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OGE AT A GLANCE

P/E ► 13.0 AVG EV/EBITDA ► 5.49 AVG ROA ► 5.8% AVG ROE ► 12.7% AVG Debt to Equity ► 2.36 AVG Current Ratio ► 0.494 VERY LOW Interest Coverage Ratio ► 3.61 AVG

 

 

 

 

 

 

OGE Energy Corporation is an electric and natural gas utility in the south central United States. The company's revenue is evenly divided between electricity and natural gas sales, but the company's electric utilities segment has always been more profitable. Growing popular support for renewable energy standards and emissions caps has led to legislation in many states, and if a national standard were adopted (likely, given the current Presidential candidates), OGE will have to break its dependence on coal and natural gas by spending large amounts of money on growing renewables' share of its portfolio; already, OGE expects its expenditures due to environmental compliance in 2008 to be equivalent to approximately 20% of their total CapEx. By 2009, the company expects this spending to nearly triple.

Furthermore, state regulation of electric utilities rates means that, while the company is guaranteed a profit, OG&E's margins are limited by the prices and returns allowed by the state. The company does not have a strong history of getting rate increases, meaning that when input costs rise, it's less likely that the company will be able to pass them on to customers. For example, in both 2005 and 2006, the rate increases granted to OG&E by state commissions were less than half the amount they requested. Both of these requested increases would have kept OG&E's rates below regional and national averages, but the commissions remained skeptical. OGE's best growth opportunities, therefore, are in its natural gas segments where, thanks to high petroleum prices, margins are large and demand is predicted to grow. As a utilities company, OGE has no competitors in its operating region thanks to government regulation and the high cost of infrastructure installation; in the natural gas processing industry, the company competes with Devon Energy, Spectra Energy, and Williams Companies.

Company Overview

OGE Corporation has four major business segments:

• Operating through Oklahoma Gas and Electric Company (OG&E), the Electric Utilities segment generates, distributes, and sells electric energy in Oklahoma and the western part of Arkansas. The company's 2007 energy mix included approximately 35% natural gas (the majority of which is purchased from Enogex), 60% coal, and the rest from wind, but OG&E has been gradually shifting towards natural gas and wind energy over the past several years. OG&E is the largest electric utility in Oklahoma.^[1]

• The Natural Gas Transportation and Storage segment is one of Enogex’s two continually operating segments, and is located primarily in Oklahoma and the Texas Panhandle. A substantial portion of this segment's revenue comes from firm transportation services, in which a shipper can reserve a minimum and maximum quantity of natural gas to be delivered each day.^[2] Its storage services are provided to third-party customers at market rates.

• Enogex’s other major segment, Natural Gas Gathering and Processing, is OGE’s fastest growing segment and a major contributor to the firm's steady income growth. Business activities in this segment consist primarily of gathering raw natural gas (moving it from the well to the pipeline) and extracting Natural Gas Liquids (NGLs) that can be sold and used to generate energy. The remaining gas is purified into "processed" natural gas, and can be sold as well. Customers of this segment agree to either “fee-based” (flat-rate services), “percent-of-proceeds” (processed gas and/or NGLs at market prices), or “keep-whole” (exchange of raw gas for processed gas) agreements.^[3]

• The Natural Gas Marketing segment is a low-margin segment run by Enogex’s subsidiary, OGE Energy Resources Inc. (OERI). OERI prepares reports on natural gas markets and pricing, enters into transactions to hedge natural gas and NGL positions, and provides Enogex with documentation regarding these services.^[4] OGE has decreased their funding for this segment by over 60% since 2005.^[5]

OGE Energy Annual Report^[7]

OGE’s revenue has decreased by approximately 55% from 5.912 billion in 2005 to $3.798 billion in 2007. This is due almost entirely to the company’s declining usage of its natural gas marketing segment, which generated $3.995 billion of revenue in 2005 and only $1.538 billion in 2007.^[8]

Due to the low profits provided by the marketing segment, the company’s net operating income has increased over this same time period, growing from $322 million in 2005 to $455 million in 2007.^[9] The increase in operating income has been aided by regulated rate increases in electric utilities, as well as Enogex’s new focus on natural gas gathering and processing services in the midst of all-time high gas prices. By decreasing spending on its marketing segment (yielding a 1.5% margin in 2007) and dedicating its budget to gathering and processing (yielding a 24.5% margin in 2007), OGE has been able to increase its operating revenue while decreasing its spending. ^[10]

Trends and Forces

Federal and state price regulation for electric utilities threatens OG&E’s growth potential

46% of OGE Corporation’s revenue currently is generated by the sale of electricity to retail customers through OG&E. The rates that OGE charges their customers must be approved by state utility commissions, but these commissions have been historically skeptical of OG&E's requests to grant their desired rate increases, even when they would have kept OG&E's rates below the regional and national averages. In 2005, when the company proposed an annual rate increase that would have increased the company's revenues by just under $90 million, Oklahoma’s OCC granted them less than half that. A 2006 request for an increase in Arkansas was met with similar results. Unfavorable regulatory decisions hurt OG&E’s profitability by lowering margins in the face of rising input prices (for coal, natural gas, and even renewable energy).^[11]

Environmental regulation trends suggest more preventative expenditures by OGE

As an energy producer, the activities of OG&E are subject to both state and U.S. environmental legislation. This regulation includes such policies as emissions caps, waste disposal (and cleanup) restrictions, and regulation of construction to avoid harming endangered species. While Oklahoma and Arkansas have not mandated programs to regulate greenhouse gas emissions, they have expressed support for legislative action on climate change issues. Many states in the U.S. and many nations world wide are gradually increasing their emissions and renewable energy regulations over the long run. There is no way to predict how much spending must be done over the long-term for compliance with waste disposal procedures from coal or gas, or for remedial purposes if there were to be an accidental release of a harmful substance. Currently, OGE has budgeted $37.9 million of its capital expenditures to be spent in 2008 on complying with environmental regulation, - 20% of its 2007 CapEx. For 2009, it has budgeted $121.4 million - a threefold increase suggesting drastic growth in compliance spending in future years.^[12]

Revenue from natural gas production is sensitive to commodities price risk

In Enogex’s “natural gas processing” segment, revenues generated by the sale of natural gas under “keep-whole” or “percent-of-proceeds” agreements are incurred at market prices. "Keep-whole" agreements present large margins for OGE when NGL prices exceed those of processed natural gas, and "percent-of-proceeds" agreements provide upside when prices are high for either NGLs or processed gas. Prices of this commodity, like oil, have historically been volatile and uncertain, and this portion of OGE’s revenue is sensitive to these fluctuations.^[13] Over the past several weeks, oil prices have stayed over $100 per barrel, flirting with all time highs. Natural gas prices have experienced similar trends, due in large part to continually growing world demand and potential inflationary concerns in the United States. In general, this current trend provides strong returns for the company, as it is able to sell its NGLs and processed gas at record high market prices.

Competition

In the electric utility industry, federal and state legislation as well as the high cost of infrastructure for electric utilities present a large barrier to entry, giving OGE a strong competitive position. Another similar but smaller electric utility company is Oklahoma's second largest electric provider, the Public Service Company of Oklahoma, which primarily serves the Tulsa region.

Enogex’s natural gas transportation and storage segment faces competition from a number of inter and intra-state pipelines, including Panhandle Eastern Pipeline, El Paso Natural Gas Pipeline, Williams Companies (WMB), Spectra Energy (SE), and Oneok Gas Transmission. Williams, Spectra, and Oneok all surpass Enogex's 1.52 trillion British thermal unit per day (Btu/d) pipeline throughput, with 2.700 trillion,^[14], 3.642 trillion,^[15] and 3.579 trillion^[16], respectively.

OGE’s biggest competitive threats come in the natural gas processing market, where the company looks to have its greatest future growth. Competitors include Devon Energy (DVN) and Spectra Energy (SE). Devon Energy processes 894 million Btu/d of natural gas,^[17] to OGE's 570 million.

References

1. ↑ OGE 2007 10-K, The Company, pg 2
2. ↑ OGE 2007 10-K, Natural Gas Pipeline Operations - Enogex, pg 10
3. ↑ OGE 2007 10-K, Natural Gas Pipeline Operations - Enogex, pg 14
4. ↑ | OERI Marketing and Administrative Service Agreement
5. ↑ OGE 2007 10-K, The Company, pg 2
6. ↑ OGE 2007 10-K, Consolidated Statement of Income, Pg 84
7. ↑ OGE 2007 10-K, Summary of Operations by Segment, pg 55
8. ↑ OGE 2007 10-K, Consolidated Statement of Income, Pg 84
9. ↑ OGE 2007 10-K, Consolidated Statement of Income, Pg 84
10. ↑ OGE 2007 10-K, OG&E and Enogex, Pg 56-60
11. ↑ 2007 Morningstar Report, OGE, 09/26/2007
12. ↑ OGE 2007 10-K, Environmental Matters, pg 19
13. ↑ OGE 2007 10-K, Operating Risks, pg 29
14. ↑ WMB 2007 10-K, Gas Pipeline, pg 7
15. ↑ | SE 2007 10-K, Item 1.Business, pg 4
16. ↑ | OKE 2007 10-K, Operating Information, pg 39
17. ↑ DVN 2007 10-K, Consolidated Statement of Operations, pg 69
18. ↑ OGE 2007 10-K, Consolidated Statement of Income, pg 84
19. ↑ WMB 2007 10-K, Selected Financial Data, pg 34
20. ↑ DVN 2007 10-K, Consolidated Statement of Operations, pg 69
21. ↑ | SE 2007 10-K/A, Consolidated Statement of Operations and Comprehensive Income, pg F-3