-K, Item 1: Businesses of Spectra Energy (Page 11)
5. ↑ SE's 2007 10-K, Item 1: Businesses of Spectra Energy (Page 13)
6. ↑ SE's 2007 10-K, Item 1: Businesses of Spectra Energy (Page 15)
7. ↑ SE's 2007 10-K, Item 1: Businesses of Spectra Energy (Page 5)
8. ↑ SE's 2007 10-K, Item 1: Businesses of Spectra Energy (Page 11)
9. ↑ SE's 2007 10-K, Item 1: Businesses of Spectra Energy (Page 13)
10. ↑ SE's 2007 10-K, Item 1: Businesses of Spectra Energy (Page 15)
11. ↑ Wikipedia - Price of Petroleum
12. ↑ NY Times (07/11/08) - Oil Prices Up $5 a Barrel on Mideast Tensions
13. ↑ Spectra Energy - Growth Projects
14. ↑ Morningstar Stock Analyst Notes (06/25/08) - Rockies Pipeline Update
15. ↑ SE's 2007 10-K, Item 7: Management Discussion (Page 42)
16. ↑ Globe and Mail (03/29/07) - From Carbon Steam to Cash Flow
17. ↑ The Oklahoman - Industry and Clean Air