Williams Companies (NYSE:WMB) produces about a billion cubic feet of natural gas every day, and runs nation-wide network of gas processing plants and transportation pipelines. In the Oil & Gas Pipelines industry, WMB competes against companies such as El Paso and Questar for pipelines in North America.
WMB's central focus is natural gas prices, which is most heavily affected by changes in demand for fuel, which in turn is affected by the weather and the price of natural gas. Though its pipelines segment is federally regulated, higher gas demand causes Williams will transport more natural gas and process more natural gas; since these two services make up about 76% of the company's revenue, higher transport volumes lead to significant increases in revenue. With no intrastate natural gas distribution segment, Williams only has to deal with one set of regulators: federal regulators. This puts it at an advantage over other pipeline companies, who sometimes have to deal with multiple complex regulatory codes. The company uses the cash flow from its pipeline business to fund its E&P business, which tends to explore for natural gas in unconventional, expensive to develop fields. Fortunately, natural gas prices have risen 43% since 2002, making WMB's production strategy very profitable - until prices fall again.
WMB operates three business segments: Exploration and Production, Midstream Gas Processing, and (natural gas) Pipelines.
WMB is one of the largest producers of natural gas in the United States, extracting about a billion cubic feet every day. Most of Williams' natural gas production comes from unconventional sources like shales, coal-bed methane fields, and tight sands. These unconventional supply sources represent the cornerstone of WMB’s growth strategy, driving a 20% increase in production in 2007 and 12% increase in proved reserves. Unconventional sources do require higher extraction costs, so income at WMB’s exploration and production segment is dependent not only on the price of natural gas and oil, but on WMB's ability to cost-effectively extract its reserves. From 2006 to 2007, revenues to the Exploration and Production segment increased 41%.
WMB gathers, processes and stores natural gas and natural gas liquids in the United States. Natural gas processing is classified as midstream because it falls within the middle of the process of taking natural gas from the wellhead to the final consumer. WMB's processing plants gather raw natural gas from the wellhead and convert it to a form usable by final consumers, including power plants, industrial users and residential households. Like its pipeline segment, WMB charges a volume based fee for natural gas processing. From 2006 to 2007, revenues to the Midstream Gas Processing segment increased 25% due to higher demand.
WMB’s interstate gas pipelines deliver natural gas to markets along the Eastern Seaboard, Northwest U.S. and Florida. WMB’s pipeline segment is federally regulated by the FERC, which sets the rates that WMB can charge to transport gas on its pipeline system. These rates are typically the company’s incremental cost to transport gas plus a reasonable return on invested capital. Regulation by the FERC creates income stability, but makes it difficult for the company to earn returns above those established by the FERC. To increase revenues in its pipeline segment WMB focuses on expanding capacity, servicing its existing network and increasing its market share. From 2006 to 2007, revenues to the Gas Pipeline segment increased 19%.
Williams Companies ranks third in the Oil & Gas Pipelines in total revenue. From 2006 to 2007, WMB revenue increased 12.6%, gross profit increased 21.4%, and total cost increased 4.5%. Also from 2006 to 2007, WMB total gas production increased 21%.
Williams extracts most of its natural gas from unconventional sources such as shale, coal-bed methane and tight sands. 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. 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.
The 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. However, the price is still up 43% since 2002. Many industrial users, who used 31% of natural gas produced in 2007, also have built-in fuel-switching capabilities. 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. Oil prices have been especially volatile in mid-October, oscillating between $70 and $80.
Increasing 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. 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). 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. Many electric companies are switching to natural gas as a cleaner alternative to coal and oil power plants. 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.
WMB’s pipeline segment is regulated by the Federal Government, including in what rates it can charge its customers. 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. 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. This is likely to increase the rates WMB can charge pipeline customers, increasing the segment's revenues.
Demand for natural gas is highest during the coldest months of winter when it is used to heat homes. 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. Demand for natural gas drops sharply during the temperate spring and fall seasons. 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.
|Competition||Williams Companies (WMB)||El Paso (EP)||Kinder Morgan Energy Partners, L.P. (KMP)||ENBRIDGE (ENB)||Spectra Energy (SE)||Questar (STR)|
|Market Cap $Mil||10,570.00||5,600.00||13,250.00||11,610.00||11,180.00||4,640.00|
|Gross Profit $Mil||5,437.00||4,403.00||2,145.80||2,909.90||1,926.00||1,394.60|
|Net Profit Margin %||8.02%||9.38%||9.52%||6.32%||19.91%||18.61%|
|Operating Margin %||17.48%||29.13%||8.76%||9.64%||30.41%||31.10%|
|Miles of Interstate Pipeline||14,200.00||42,000.00||25,000.00||--||--||2,505.00|