Feb 5, 2009
Executives
John R. Arensdorf - Chief Communications Officer Gregory L.
Ebel - President and Chief Executive Officer John Patrick Reddy - Chief Financial Officer Thomas C. O'Connor - Chairman, President and CEO, DCP Midstream
Analysts
John Kiani - Deutsche Bank Lasan Johong - RBC Capital Carl Kirst - BMO Capital Keith LaRose - Bradley, Foster & Sargent Matt Akman - Macquarie Leslie Rich - Columbia Management Nathan Judge - Atlantic Equities Becca Followill - Tudor, Pickering, Holt Richard Gross - Barclays Capital
Operator
Good morning. My name is Janus, and I will be your conference operator today.
At this time, I would like to welcome everyone to the Spectra Energy Earnings Conference Call. All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Now I would like to turn the call over to Mr.
Arensdorf. Sir, you may begin your conference.
John R. Arensdorf
Thank you, Janus and good morning everyone. As Janus said, I am John Arensdorf, Chief Communications Officer for Spectra Energy.
We are pleased that you could join us today as we share our 2008 fourth quarter and year-end earnings results as well as our 2009 business plan. Let me briefly review our agenda and introduce you to today's speakers.
We're covering a lot of ground this morning combining our customary fourth quarter discussion with the rollout of our 2009 plan. Greg Ebel will begin our discussion by sharing his perspective on our very successful 2008 and provide an overview of our 2009 business strategy.
We will then look forward to introducing you to Pat Reddy, our new CFO, who will share the details around our financial results for the quarter and cover the details of our 2009 financial plan. Next, Tom O'Connor, Chairman, President and CEO of DCP Midstream will provide perspective on our Field Services business.
And then Greg will return to wrap things up and provide his thoughts on what makes Spectra Energy such an attractive investment opportunity. As always, we'll allow plenty of time for your questions following our prepared presentation.
In addition to the slides we'll cover with you today, you'll find in the materials on our website, an appendix of information that we hope will be hopeful to you. As you know some of what we'll discuss today concerning future company performance will be forward-looking information within the meanings of the securities laws.
Actual results may materially differ from those discussed in these forward-looking statements, and you should refer to the additional information contained in Spectra Energy's Form 10-K and other fillings made with the SEC concerning factors that could cause these results to be different than contemplated in today's discussion. In addition, today's discussion will include certain non-GAAP financial measures as defined by SEC Regulation G.
A reconciliation of those measures to the most directly comparable GAAP measures is available on our website at spectraenergy.com. With that, let me turn things over to our President and CEO, Greg Ebel.
Gregory L. Ebel
Thank you, John and thanks for... to all of you for joining us today.
My pleasure to be with you again this time, however, as CEO of Spectra Energy. I'm not the only one here in a different role today.
We are pleased to have Pat Reddy join us as Chief Financial Officer. Many of you know Pat from the days as Senior Vice President and CFO at Atmos Energy.
During his career with Atmos, Pat also led the corporate development and treasury functions. And before joining Atmos, he served as Vice President of Planning and Advisory Services for Pacific Enterprises.
Very pleased to have Pat on board. With all his great experience, he is a strong addition to the Spectra team.
As John mentioned, I'm going to spend most of my time with you today, delving into the highlights of our 2009 plan, the opportunities and challenges we've identified and our objectives for the short term. I also want to tell you how Spectra Energy is positioning itself to continue our long-term growth strategy.
But first, let's take a quick review of our 2008 accomplishments. Spectra Energy's 2008 financial and operating results exceeded our expectations.
Ongoing earnings per share of $1.83 for the year were significantly above $1.56 EPS employee incentive target that we shared with you about a year ago. We increased our dividend 14%.
We did a fine a job of executing our capital expansion program placing about $1.8 billion projects into service during 2008. And we delivered those projects as scheduled, then they will provide solid returns, averaging slightly above our 10 to 12% return on capital employee target.
We've maintained strong liquidity in the midst of a severe credit crunch. And as you might recall, in early September we moved into the credit markets and got the remainder of our 2008 debt issuances out of the way but a week before the credit crunch really hit.
We ended the year with less debt than we originally expected. And we also finished the year with about $200 million of cash on our balance sheet.
Just take a look at those projects we placed into service last year, all of which will generate 2009 earnings and cash flow. This slide lists the 19 projects we placed into service last year, projects that will deliver total annual EBIT of approximately $225 million this year.
And we enjoyed EBIT from these projects of about $95 million in 2008 and expect an incremental $130 million in '09. 2008 was by far our largest capital expansion year.
And we're extremely pleased that we were able to get most of the heavy lifting out of the way last year, bringing substantial value adding projects into service to meet our customers' need and help grow our stable fee-based EBIT. Pat will share more details on our 2008 performance in a few minutes.
So I want to turn now to a top level look at our 2009. A little later in the call we'll go into greater detail regarding our assumptions and related sensitivities.
But here is the highlights. We set our 2009 earnings per share guidance at $1.15 per share based on $55 oil with an estimated NGL to crude relationship of 60%, $6 natural gas and a $4.75 frac spread at our Empress plant.
We've also assumed a Canadian FX rate of 1.2 Canadian dollars for every one U.S dollar. We know that the dividend is a key component of the value shareholders place in Spectra Energy's common equity and our annual dividend for 2009 will remain at $1 per share.
Our 2008 payout came in around 55%. 2009's payout will be considerably higher than our 60% long-term payout target.
But over time as earnings grow we'll aim for a return of that type of payout ratio. We previously told you our 2009 growth CapEx would be about half of what we spent in 2008 or about 800 million.
But given the external environment and market dynamics at play, the number now looks like it'll be in the $500 million range. We've deferred some capital spending to match our customers' needs and align with the current market environment.
For example, we terminated the Maritime's Phase 5 project at our customers' request but with no financial exposure to us. We also reduced the size and scope of AGT East/West project and delayed its in-service date to 2010, again following discussions with our customers.
The 2009 CapEx adjustments do not significantly alter our long-term growth prospects. In fact, we fully expect to proceed with all or most of those projects as well as new opportunities once we see return to more favorable economic conditions.
We've got a good record of prudently managing our costs and during these economic times, we'll double those efforts. To that end, we've already taken some important steps which are reflected in our plan.
We restricted our salary increases. We're targeting our personnel count at 5% below our original budget level.
And given a smaller CapEx budget this year, we've already reduced our U.S. project or contractor (ph) group by about half to 250 people.
These actions should alone result in cash savings in 2009 of more than $50 million, combination of operating and capital dollars. And of course, we'll continue to look for other ways to reduce costs.
A number of key points I really want you to take way from our discussion today. First of all, Spectra Energy does have the finest asset base in the business.
You've seen this map many times before and it shows the scale and scope of the assets which connect key producing basins in the U.S. and Canada with major gas consumption areas of Eastern and Southeastern U.S.
and Ontario. We interconnect with substantially every major pipeline in the U.S.
and Canada, and we're well positioned to take advantage of the important developing shale basins like Haynesville and Horn River. Expanding our footprint through prudently incurred capital expenditures that meet our customer's changing needs will allows us to remain the supplier of choice for customers and the investment opportunity of choice for investors.
With the unprecedented volatility we've seen in commodity prices over the last year, I want to remind you that the overwhelming majority of our 2009 EBIT comes from fee-based businesses, with less than 20% sensitive to commodity prices. That's important today.
So let's take a closer look at that. This chart shows the parts of our business that have commodity sensitivity versus those that are primarily fee businesses.
We're fortunate and we believe our investors are too that more than 80% of our projected EBIT and more than three quarters of our projected EBITDA comes from non-commodity sensitive businesses. Of course, these percentages will change as commodity prices change.
But the core of Spectra Energy's earnings is from predictable fee-based businesses. This slide shows...
provides a reminder of the strong fundamentals underlying our business. You can see here that we have contract stability on all of our U.S.
Pipelines with average contract terms from 4 to 20 years. As the contracts on our U.S.
Pipelines expire, we see renewal rates approaching 99%. We also have a favorable regulatory environment at Union Gas.
The business operates under an incentive rate mechanism which goes through 2012 and in addition Union's ex-franchise storage services are provided at market base rate with the profit being phased in through 2010 which is obviously a benefit. About 30% of Western Canada's earnings come from BC pipeline which provides below risk, steady regulated revenue.
Another 50% comes from the fee-based gathering and processed assets and the final 20% comes from our Empress facility. Except for Empress the gathering and processing business in Canada has no direct commodity exposure but it's operated on a fee-based service.
It's also important to note that over 80% of Spectra's customers are investing in great entities and another 15% of our exposures are secured with collateral. To further highlight the stability of the U.S.
Transmissions revenue, we've shown here the breakdown of firm versus interruptible or other revenue on our U.S. Pipelines for 12 months ending December 31st 2008.
As you can see, well over 90% of our pipeline revenue is from demand charges which the customers state a reserve capacity. The revenue is not sensitive to throughput variations or short-term economic turmoil.
Another key takeaway I want to leave at you is that Spectra Energy has liquidity to support our 2009 needs. Our liquidity is underpinned by four separate credit facilities aggregating about $2.6 billion.
We begin 2009 with an estimated available liquidity of about 1.4 billion. And expect to end the year was about 1.6 billion of available liquidity.
We will continue to exercise prudent financial decision making and take the actions required to ensure our balance sheet, remains flexible for the long term. We began 2009 with less debt than we expected a year ago, and we reduced our CapEx spending for the year.
Both those factors will help us maintain financial flexibility. I've mentioned what we're doing to manage costs in 2009 and this will continue to be an area of focus for us going forward.
And finally, we're confident that markets will recover and when they do, we'll be ready to quickly reengage our delayed projects and take advantage of additional opportunities. Let me turn now to the growth CapEx projects we expect to place into service this year.
We expect approximately $650 million of major projects coming into service by year-end. These projects will deliver $35 million of EBIT in 2009 and an incremental $45 million EBIT in 2010 for a total annual EBIT contribution of $80 million.
Returns on capital employed in these projects will be a little above our 10 to 12%. What does targeted returns?
So what is that mean for the longer term for 2010 and beyond, well our modest CapEx plan in 2009 means that same of our originally scheduled projects for 2010 and 2011 will be deferred. But the longer term demand for pipeline gathering and storage projects continues to be robust.
This slide shows in further detail the projects we're working on and those we'll be ready to move forward with these negotiations with our customers are completed. As always, we'll keep saying our details on these plans as they firm up.
While our level of 2009 CapEx has been reduced, we haven't taken our eye off the end goal of creating shareholder value by investing in vital and necessary energy infrastructure projects in the long term. Between 2007 and 2009, we'll have placed into service more than $3 billion in expansion projects, which will contribute annual EBIT of $380 million for a combined return on capital greater than 12%.
That track record should give you a healthy level of optimism about Spectra Energy's future. We remain open to new opportunities and transactions that align with our business model and serve our investors.
I'll step back but we won't trade too far from our home base. We're investing in energy infrastructure as we know well, and there are great opportunities, even in the current environment.
And every region we serve, we're working with customers on critically needed expansion projects. In the Northeast U.S.
customers on both ends of our pipeline recognize Spectra Energy as a preferred conduit. We're helping Northeast customers access, growing supply sources and we're connecting suppliers with premium Northeast consuming markets.
We're seeing real results from producers in the Marcellus Shale region. Our existing infrastructure cuts right through Marcellus on its way to high demand Northeast markets.
Southern Appalachian production continues grow seeking incremental capacity on our East Tennessee system into the Southeast market. And at Union Gas, we're continuing to pursue unregulated gas storage additions and the opportunities in projects that accompany increased storage.
In Western Canada, our assets are strategically positioned for growth in conventional and tight shale resource plays. Both the Montney and Horn River basins enjoy close proximity to our Fort St.
John and Fort Nelson infrastructure. Predictions are that Horn River will be every bit as prolific as the Barnett Shale which is not more so.
We made existing plants for acid gas re-injection and carbon capture and sequestration in Western Canada and received support for future projects along those lines from various governments. Whether it's for Rocky supply arriving at Algonquin (ph), Marcellus Shale, and Appalachia, exciting new production from Canadian basins are from the three...
it's going to be four LNG terminals in the Northeast. Suppliers and customers alike are looking for us for the solution.
Spectra is headed in the right direction, and you can continue to expect that we'll invest in solid returning, natural gas infrastructure projects both in Canada and U.S. And we will use our financial position and continuing access to capital markets to take advantage of opportunities we expect to see in our core business areas.
With that, I'm going to turn things over to Pat who will brief you on our fourth quarter and year-end 2008 results and give you some more details on our 2009 plans.
John Patrick Reddy
Thank you, Greg. It's wonderful to be here this morning both at Spectra Energy and with you today.
As you've seen in our earnings release, Spectra Energy reported fourth quarter net income of $171 million or $0.28 per diluted share. After removing the effect of special items in discontinued operations, ongoing earnings were $197 million or $0.32 per share.
For the year, we delivered ongoing earnings of $1.14 billion or $1.83 per share compared with 965 million or $1.52 in the prior year. The annual results reflect strong earnings and sound operating performance from all of our underlying businesses.
The company benefited from expansion projects placed into service in both 2007 and 2008 and from higher commodity prices during the year. Let's review the results for each business segment in a little more detail.
Let's start with U.S. Transmission which reported fourth quarter ongoing EBIT of $205 million before the effect of the Islander East impairment compared with 221 million in the fourth quarter of 2007.
The segment benefited from higher EBIT from business expansion projects placed into service during the 2008 period. These earnings were more than offset by lower processing revenues resulting from lower volumes and prices and higher development costs associated with ongoing pipeline and storage expansion projects.
Year-end ongoing EBIT for U.S. Transmission was $861 million compared with 894 million in 2007.
2009 is off to a great start with most of our U.S. pipelines and storage facilities, experiencing record peak days in January.
East Tennessee, Gulfstream and Egan all had new peak delivery days during the month. Execution's top two delivery days occurred this winter, and six of our offerings top ten delivery days occurred this winter as well.
The new infrastructure we put into place over the last two years is definitely needed and a record setting usage we're experiencing underscores that the need continues. Now, let me turn to our distribution business, Union Gas.
Distribution reported fourth quarter 2008 EBIT of $90 million compared with 84 million in the fourth quarter of 2007. These results reflect a continued increase in storage and transportation revenues, lower operating costs and increased customer usage as a result of weather that was 13% colder than last year.
These improvements were partially offset by lower Canadian dollar and earnings sharing with customers related to the incentive regulation of framework implemented in 2008. Year-end EBIT for distribution was $353 million compared with 322 million in 2007.
Union Gas is off to a strong start this year. Ontario experienced a very cold January, some 25% colder than a year ago.
Last month, we saw a record spend-out from dawn fog (ph) and also set a new record for storage withdrawal. Let's turn now to our Western Canadian operations.
Western Canada Transmission & Processing reported fourth quarter 2008 EBIT of $65 million compared with 141 million in the first quarter of 2007. The decrease resulted primarily from lower frac spreads at the Empress operations and the lower Canadian dollar.
Year end EBIT for this segment was $398 million compared with 359 million in 2007. This winter Western Canadian operations have benefited from extreme winter temperatures and increased demand, our BC pipeline's top four delivery days and 14 of the top 25 days occurred in December with deliveries well above contracted capacity.
Our gathering and processing assets experienced exceptionally high levels of throughput as well. Now let me turn to Field Services.
Our Field Services business segment which represents Spectra Energy's 50% interest in DCP Midstream reported fourth quarter ongoing 2008 EBIT of $69 million compared with 195 million in the fourth quarter of 2007. The decrease was primarily driven by lower NGL prices which correlate to lower crude oil prices.
Crude oil averaged $59 per barrel in the fourth quarter of 2008 versus 91 per barrel during the same period in 2007. In addition, the NGL to crude oil relationship also decreased quarter-over-quarter from 65% to 46%.
The decrease in fourth quarter 2008 results was partially offset by non-cash mark-to-market gains compared with mark-to-market losses in the fourth quarter of 2007, both from hedges used to protect distributable cash flow at DCP Midstream's master limited partnership. For the quarter, DCP Midstream paid distributions of $105 million to Spectra Energy.
Year-end reported ongoing EBIT for Field Services was 716 million compared with $549 million in 2007. Now let us turn to other which is primarily comprised of our corporate costs.
Other reported net costs of $21 million in the fourth quarter of 2008 compared with 56 million reported in the fourth quarter of 2007. Excluding special items in 2007, net corporate costs were $28 million lower in the fourth quarter of 2008.
As you'll see in a few minutes when I review 2009, our run rate for corporate costs is in 85 to $90 million range. Year-end ongoing net costs for other were $78 million compared with 89 million in 2007.
Our next slide shows several important additional items. Interest expense was 166 million for both the 2008 and 2007 fourth quarters.
Interest on our higher debt balances in 2008 was offset by lower interest rates and the effects of the lower Canadian dollar. For the 2008 quarter, Spectra Energy's effective tax rate was 20% compared with 31% in the year prior quarter.
The lower tax rate this quarter was primarily due to favorable adjustments in 2008 for final 2007 tax returns and lower 2008 state income tax. The full year tax rate for 2008 was about 31%.
As of December 31, 2008, our debt to total capitalization relationship stood at almost 62%, a couple of percentage points above our comfort level. Because substantially all of our goodwill relates to our Canadian subsidiaries, a lower Canadian dollar increased our debt to total cap ratio at year end.
When the Canadian dollar weakens both goodwill and shareholders' equity are reduced. The result is the higher debt to total cap and would have been the case had the Canadian dollar been at parity with the U.S.
dollar. As of December 31st, we had total capacity under our credit facilities of 2.6 billion and available liquidity of 1.4 billion.
Finally, the Canadian currency exchange translation also had an unfavorable net after tax effect on earnings for the fourth quarter of 2008 of about $15 million compared with the fourth quarter 2007. So a challenging quarter but a strong year overall.
Now let's turn to what you are probably most interested in, our 2009 financial overview. Let's look at the components of our 2009 plan.
This chart provides projected EBIT and EBITDA detail for each of our business segments along with all the information needed to develop our EPS number. We're confident that you'll see solid performance in each of our businesses this year and through 2010 and beyond.
Let's turn to the key assumptions which underlie our 2009 projections. As Greg mentioned, our $1.15 EPS target is based on $55 per barrel oil with an NGL to crude relationship of 60%, $6 natural gas and $4.75 fracs spread at Empress.
The Canadian dollar to U.S. dollar exchange rate is assumed at $1.20.
These are assumptions of course and we're not attempting to forecast 2009 commodity prices relationships or the Canadian to U.S. dollar exchange rates.
I'll discuss the sensitivity to these assumptions in a few minutes. We expect net interest expense in 2009 to be about $680 million which reflects higher average debt balances and higher interest rates compared with last year.
We will have no U.S. pension funding this year and our Canadian pension funding will continue at about the $50 million level, the same as we funded last year.
As mentioned, our dividend will remain at $1 per share. We have assumed an effective tax rate of about 30% for the year, and in a change from past practices, we will fulfill our dividend reinvestment purchases with newly issued shares in 2009.
Previously the DRIP shares have been purchased in the open market. In addition, we expect to issue new equity to fund our employee's savings plan contributions.
We would expect both of these actions to add between 3 and 4 million shares by the end of 2009, with the majority of that impacting some in 2010. Let's turn now to our 2009 projected cash flow summary.
This schedule shows our expected primary sources and uses of cash. You can see that we have total sources of cash of about 1.3 billion.
We expect internally generated sources to be sufficient to fund our dividend and our maintenance CapEx and to make a partial contribution to growth capital. So that leaves us with net cash requirements of just over 300 million before financing activity, more than $1 billion flat forecasted 2008 requirements.
We have a stand that we will issue project financing at two of our joint venture projects representing 600 million for our share. We have debt retirements due this year, with little more than $800 million.
Only about 115 million of this is due in the first quarter, but the remaining amount coming due in the fourth quarter. While our plan assumes we will access to capital markets for the remaining $600 million, we have the capacity under our existing credit facilities to fund this requirement without doing so.
That's a noteworthy advantage to have and one that allows us to move through 2009 with the intended issuing debt only when we are comfortable with our leverage ratios and when the market provides attractive opportunities. Now let's look at the commodity sensitivities we've mentioned.
This slide is very similar to one we presented at various times in 2008 that has been updated for our 2009 expectations. Our largest exposure as you know is at DCP Midstream.
The sensitivities shown here represent our 50% shares in sensitivities that Tom will review with you in a few minutes. The primary exposure in that business relates to natural gas liquids prices, which are correlated with oil prices.
At the Spectra Energy level, we have a sensitivity of approximately $11 million in EBIT for every $1 change in crude oil prices for the full year. This sensitivity remains constant at all oil prices.
At $55 per barrel oil there also is a sensitivity of about 8 million of EBIT for each percentage change in the NGL to crude relationship. This sensitivity increases or decreases as the crude oil price increases or decreases.
At the Spectra Energy level, we would expect a 2.5 million EBIT variance for every $0.10 change on an annual basis in natural gas pricing. Our Empress System in Canada processes gas on a key pole basis.
So it has exposures to changes in the frac spread. Our forecast assumes a frac spread of $4.75 and we have an annual sensitivity of about 16 million in EBIT for every $0.50 change in that frac spread, all other things being equal.
Our Canadian earnings are exposed to changes in the rate of exchange between Canadian and U.S. dollars.
We would expect that every $0.01 change in the $1.20 rate we assume to translate into $3 million variation in net income, essentially the same as in 2008. This sensitivity has recorded at the net income level to give effect to the changes in EBIT, interest and Canadian taxes.
I'll reiterate that we have no hedges in place for the exposure shown here, except for the cash flow hedges at DCP Midstream Partners. Now of course in today's volatile marketplace, it's hard to put a lot of credence in commodity assumptions no matter the source.
So we've provided a couple of examples of what we might see play out during the year, both in the event of either higher or lower commodity and FX effects. Let's take a look now.
Of course, we can't know with certainty what commodity prices will average in 2009. So this example presents a case in which commodity prices are higher on average than our base case and one in which they are lower.
The purpose of this example is not to tell you we think our earnings will come in between this range but rather to provide a model which will allow you to test your own assumptions. The detailed computations behind this example are included for your reference in appendix 1 to this presentation, which is posted on our website.
The next slide will show you how we get from 2008 actuals to our projected earnings in 2009. We began with 2008 net income of 1.1 billion which equates to our ongoing $1.83 per share and then we walk it forward to our 2009 projected net income of 705 million or $1.15 per share.
First, we expect projects placed into service in 2008 and 2009 to provide incremental EBIT of about $165 million. Roughly, 115 million of this EBIT is from expansion projects at U.S.
Transmission while the remaining 50 million is spread about evenly between distribution and Western Canada. The next part shows the decrease of $80 million related to processing revenues at U.S.
Transmission. If you recall, beginning in late 2006, Texas Eastern experienced increased processing volumes after hurricane Katrina damaged another company's major processing plant.
This situation continued through June of last year at which time the other plant was restored to full operation. As a result, the last half of 2008 and all of 2009 reflect lower processing volumes.
In addition, lower expected NGL prices in 2009 will negatively affect processing revenues. Next, interest expense, net of interest income is expected to increase by $70 million, due to higher interest rates and higher average debt balances in 2009.
The next three bars summarize the effective commodity and currency declines on our 2009 earnings. Our 50% share of DCP Midstream's earnings are expected to be $465 million lower and Empress EBIT will decrease by $115 million, both primarily as a result of lower commodity prices in 2009.
We also expect to see an EBIT decrease of about $95 million as a result of the lower Canadian dollar. These commodity and currency items represent the significant drivers of our projected lower earnings in 2009.
As you would expect, these lower pre-tax earnings and a lower effective tax rate in 2009 produced an income tax benefit of some $200 million. And finally a benefit of 24 million from various other items adjusted to net income of 705 million or $1.15 per share.
Excluding commodity and currency reductions, we expect to see growth at each of U.S. Transmission, Distribution and Western Canadian business units.
Now, I would like to make a few comments about our pipeline and storage MLPs, Spectra Energy Partners. Our fundamental objectives for SEP, of course, have been to provide an attractive currency for growth and to continue increasing our cash available for distribution.
We've succeeded. Since the initial IPO in July of 2007, SEP's unit prices performed relatively well and annual distributions have increased by more than 10%.
SEP's steady and dependable earnings and cash flow from its five plant storage assets and its strong financial profile position it well for continued growth. Through its existing credit facilities it has more than adequate liquidity to fund its organic expansion program.
In a year which has been quite challenging for the MLP space generally, Spectra Energy Partners has retained a strong currency. That's strength coupled with the support of Spectra Energy will position it well to pursue opportunities which may arise during this year.
SEP will provide the detail of its 2009 financial plans during its conference call tomorrow. Finally, let's take a look at our disciplined approach to financial management which is the key advantage in the current environment.
Just as in 2008, we are moving into 2009 with continued diligence and rigor in our financial policies and approach. We will maintain adequate liquidity to allow us to execute our 2009 CapEx plan.
We will only pursue those capital projects with expected returns appropriately balance risk and reward. We will be opportunistic in our approach to long-term financing which will allow us to maintain the lowest cost to capital.
This will allow us to remain competitive in providing new and expanded services to our customers. We will continue to maintain a flexible balance sheet and investment grade credit ratings.
And we will keep all our options open for accessing the debt and equity capital markets. Through this year we are prepared to take advantage of the opportunities we expect to arise in 2009, which will provide long term benefits to our shareholders.
I want to turn your attention now to an important component of our business DCP Midstream, led by Tom O'Connor who will speak next. DCP Midstream is a great must run business, a business with historically high returns and capital employee in excess of 20%.
Even today, when we're experiencing lower commodity cycles, its returns remain very attractive. And with that I'll turn the program over to Tom.
Thomas C. O'Connor
Thank you Pat. And good morning everybody.
I appreciate the opportunity to speak with you about how DCP Midstream will contribute to Spectra's earnings in 2009. Last January when I spoke to of our view of 2008, I talked about the potential for a record year of earnings and cash generation from this business.
Well as you heard earlier, we did realize our aspirations. Helped by strong commodity pricing and an exceptional year of operations, we realized earnings and cash flow well in excess of our targets.
While 2009 is shaping up as a year with a lot of challenges on the commodity front, as I review the business today, please keep in the following in mind. First, this is a must run business.
Over 75% of the gas produced in the U.S. and virtually all the gas produced in our key basins require some level of treatment or conditioning.
Second, the fundamental outlook for U.S. gas supply development remains very favorable.
And the strategic location of our assets and basins with growing supply has not changed. Third, this business has enjoyed strong performance during the commodity run over the last several years, yet it's still expected to deliver double-digit returns in the comparatively low commodity price environment of today.
And finally from a solid base, we provide Spectra with an option for significant upside when commodities return to more fundamental levels. Let me start with the review of our asset position.
You've seen us map many times but it is a good reminder of the overall scale of DCP Midstream. Our portfolio includes 53 gas processing plants and over 59,000 miles of gathering and transmission pipelines.
We have a significant presence in most of the major U.S. gas producing regions.
Our asset position is unmatched in the midstream business. During 2008 we gathered and processed close to 6 trillion Btus per day and produced on average 360,000 barrels of NGLs per day.
Including volumes transported on our pipelines we handled over 7 Trillion Btus per day. And we've several competitive advantages which contribute to our ongoing success.
Our size provides us with numerous operational and financial levers which equal flexibility to respond to commodity volatility. With geographic diversity, a drilling slowdown that occurs in one region may be offset by drilling in another region.
An extensive and the diverse customer base mitigates our exposure to any one company's exploration plans and with predominantly a percent of proceeds contracts, we prosper with rising commodity values with protection from an economic frac spreads. In an industry which is must run, these attributes result in consistent value delivery and a solid fundamental outlook.
Let's turn now to a brief look at our 2008 accomplishments. At the 100% level our 2008 EBIT was about 1.6 billion with EBITDA of over 2 billion and net income of over 1.4 billion.
We paid dividends and tax distributions of over $1.8 billion for 2008, inclusive of $500 million special dividend. We benefited from strong commodity prices during most of 2008 with oil averaging just under $100 a barrel.
However a big part of a 2008 story is the operations, which performed very well despite challenges associated with Hurricane Ike. We delivered strong mechanical reliability and BTU efficiency performance and completed a record number of well connects.
We also initiated several low risk expansion projects at Midstream with our East Texas, Weld County and Woodford Shale initiatives. And at partners we completed the Michigan acquisition and are building out the Collbran system in the Peance Basin.
As we enter 2009, our focus remains on the basics of the business, continuing to deliver on our operational performance goals of reliability, efficiency and cost control, modest expansion around the footprint, primarily completing the projects that we started in 2008 and ensuring the continued financial strength of the company, including preserving our investment grade rating. So, let's turn to 2009 and take a look.
By looking at this graph you can get a feel for the earnings power of this business. DCP Midstream has delivered very solid earnings and excellent returns over the last several years.
As we look to 2009, earnings will moderate with commodity prices but the indicative commodity deck I will show on the next slide, we are still expecting a return on capital employed in the mid-teens. The current macro environment has created several challenges which we will have to manage through.
Commodity price volatility requires a near-term focus on cash generation versus capital deployment opportunities. Drilling plans for 2009 continue to evolve and rig counts are declining.
Most of our customers are remaining flexible, entering the year with reduced capital budgets with the ability to ramp up when prices recover. And demand for NGL softened significantly in the last quarter of 2008, as a result of both hurricane and recession impacts to the petrochemical and refining industries.
This has created weakness in NGL prices, particularly ethane, although during January, the price of a composite barrel has recovered from its December lows. But for DCP Midstream there are several positives as we enter 2009.
The robust drilling of 2008 should keep processing volumes strong well into 2009. As of today, volumes are holding steady, however, some softening could occur later in the year, if oil prices persist.
The intense competitive pressure over the last couple of years has moderated, as capital availability constrains new construction. This should keep our contract renewal rates high and reduce margin erosion.
Cost inflation has eased and we are seeing price declines on a wide range of materials and services. And there will be opportunities to prudently invest within the footprint and solidify our long-term competitive position.
On balance, our strong foundation of assets and contracts ensure that we'll weather the storm and prosperous commodity prices return to fundamental levels. Let's turn now to the numbers for 2009.
Please keep in mind that all numbers I show are at the 100% levels while Pat showed you the 50% impact to Spectra. Consistent with Spectra's presentation the numbers shown here are based on an average full year crude price of $55 per barrel and 60% NGL crude relationship.
This approximates a $0.79 per gallon NGL price. The natural gas price for the year is assumed to be $6 per MMBtu.
Based on this price tag, EBIT is estimated at 730 million and EBITDA at 1.1 billion. Net income would be about $500 million with tax distributions and dividends at 290 million.
With our contract structures, we have long natural gas liquids natural gas and condensate. When Pat reviewed our sensitivities with you, he showed you a consolidated crude sensitivity for our NGL and condensate exposure.
I am providing the sensitivities for all three commodities. This additional detail will reduce the need to follow the NGL-to-crude relationship, which in the last few months has been very volatile.
For example, you probably have noticed that since the first of the year, while oil traded down with significant day-to-day volatility, the value of the NGL barrel has been much less volatile. The result is that the correlation has been moving significantly during this period.
Over time, we expect these relationships to come back in line with the historical perspective. The sensitivity shown here represents the change to the earnings potential in the business, should the price delta from actual realized prices occur for the entire year.
For example, a $0.01 change in NGL pricing from $0.79 per gallon that continued for the full year, would result in an EBIT impact of about $12 million. For the month of January, we experienced a weighted average NGL price of about $0.60 per gallon, which is up from a low point of $0.50 per gallon in December.
The NGL to crude relation... correlation in January averaged close to 60% which is up from about 50% in December.
Commodity markets remain in contango (ph) and while we budgeted low prices to start 2009, the expectation is that the value of an NGL barrel will continue to strengthen as we move through the year. Let's turn now to our contract mix and margin data and show you how 2009 is shaping up.
Projected volumes are slightly over 8 trillion BTUs per day and gathering and processing volumes are estimated at 6.5 trillion BTUs per day. As expected, unit margins are down in 2009 versus 2008 with lower commodity prices and the percent contribution from the various types of contracts have shifted accordingly.
The contribution from percent of proceeds contracts with an average margin of $0.65 per MMBtu is projected at 60%. The contribution from key pole contracts with an average margin of $0.50 per MMBtu is projected at 10%.
Fee-based contracts should contribute about 15% of our margin in 2009 and our fee-based margins are estimated at $0.15. Other margins which come primarily from condensate sales, NGL and gas trading and marketing should contribute about 15%.
In conclusion, we believe this business will deliver solid operating results in 2009 and will continue to be an important part of the earnings picture for Spectra. Notwithstanding today's weak commodity environment, this business should deliver double-digit returns and enhance earnings and cash flow as commodity prices strengthen.
I hope you will agree that our focus on delivering reliable and efficient service growth around the footprint and preserving the financial strength and flexibility of the company is really the right place to be. And with that, let me turn it back to Greg.
Gregory L. Ebel
Well, thanks very much Tom. And now we've provided you with lot of information today and no doubt that that the economic front is a challenging one.
And there is the lot of uncertainty and angst among market watchers and investors alike. But for Spectra I am certain about the following.
We will successfully manage through the current downturn in the economy. We will pay our dollar of share per dividend.
We'll continue to control our costs. We'll protect our core business, our assets or customers, our balance sheet, our credit standing.
And by doing so we'll get the opportunity to grow our earnings and create value for investors. With an asset footprint that's frankly a replaceable, geographic position that serves growing markets and dependable earnings from fee-based businesses, we're well positioned for 2009 and for ongoing growth in 2010 and beyond.
Well thank you for your continued interest, your investment in the company. And I'll turn thinks back over to John so that we can your questions.
John R. Arensdorf
Thanks Greg. Janus, we'll now take questions, if you can get us started please.
Operator
Thank you sir. (Operator Instructions).Your first question comes from the line of Sunara Gussini (ph) with UBS.
Unidentified Analyst
Hi good morning guys.
John Arensdorf
Hi Sunara.
Unidentified Analyst
Congratulations on both of your new roles.
Gregory Ebel
Thank you.
Unidentified Analyst
You guys gave out thorough details today which is great and greatly appreciated. I just wanted to ask I guess two kinds of big picture questions, one kind of bullish, one kind of bearish.
Just starting with the bearish one, given where oil and nat gas is kind of sitting today, how does your capital plan, liquidity plan, so forth to change if these assumptions... if your lower case assumptions and to the high...
come mid-year and so forth, would you be swallowing back any back further CapEx or this is a solid plan for the year and so forth?
John Patrick Reddy
Well from a CapEx perspective, I don't see any significant changes. As you know when we put projects to work, they are already contracted up with good investment graded customers.
I don't see any change on that front. I mean if anything, I guess if gas prices really took up and it cranked up some of the domestic drilling that folks are pointing out how rigs have been laid out, then that might crank up the interest in accelerating projects.
But I don't see a downside from that perspective. Obviously if oil prices were lower than we expected on average for the year, that has an earnings impact out of DCP and some cash impacts.
But I don't see that change in the CapEx program for 2009.
Gregory Ebel
And the real judgment call is as we go through the year, how are things going to look for 2010 and going forward.
Unidentified Analyst
Okay. And then the flip side is, if the capital markets ever return and specifically for the MLP market, is it a safe assumption that we could see SEP and DPM seeing some asset dropdowns on both sides and so forth, is that a reasonable assumption?
Gregory Ebel
Well I'll speak to SEP and maybe Tom as the Chairman of DPM can speak on that front. With respect to SEP, we put that vehicle in place to grow the entire pie.
So, and frankly as currency is held up quite nicely relative to other currencies and definitely see that as a vehicle that we can use to grow the entire business as opposed to doing dropdown. One thing I will say, obviously we've indicated our desire to keep growing that business and distributions.
But the first focus would be on the organic growth that it already has, which is nice in the pipeline and storage business. Looking at if acquisition opportunities are out there and we think some of that consolidation in the MLP world will happen.
And then last, we would look at dropdowns. So maybe Tom, maybe you want to speak to DPM a little bit.
Thomas O'Connor
Sure. I think DPM strategy is basically consistent.
We look at dropdowns as kind of a means to an end to grow the overall enterprise. Right now, they are focused on completing a couple of organic projects that they have on tap and those are moving ahead towards completion around the mid point of this year.
And then we also have announced that we will do a dropdown of 25% of the East Texas asset from Midstream to Partners. And that is on track and Partners will provide an update on the status of that at their earnings call here in a couple of weeks.
Unidentified Analyst
Great and just one final question. Greg, when you look out to 2011, 2012 kind of where do you like to see the long term payout ratio for the dividend?
Gregory Ebel
Well I would like see it move back towards that 60% range. That's as I said, we are considerably lower than that in 2008 and will be above that in 2009.
But I think that 60% payout ratio would be a fair target. Now obviously we're growing the pipeline the fee based side of the business quicker than we are at the any elements that have a commodity piece to it.
So if that continues to occur and you get the fee-based business up to a much larger percentage, then that could moderate even higher.
Unidentified Analyst
Great. Thank you very much.
John Arensdorf
Okay, thank you.
Operator
And next question comes from the line of John Kiani with Deutsche Bank.
John Kiani - Deutsche Bank
Good morning.
Gregory Ebel
Hi John.
John Kiani - Deutsche Bank
On slide 35, I am trying to just get a little bit of better handle on the scenarios that you all showed. In the lower case scenario that gets you to the $1 or $1.01 of earnings per share for 2009.
Are those assumptions basically kind of like the current forwards? I mean the $45 per barrel, crude assumption to me looks like, it's inline with the current forwards.
I was wondering perhaps more about the 65% NGL-to-crude relationship used in that scenario. How does that compare to current market?
John Patrick Reddy
John, they weren't meant to imply anything about, we were just trying to take 5 bucks off 5 bucks. I think the forward market cushion of $50 is actually on the oil right now.
But that wasn't what we were trying to do. We were just if...
depending on your view on where commodities are, if you are higher and lower, here's what the results would look like. Typically you see NGL correlations go up as oil prices go down, I think as Tom mentioned in November, we saw correlations in the 40% range, in December they were 50 and for January they have been a little bit above 60.
So, that's... this is just trying to show some of the historic relationships that you have seen.
John Kiani - Deutsche Bank
Okay. And thank you and then on the third quarter call, you talked briefly about the potential to update your long-term earnings per share growth rate.
And I know previously you had talked about 6%. I was wondering what you all think about that now and where you kind of stand on that.
Gregory Ebel
You know what John, I think at this point in time, let's see how the first part of 2009 plays out before we go there. I guess what I would, as you know we are talking about that and if you assume oil is in the 85, 90% on a flat basis, you could see that 6% type of increase.
That may have moderated a bit, if you took a apple-to-apples comparison of our fee based businesses, so the pipeline storage distribution and you accounted therefore for any commodity or FX changes. We'd be seeing about a 6% annualized growth rate.
But exactly how that will flow down into the EPS element, I think let's see how the year progresses before, given the kind of volatility we see out there.
John Kiani - Deutsche Bank
Got you, thanks. And then one just last question is on, the tax rate for 2009 it looks like you all are assuming 30%.
And for 2008, it looks like it was about 33% from an assumption perspective at the beginning of the year. Can you talk a little bit about what the changes of the benefit there?
John Patrick Reddy
John, the tax rate for 2008 averaged 31% and with lower state tax rate that were enacted during the course of 2008, we've rested that down to 30% for this year.
John Kiani - Deutsche Bank
Okay, great. Thank you.
Operator
Your next question comes from the line of Risa Hatapi (ph) with Decade Capital.
Unidentified Analyst
Thank you very much. You mentioned a little bit your financing plans and your debt to cap ratio, I guess is 62 at year-end.
Could there be a potential need for equity going through the year or your credit lines are going to be sufficient to meet your financing needs?
Gregory Ebel
I kind of look at that as Pat mentioned, we'll raise some equity through the DRIP plans and finance in the benefit plan. We've got a lot of great projects that were out there financing.
And if I thought you could take any some of the volatility off the market you see in things like currency rates and how that might move around the balance sheet. If you thought that you could access to capital markets either debt or equity, that's something that you have to consider, but only if you thought you could do it, obviously reasonably it will be price band (ph) would allow you to grow the...
continue to growing the business?
Unidentified Analyst
Thank you very much.
Operator
And next question comes from the line of Lasan Johong with RBC Capital.
Lasan Johong - RBC Capital
Good morning. Thank you.
Greg and Tom I guess have you guys spoken to the E&P companies in your operating areas and ask them kind of what's your CapEx plan?
Gregory Ebel
Well, maybe I'll let Tom go first on the processing side but then we can speak to you as well little bit.
Thomas O'Connor
Sure. I think the answer is yes.
We've had a number of conversations and quite honestly they vary company to company. And I think most are consistent with what you're seeing in the public domain as they announced their plans here over the last, over the last month.
I think the key word that I am hearing is flexibility, trying to live within cash flow. Yes rigs are being laid down, but decisions are being made around what are the most profitable areas for them to continue drilling.
The other thing I'm hearing is maintaining the flexibility to ramp up quickly when prices recover. So those are the key themes and we're sticking pretty closing obviously to them as our major customers.
Gregory Ebel
Yeah, as we look at on the pipeline side and storage and distribution side, I continue to see activity in the Marcellus and Appalachia. Obviously it's centralized where we're continuing to, I think a little bit spreads, we haven't seen some slowdown in Western Canada and the areas where we are.
But the Horn River, Montney basin producers continue to be working hard. And I think some really large producers obviously look at this from a long term perspective.
I know that the gas is there and the value and you're looking at longer term development opportunities. So we've seen some slowdown obviously but perhaps not as much that you are seeing in some other areas.
Lasan Johong - RBC Capital
Let me ask you a what if question. What if capital budgets come down by another 30% in the second half of the year and let's say that your low case gas price scenario is roughly correct and oil prices stay around the same numbers.
What kind of fall, gas prices fall even further than that scenario of 550, where do the numbers go? Does that not then change your thinking on what you would spend on CapEx as well?
Gregory Ebel
Well I guess again two ways to look at it. Obviously the majority part of the business, the fee-based part of business, in short-term changing gas prices is not going to affect the capital we put to work on our long-term asset...
the assets that we put in the ground for 30, 40, 50 years. So when we look at gas we kind of see in that 5 to $7 range from a long-term perspective.
We don't put that steel in the ground if you will, until we've got signed up contract. I don't think that has an impact on our capital plans for this year.
I think what it does, if it was significantly below that and for a sustained period what does that mean from a longer term opportunities and so that's something we will be watching closely. Tom, would you...
Thomas O'Connor
I would say a couple of things. First of all, our capital budget is pretty modest.
And as we spend capital, we watch for development and are lined up pretty closely with our producers in terms of what we say their rig activity and volume growth. But in general, our capital heading into this year is pretty modest and down significantly from last year.
The other thing, I would note is that although prices have come off a number of producers are still saying they will have volume increases this year. And that's something I think we've got to factor into how we think about overall our capital deployment.
Lasan Johong - RBC Capital
And then is it fair to say that you guys don't think there is any impact from LNG in the next year or two?
Gregory Ebel
Well I think you trigger point for that Lasan, and we watch LNG closely. And as you know there has been a lot different views over the last three years, it's coming, it's not coming.
And if you look there is a lot of liquefraction coming on offshore, North America later this year. That gas got to go somewhere, so that could definitely come to North America, or it can go to Europe but, I think we will have some interesting views on that as you move into the last half of the year and that liquefraction comes on.
You're seeing, we've got gasification abilities here. And definitely on the East Coast you'll see, our accelerate plants that went into service late in '07 and obviously Phase I Maritime is very much tied to direct sales (ph) plant.
So, we'll see. That could lead to both pipeline and storage opportunities our East to West project is very much designed around LNG producers and their desire to get their gas to market.
Lasan Johong - RBC Capital
That would have very devastating effects on DCP Midstream or not?
Gregory Ebel
No, I don't. Why would you say that in terms of lower gas prices overall?
Lasan Johong - RBC Capital
Yeah, and the E&P will probably cut CapEx budget by at least another 20 or 30%. I mean at 450 gas there are hardly anything in the U.S.
that's economic all-in costs?
Thomas O'Connor
I think you're... to me that's a bit of a draconian scenario.
And if you look back over the last couple of years we've gone back and forth on the expectations of LNG imports as Greg has said. Now, we've also experienced over the last three to five years significant growth in domestic production, my expectation is that the market continues to grow.
Domestic production will compete with LNG. And the supplies will move to the market from both sources and from DCP standpoint, if you look at our diversity at the number of basins that we operate in, most of those basins have been producing gas for years, and we would expect that to continue.
But the key element of all of this is the growth in the market and we've continued to experience growth in the market.
Operator
Your next question comes from the line of Carl Kirst with BMO Capital.
Carl Kirst - BMO Capital
Hey, good morning everybody.
Gregory Ebel
Good morning Carl.
Carl Kirst - BMO Capital
And congratulations Pat, since I haven't spoken to you in many years. Couple of questions, actually first maybe start off with the fourth quarter question.
And I just wanted to delve into the U.S. Transmission number a little bit more and make sure I understand what the deltas were year-over-year both on the processing dynamics as well as the higher development costs.
And I want to be clear that is this processing dynamic, are you saying that you had some lower throughput through your system or is this from straddled plants on the pipes themselves?
John Patrick Reddy
On the processing side, it was specifically related to the one plant that Greg talked about that had higher throughput as a result of hurricane produced outages, another pipelines plant. And that began to trail off in the middle of last year and so that really is the impact for U.S.
Transmission.
Gregory Ebel
Yes, I think it's a combination of the two, in terms of another plant being down and thus getting more volumes post Rita and Katrina. And if that other plant came back up we obviously lose those volumes.
Obviously, you got a delta there on NGL prices as well. But it's probably about $25 million of that impact.
Carl Kirst - BMO Capital
From the combined plant plus the lower NGL prices.
Gregory Ebel
Yes, correct.
Carl Kirst - BMO Capital
Perfect.
Gregory Ebel
Versus Q4, 07.
Carl Kirst - BMO Capital
I appreciate it. Sort of sticking with processing maybe going over to DCP.
Tom, I don't know if I'm looking at apples-and-apples numbers. So, if you could help me clarify.
I am looking at what was I guess on slide 44. You've got volume gathered and processed to 6.5 TEs and total throughput of 8.1 for 2009 that seems to be sort of 10% to 15% higher than what was done for 2008.
If I have those numbers correct. I think that was listed on page 40.
So with your stance of, hey we could see some volume softening depending on what prices do... is 2009 actually modeling up a volume increase right now?
Thomas O'Connor
Yeah we are showing some volume increase, but what you need to account for their Carl is we did add some assets during 2008. And remember this is a consolidated view which includes Partners and in particular the larger asset that we added was Michigan.
So that contributes to that number increase. And then we expect to see some modest increases around the system in some of our specific areas.
But we have included asset adds on that number.
Carl Kirst - BMO Capital
Okay. How do you think that translates into, as far as growth in liquids produced, are you looking for something kind of the similar 10% gain as well then?
Thomas O'Connor
No, I think liquids were probably around 5% or so. And also one of the other things you need to account for in the '08 numbers is we've got a clip by the hurricane pretty good there.
And so those numbers reflect some volume losses associated with hurricane in '08 as well as liquids loss associated with hurricane in '08.
Carl Kirst - BMO Capital
Okay, now a fair point. And Pat, just one question going back to the tax issue, do you think that this 30% level can be sustained beyond 2009?
John Patrick Reddy
I think we have looked at 2009 and 2010 and I think that 30-31% is sustainable.
Gregory Ebel
Here is the fact that is going on there Carl. You've got, we've got a bigger proportion of our earnings is coming out of Canada right now given less coming out of DCP.
And you've got lower corporate tax rate in Canada as you may be aware
Carl Kirst - BMO Capital
Right.
Gregory Ebel
Beginning some of that benefit, so it's a little bit variably and obviously, if commodity prices came back strong, you'd see it reversed to more U.S. based earnings.
So, that's the accelerator or decelerator if you will.
Carl Kirst - BMO Capital
Okay. No, appreciate the clarification.
That's it. Thank you.
Gregory Ebel
Thank you.
Operator
Your next question comes from the line of Keith LaRose with Bradley, Foster & Sargent Incorporated.
Keith LaRose - Bradley, Foster & Sargent
Hi, good morning.
Gregory Ebel
Good morning.
Keith LaRose - Bradley, Foster & Sargent
It's LaRose, just for the record. But can you, 80% investment grade client, I think you mentioned.
And in today's environment and going forward that really doesn't help you very much.
John Patrick Reddy
Okay.
Keith LaRose - Bradley, Foster & Sargent
Can you give a more color on the layers of your customers and some of the concerns you may or may not have within the customer base?
Gregory Ebel
Sure, I mean when you think about the Northeast and the Southeast maybe that's a way to look at it. You're talking about the folks like FPL; you're talking about National Grid, you're talking about major fee seg et cetera, major LDCs that are really off takers of our services.
On the producer side, everything, the big guys will include guys like EnCana, folks like BP. If you look at the U.S.
portfolio about half of them would be at or higher in terms of our exposure. So hopefully that gives a little bit insight but generally speaking we don't have a lot of financial players since we don't have a trading operation.
Keith LaRose - Bradley, Foster & Sargent
I know.
Gregory Ebel
Some of that capacity would be held by some of the trading operations. But pretty minor.
So, you are talking about largely big producers and largely big LDCs.
Keith LaRose - Bradley, Foster & Sargent
Thank you and are you seeing any customers with current problems?
Gregory Ebel
No, we have not... when we have a proceeding the Wall Street in late third quarter, early fourth quarter, we did have see some exposure there we were concerned about.
But largely that's been either collateralized or they've sold those positions to other players. Even at Union Gas, where we have a large retail operation, we have not seen an increase in debt for example.
So they are obviously we're in rates for that, but nonetheless it's the kind of thing you watch from, we have not seen that happen to date.
Keith LaRose - Bradley, Foster & Sargent
Thank you. What on the cost of capital side for debt are you assuming 2009?
John Patrick Reddy
As we look at credit spread and treasury rates, it's about 8.25% for new issuances at Spectra Energy Capital.
Keith LaRose - Bradley, Foster & Sargent
Okay. And then one more question on the pension side, what's your return assumption?
Unidentified Analyst
A little bit over 7%.
Gregory Ebel
Yeah, it's slightly over 7% for our long term return.
Keith LaRose - Bradley, Foster & Sargent
Okay, thank you so much.
Gregory Ebel
Thank you.
Operator
Your next question comes from the line of Matthew Akman with Macquarie.
Matt Akman - Macquarie
Thanks very much. Couple of questions for Tom on the DCP Midstream.
I guess first of all why would the return on capital be lower in 2009 than 2005 given the crude oil price assumption is similar?
Thomas O'Connor
Matthew what you're seeing is what happens as we renegotiate contracts over time they come up, they may be set at a particular sharing. And then as prices move, those contracts get renegotiated.
And that's probably what contributes to most of that change
John Patrick Reddy
Matt, we had a lot of key pole as I recall going back to those times to which as you know, we've moved away from that for the right reasons given the risk parameters of key pole contracts... one percent of proceeds type returns.
Matt Akman - Macquarie
Okay. And this chart Tom, just correct me if I'm wrong, would this be EBIT on capital employed?
Thomas O'Connor
Yes it is.
Matt Akman - Macquarie
So, that implies capital employed in this business of maybe $5 billion to $6 billion, is that right?
Thomas O'Connor
About $5 billion.
Matt Akman - Macquarie
Why is that numbers so low? I mean with 59,000 miles of pipes and 53 plants is that just depreciation of that, those assets over time, because the replacement value of those would be much, much higher than that?
Thomas O'Connor
It would be but you are exactly correct. And over the years, we've pretty much tried to live within our depreciation.
And so we've not been building capital employee significantly over the years.
Matt Akman - Macquarie
So I guess I am trying to get to the fundamentals of how this business, the business modeling. I mean if now, at today's oil price you're going to be earning a suboptimal return on capital in that business, maybe at $55 or you could argue.
It's approximately correct, I guess sort of low mid double-digits. But at today's oil price is lower and yet, as you said this is a must run business.
The U.S. gas business cannot exist without this business.
So, is this the right business model because, I mean it will be awful for business that big and not necessary to earn a suboptimal return for a period of years, if we are in a multiyear recession? So is there something you should be looking out in the business model to stabilize this?
Thomas O'Connor
Well I think what you have to look at it and we try to illustrate though this chart is that the returns have been anything but suboptimal over the year, over the last several years. And what this business has the flexibility to do is reset contracts as it moves forward if we're not happy with the returns and not happy with the returns we would need to continue to invest in the business.
But what we are illustrating here is that even in a year of challenging commodity prices we still expect to see returns in the mid teens. And obviously as prices correct and recover we would expect those returns also to trend positively north.
Matt Akman - Macquarie
So, you don't see really any changes to the business model. You are happy with, the way the contracts work and the way the business makes money today?
Thomas O'Connor
I think as we look at it today, we're pretty much aligned with our customers and my belief is that, it's always a good equation. Now don't forget as...
and these contracts and we haven't talked a lot about this. So you do have minimums in them, so that as if for example, volumes came down, minimums might kick in.
And if prices came down, minimums might start to kick in. So, there is a floor to these things.
And then if you were in a sustained period of low commodities and became concerned about a particular area or particular basin, we always have the ability to start negotiating fee type contracts for the business. It's not been where we have been, we prospered over the years with the setup that we've had.
As Greg mentioned, we have moved from significant key poles to more POPs, that's worked for us. As this chart shows, it has worked very well over the last several years.
Unless we see a dramatic change and believe that there would be a dramatic change in the business, and I think we are pretty comfortable with where we are.
Matt Akman - Macquarie
My last question is maybe a bit of a statement but it's that... there is a lot of very pessimistic views out there on oil right now.
And I think people want to get comfortable that you will not operate this business at any kind of a loss or anything really close to that?
Thomas O'Connor
Well, you can get comfortable with that.
Matt Akman - Macquarie
Thanks. Those are my questions.
Gregory Ebel
Thank you, Matt.
Operator
Your next question comes from the line of Leslie Rich with Columbia Management,
Leslie Rich - Columbia Management
I wondered if you could walk through your financing plans in a bit more detail. You said that you would be free cash flow negative by 300 million or so and then that you had 800 million of maturities.
And I missed what you said about how you plan to address that.
John Patrick Reddy
We do have refinancing primarily in the fourth quarter of about $625 million, call it that comes due and that's kind of a normal course of our long-term debt refinancing. We have a couple of project financings that we have on the table to pursue this year.
But that's not... that's basically to repay ourselves for outlays that have already been made in prior period.
So, with respect to newer incremental financing it's fairly modest for the year.
Leslie Rich - Columbia Management
So, the 310 million negative free cash flow. I was just trying to understand if you're doing 800 million of refinancing plus 300 million of new financings or some of that?
John Patrick Reddy
Yes, that's about the order of magnitude.
Leslie Rich - Columbia Management
Okay. So total of 1.1?
John Patrick Reddy
Yes
Leslie Rich - Columbia Management
Okay. Thank you.
Operator
Your next question comes from the line of Nathan Judge with Atlantic Equities.
Nathan Judge - Atlantic Equities
Good morning, I wanted to ask a question to Tom with regard to M&A and the DC Midstream. I think the company has had a long history of waiting until prices for Midstream assets have fallen and looking at M&A across the industry.
Is that an option right now and how is that all paying out, is that even objective of this company?
Thomas O'Connor
Well, I think you rightly pointed out that the history of the company is one where it has been built over the years taking advantage of the need to... the need for consolidation and industry to drive efficiencies and deploy capital effectively.
That is the history. I think we obviously continue to evaluate those types of opportunities.
My own belief is that there is quite a bit of... the industry is quite fractionated.
And I would expect that as things go forward you're going to see some consolidation. Obviously we're interested in continuing to grow the company and grow the enterprise.
We do have the MLP and that has been a focus of the MLP over the last couple of years. Right now, I would say that they are very much focused on their organic projects and getting those complete.
But we have that available to us, and it is my belief that there will be some consolidation here as we go forward.
Nathan Judge - Atlantic Equities
Thank you. Just with regard to the comments on the gas transmission business and as far as delays of capital, it sounded interesting given the amount of flexibility there appear to be.
I just want some more color obviously, you said in your comments that you are approached by customers in providing that delay and the expansion of CapEx. But going forward, if at how much flexibility the Spectra have in approaching clients and customers building new pipes to renegotiate perhaps to lay and how does that actually work out, who would be...
the how much flexibility do you have in 2010, 2011 et cetera?
Gregory Ebel
Well as you know Nathan it usually takes us anywhere from 18 to 24, sometimes 30 months to bring projects to fruition. So until you have got FERC approval et cetera there is always an opportunity to reopen issue.
I am not expecting to have to do that. The 2009 projects the Maritime's Phase 5, EnCana big producer was looking at opportunities there and move forward with this, we'd had various approvals to go forward.
But when a customer indicates that they're perhaps having challenge with the project, we look at this from a long term relationship perspective. And the key is making sure that we weren't disadvantaged financially, at least kept hold financial and we're able to do that.
The other key one for 2009 and this really is just being spread out is East to West. And that's an LNG related project.
We had a little chat earlier in this phone call about some of the volatilities and movements on people's views as to whether LNG comes in or not. So, again that was in discussion with customers.
So I think there is some room on the 2010 and 2011 projects given that the stage that they're in. But it depends in projects where we are again with regulatory approvals and with contractual approvals.
Nathan Judge - Atlantic Equities
Given large projects seem to have at least you've mentioned about less interest from customers on providing new large projects, do you see that the potential for continuing long... elongated higher growth rate is perhaps more challenging today than it has been?
Gregory Ebel
Well, I think everything is more challenging today. Nathan, I mean I think with uncertainty that's out there, from top to bottom in the economy, I think that really super large projects create some real challenges both for customers and for those providing the service.
We focus on, and not to say we wouldn't do very large projects. Since we've really focused on relatively modest size projects, the Southeast supplier was around the largest project we did last year at $600 million.
And most of our projects are call it 2 to $400 million. I think that gives you some more flexibility both with customers and yourself in terms of making decision.
And I think it leads to less opportunity for big surprises. For example, we've seen some of the very large projects, with various expenses to come in.
And when you are halfway through some of those types of projects and you run it extra challenges unforeseen by virtually everybody that we have seen during this year, that's a tough place to be. Most of our projects once we start, we are getting it done in 12 months.
And again they are not multi-billion dollar projects. Again, in the right scenario that might be what you would do.
But I think those projects would be tougher to pursue in the current environment.
Nathan Judge - Atlantic Equities
Okay, good. Just lastly, obviously the dividend payout ratio has come up with a question earlier.
Could you just run through your options as far as being able in your determination to stay in that level of dividend, if perhaps your lower pricing environment scenario work to it just in a dollar earnings per share payout ratio. What are your options going forward over if that scenario persisted the next several years?
Gregory Ebel
Yeah, I think the key thing is to look at our EBITDA in 2009 about $2.6 billion. And so when you look at when you bring that down to earnings after tax excluding DD&A and stuff, you are talking about close to a $1 billion, $960 million dividends around 600.
So you're 1.5 times 156% of SEP EBITDA, if you look at it that way. Obviously, we bring in cash that more than covers our maintenance, makes a contribution as Pat meant to expansion capital and then pay the dividend.
So, obviously you could pull back on some of the expansion capital. But again, we see the growth opportunities allowing that fee based business both in Canada and United States to continue to grow.
And therefore supporting the dividend... about 85 to 90% of what we earn today is supported by those fee based businesses...
supports the dividend.
Nathan Judge - Atlantic Equities
That's very helpful. Thank you.
Gregory Ebel
Thank you.
Operator
Your next question comes from the line of Becca Followill with Tudor, Pickering, Holt.
Becca Followill - Tudor, Pickering, Holt
Good morning. Thank you guys for all this time.
Clarification on some of the questions that have already been asked. I think it's a $200 million reduction in CapEx, in that is it all related to Islander East and AGT East to West?
Gregory Ebel
No. Again we've kind of given some indications as being in the $800 million range.
And it's going to 500 in expansion capital, so that's 300 Becca. So Islander East wasn't a big factor because that's been in the work for a long time, and we weren't really spending any new dollars on it.
It's really largely related to the East to West project and the re-scoping and changing of that project as well as the Maritimes number 5 expansion that was related to EnCana which I think was around $350 million project, much of which would have spent this year. So, there is some other middle niche but those are the big drivers there.
Becca Followill - Tudor, Pickering, Holt
Okay. And then on tight, the delta between '08 and '09, I think you said 25 million is due to just some uptick you got because volumes being temporarily diverted.
I still would have expected it to be higher, what else just given the number of expansions that you put in '08 and then '09, so what else is... is it acting as a reduction in there?
Gregory Ebel
Well, processing is a piece of debt, that's about $80 million negative.
Becca Followill - Tudor, Pickering, Holt
Okay.
Gregory Ebel
Year-over-year, for the plant outage that we talked about earlier Becca.
Becca Followill - Tudor, Pickering, Holt
Okay. And then on the Midstream side of the business, DCP Midstream, excluding the hurricanes impacts or you get a pick-up in '09 and excluding the acquisitions that were made in 2008, are you looking for volumes to be up or flat or down in 2009 excluding the noise?
Gregory Ebel
I would say volumes would be slightly up in 2009.
Becca Followill - Tudor, Pickering, Holt
Okay.
Thomas O'Connor
And a lot of that driven by the fact that we saw rig counts in most of our areas actually peak late third quarter, fourth quarter was still actually cooking up some of that gas. So, we come into the year and we did have a record year well connects in 2008.
So we come into the year with the bit of a tailwind on volume.
Becca Followill - Tudor, Pickering, Holt
Okay. Great thank you, guys.
Gregory Ebel
Thanks Becca.
Operator
Your next question comes from the line of Rick Gross with Barclays Capital.
Richard Gross - Barclays Capital
Good morning.
Gregory Ebel
Good morning Rick.
Richard Gross - Barclays Capital
Couple of topics, first is that at Union Gas you guys are early on in the PBR. And maybe you could either help me with incrementally you reset the rates, you reset your returns what you expect to be able to improve on that by the time you get to 2012?
And then the other question for Union would be with all of these records send outs you articulated at Union Trafalgar, your two Northeastern pipelines, what are the prospects for sizeable storage project coming out of that?
Gregory Ebel
On the first, you are right, so we just finished the first year on PBR and they set the rate for the ROE at about 8.5%. And then so those rates get set every year and then there is a productivity factor that goes in.
So, your net will be up a little bit in terms of rates and then your losing the productivity factor. You've got...
the way the deal works is that you could earn up to 200 basis points above that ROE, then you cheer after that. And then there is an off ramp if you were above 300 basis points.
So, that's the way it would work. You can see that I think on an apples-to-apples basis Union grew at about 6% in 2008.
And you'd see a similar again an apples-to-apples basis in 2009. Obviously there are a couple of drivers there.
On the positive side we have put three new Dawn-Trafalgar expansions in over the last three years I believe. Storage opportunity is probably even more important than PBR because we...
about a third of our storage up there... at already market base rates but we use to provide that feedback back to retail customers.
Instead that's now going to the benefit of investors. So that's where I see the opportunities there.
So, through 2012, I expect you'd see pretty nice growth probably little bit more than what you'd see from a typical LDC which as you know Union with the big storage and 5 Bcf a day pipeline, it's not a typical LDC. We do see some...
we're looking at storage opportunities up there. I think on some of the slides we gave there is some projects there on the storage front.
Beyond just size though it's also deliverability. As you move more and more into gas-fired generation throughout the Northeast and in Ontario, our deliverability becomes really important because as you know the power market and the gas market work on two different fashion, then you need quick deliverability that provides opportunities.
And then obviously sure, we keep seeing peak days on the pipes that we have, and one thing you can't do as an LDC is not have your gas available on the cold days in the winter. So as we see top 10, top 20 peak days, I am hopeful that customers will see the opportunity and the need to continue building out those pipelines.
And want to make sure we're positioned to take advantage of those, may not come in 2008, but I think they will be there going forward.
Richard Gross - Barclays Capital
Okay. Somebody asked the DCP M&A question, but I'll ask it in a slightly different way, because they have been very aggressive in all the downturns.
I noticed in net income versus distribution piece the relationship with from record year special payout to paying out materially less than the net income in this coming year. And I was curious as to whether that said anything about collecting capital, getting ready to do something or conversely whether you're little short of debt capacity there, in case you might want to do something.
So maybe Tom could flush out, what your debt capacity is to make an acquisition at DCP and why you're operating with the distribution below net income?
Thomas O'Connor
Okay. As far as the payment of the dividends, tax distribution that basically reflects the formula that we have in place at the LCC which is either 90% of net income or 75% of cash flow.
Now of course the Board always has the ability to look at that and decide what's optimum for the company as well as the sponsors in terms of what they're willing to pay out. To your question around M&A activity, I think as I said earlier, it's something that we'll evaluate as we go forward...
the company's always been pretty optimistic... I am sorry opportunistic about M&A activity.
And the sponsors have been very supportive and we have a couple of places obviously where that could take place, either at the LLC or at Partners. Over the last year to two years hopefully what you have seen also at the company is that, we are focused on our organic projects, and as we talked earlier this...
I am sorry about the middle part of 2008, we laid out several organic projects that we had on the table. We continue to pursue those.
Those are very high return projects. So, what we are trying to get the company to is a place where yes, it's opportunistic around M&A but it's also very good executor of organic projects because those are some of the best returns I can see.
Richard Gross - Barclays Capital
Okay. You alluded to contracts and rollover of contracts.
A couple of maybe questions in that regard. Part of that margin deterioration is, we call it, historical legacy of probably some real low very-very high margin, POL, POP contracts.
And I guess first of all, what percentage of your gross margin is still what we would call real old lying (ph) kind of out of the money types of things. The other piece of it is, as these things mature what percentage of your gross margin typically rolls over every year in this contract renegotiation?
Thomas O'Connor
In terms of rollovers... if you put our contracts into buckets, you're probably dealing with about a third of our contracts come up every year for renewal.
Now some of those are renegotiated, some go right into evergreen and they just continue to produce at the originally negotiated sharing. But about a third of those turnover every year, what really is, really where we spend a lot of time is on some of the larger more aggregated contracts that come up every year with...
that have significant volumes associated with those. And those can be subject to change.
Now if you look at year-over-year, again about a third of our volume comes up, a portion of that goes into evergreen portion gets renegotiated. We probably see a couple of percent gross margin degradation year in and year out from renegotiations.
Now the other thing I'd mention Rick, is that of course in a $100 oil environment, that's a very different number from say where we are today. And as I mentioned in my points that we would expect less of that to be occurring in today's environment as we look out and say this is what we need to process the gas versus say sharing arrangements may be changing more so in a $100 oil environment.
Richard Gross - Barclays Capital
Okay. Great.
And then, just maybe add one observation. You've got a lot questions about dividend payment.
And I thought it might be handy to provide debt income from your just fee-based businesses. And you've shown that kind of in a contract structure and a kind of percent of EBIT and all those kind of things.
But if you just kind of tuck all your fee bases down to net income, you would probably show a very significant portion of your net income is coming from that fee-based stuff?
Gregory Ebel
Yeah, it's just about a dollar; it's a little hard to do directly. But because as you know we don't raise the debt specifically to each one of those businesses directly.
Richard Gross - Barclays Capital
That's fine. I understand issue.
Gregory Ebel
Fair point though.
Unidentified Analyst
Hey, it's Jim Harman. I'm in your queue somewhere but I thought I'd jump in and you can take me out.
Good morning. Two quick questions.
How much interest did you capitalize in 2008 and what's your expectation for '09 and how do we think about that line item going forward?
John Patrick Reddy
Hi, Jim. This is Pat.
Unidentified Analyst
How are you?
John Patrick Reddy
Great, how are you?
Unidentified Analyst
You look like you took an easier role than we did to get to a new position.
John Patrick Reddy
Well in 2008, we capitalized debt FUDC at about $25 million of Spectra Energy Transmission excluding Gulfstream and SESH and equity AFUDC of about 33 million, so about 88 million in total. And for 2009, I don't have that broken out from our budget.
let me think about that for a minute Jim.
Gregory Ebel
It's probably in the $40 million because obviously we got a lot of less CapEx. I am trying to go back...
In '07 that's about what we would have spent, Jim. So and obviously that's going to move up and down depending on the CapEx number.
John Patrick Reddy
It was 40 million in '07, that's correct
Unidentified Analyst
Okay, great. And then second question is could you quantify what the year-over-year swing was in processing at the Transmission subsidiary?
I don't think you could do it on a quarter-on-quarter basis for full year of both?
Gregory Ebel
Year-on-year it's $80 million. So it's a combination of some volume and some pricing.
John Patrick Reddy
That's right
Unidentified Analyst
Other than that gives you some upside on occasion why not renegotiate that out of that straddled plant?
John Patrick Reddy
Well it's part of the business going forward. That's something we could look at.
But that's... there will be a variety of customers to date.
I mean it's not typically the type of swing you would Rick. I mean I think the volatility you've seen in last year 18 months has been extraordinary, and we can typically expect it to be a significant different.
But...
Unidentified Analyst
Fair comment.
John Arensdorf
Operator, that's all the time we have for questions today. So I would like to thank everyone for joining us on the call today.
And if you do have additional questions, please feel free to give either me or Patty, that's Patrick, a call and we will try to get the questions answered.
Operator
Ladies and gentlemen this concludes today's conference call. You may now disconnect.