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Williams Companies (WMB)Stock (Energy Industry, Oil & Gas Pipelines Industry)
 [edit] Business FinancialsWMB operates three business segments: Exploration and Production, Midstream Gas Processing, and (natural gas) Pipelines.
WMB’s revenues by segment are presented below. In 2007 the company's volume based services accounted for 76% of all revenue. Fluctuations in demand for natural gas have a large affect on these segments as revenues are dependent on volumes transported or processed. During 2007 WMB sold all of its power trading assets to Bear Energy, LP. for $500M.[9] The power trading unit posted operational losses for many years and exposed the company to the volatility of the power trading market. The sale enabled the company to continue paying down their debt, and in late 2007 they were given an investment grade rating by credit rating agencies. An investment grade rating has a number of positive advantages. Many institutional investors will only invest in investment grade companies, increasing WMB's access to capital. High debt ratings also decrease WMB's cost of debt capital, decreasing interest expense. Revenues and operating income increased during 2007 for a number of reasons. The first was an increase in the margins in the company's midstream processing segment to higher demand.[10] As prices for natural gas dropped in the areas where WMB operates, demand for natural gas from these areas increased. Increased demand for natural gas leads to higher production and more need for processing services. High demand enabled WMB to increase processing prices.[11] WMB also had a rate increase approved by the FERC in 2007, driving up revenues at WMB’s pipeline business. [12]Finally, increasing production volumes led to increased revenues at WMB’s exploration and production segment.[13] The graph below illustrates WMB’s transformation over the past five years. WMB’s revenues have steadily declined as the company divested underperforming assets and became smaller and more focused. Its operating income rose, however, as the company concentrated on its best performing assets and decreased expenses. [edit] Trends and Forces[edit] Williams´ Exploration And Production Segment Uses Unconventional Sources, Which Rely on High Energy PricesWilliams extracts most of its natural gas from unconventional sources such as shale, coal-bed methane and tight sands.[15] By using such unconventional sources Williams decreases its competition and increases its sources of new reserves. These unconventional supply sources also represent the cornerstone of WMB’s growth strategy, driving a 20% increase in production in 2007 and 12% increase in proved reserves.[16] Unconventional sources do require higher extraction costs, leading to high operating expenses at WMB's exploration and productions segment. In order to remain profitable, the price Williams is able to sell its petroleum at needs to remain high, making the company more sensitive to changes in the price of natural gas. [edit] Fluctuating Natural Gas Prices Affect DemandThe price of natural gas has undergone wide fluctuations in the past five years. The price has declined in the past two years, down 5% since a record high in 2005.[17] However, the price is still up 43% since 2002.[18] These price fluctuations affect demand for natural gas as other fuels become cheaper substitutes, especially at power generating facilities with the capacity to switch to other types of fuels. For example many electrical power companies, who consumed 32% of all natural gas produced in 2007, switch to coal power during periods of high natural gas prices.[19] Many industrial users, who used 31% of natural gas produced in 2007, also have built-in fuel-switching capabilities. [20] While residential and commercial users usually have no built in switching capacity many still conserve energy during periods of high gas prices. When demand for natural gas falls, WMB feels the effects in all of its business segments. In pipelines, revenue falls as smaller volumes are transported to end users. Lower volumes have a similar effect in midstream gas processing. High prices can also lower the volume sold by WMB's exploration and production segment, which partially offsets the effect of high sale prices creating wider margins. [edit] The United States is Switching Towards Eco-Friendly Energy Sources, Which Has A Mixed Effect On Demand For Natural GasIncreasing environmental concern has a direct affect on the demand for natural gas. In the long run, increasing consumer concern over global climate change will decrease the demand for natural gas. Already increasing environmental consciousness has led both consumers and electric companies to seek out and invest in renewable energy sources such as nuclear, solar, and wind power to heat homes and generate electricity.[21] To date, 24 states have adopted renewable portfolio standards, which require power companies to purchase a certain percentage of their electricity from renewable sources by a certain date (percentages and dates vary from state to state).[22] As residential customers and electric power plants switch to other forms of energy, the demand for natural gas will fall. However, these renewable sources of energy are not yet developed enough to provide for the majority of energy use in the United States. In the short run, natural gas is one of the cleanest burning fuels in widespread use.[23] Many electric companies are switching to natural gas as a cleaner alternative to coal and oil power plants.[24] Until renewable energy sources are better developed, environmentalism in the U.S. will actually lead to an increase in short-term demand for natural gas. [edit] A 2007 Court Ruling Will Likely Increase Rates WMB Can Charge The Customers Of Its Pipeline SegmentWMB’s pipeline segment is regulated by the Federal Government, including in what rates it can charge its customers.[25] Pipeline regulation is a double edged sword, it virtually guarantees a minimum level of company income but also caps potential net income growth. The FERC determines the rates WMB can charge its pipeline customers by examining the pipeline’s operating costs then adding what it determines as a reasonable return on invested capital. That reasonable return on capital has historically been determined by the FERC using a group of proxy companies which included local natural gas distribution companies.[26] Pipeline companies sued the FERC, arguing that local distribution companies do not face the same risk or competition as interstate pipeline companies so their return on equity is lower to reflect that decreased risk. In 2007 the D.C. Court of Appeals Ruled that if the FERC continued using local companies as proxies it would have to revise its return on equity upward to reflect those company’s decreased risk.[27] This is likely to increase the rates WMB can charge pipeline customers, increasing the segment's revenues. [edit] Demand for Natural Gas is Dependent on the Weather, Creating the Risk of Unfavorable Weather Conditions and Seasonality in WMB's RevenuesDemand for natural gas is highest during the coldest months of winter when it is used to heat homes.[28] Due to the shift towards natural gas for generating electricity, demand for natural gas is also high during the summer months when people are using more electricity to cool their homes.[29] Demand for natural gas drops sharply during the temperate spring and fall seasons.[30] This seasonal shift in demand creates seasonality in WMB's revenues, lowering income during mild seasons when demand is low. For example, in the first quarter of 2008 (January through March) Williams´ operating income was $815M. To contrast, their operating income for fourth quarter 2007 (September through December) when the weather was milder and customers demanded less heating fuel was just $433.7M. The weather can also impact annual revenues. If a winter or summer is longer and more severe than usual customers will demand more natural gas, increasing revenues. The opposite is also true, if the winter and summer seasons are short and temperate customers will demand less gas, decreasing WMB's revenues. [edit] CompetitionWMB competes with a number of other companies in each of its business segments. In the exploration and production WMB competes to purchase reserves, find new sources of oil and natural gas, and produce more output. This is a large space, however, and WMB has no control over the prices in the market. WMB competes as a price taker, selling at spot prices in the market. In the pipelines and natural gas processing, WMB competes with other companies for market share and long term transportation or processing contracts. Though the FERC establishes caps on the rates WMB can charge on its pipeline unit, it sometimes lowers its rate below these caps to maintain competitive within the market. WMB has the highest market cap and revenues of any of its competitors. It has the largest proved reserves of any of its competitors, and a relatively small pipeline segment. The company's also has a large oil and gas processing segment, which accounted for 58% of revenue in 2007. In addition to competing with other natural gas companies, WMB competes with suppliers of alternative fuels. The increasing consumer demand for alternative sources of energy has led both companies and consumers to invest in renewable energy sources such as nuclear, solar, and wind power to heat homes and generate electricity. As the demand for these renewable sources of energy increases, the demand for WMB's natural gas, natural gas processing and natural gas transportation services will fall.
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