May 3, 2007
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Executives
Travis Campbell - Head of IR Steve Malcolm - CEO Don Chappel - CFO Ralph Hill - SVP, E&P Alan Armstrong - SVP, Midstream Gas Phil Wright - SVP, Gas Pipeline Bill Hobbs - SVP, Power
Analysts
Shneur Gershuni – UBS Craig Cheer – (inaudible) Capital Sam Brothwell – Wachovia Securities Faisel Khan – Citigroup Gordon Howald – Calyon Brian Olson - Luminous Management Peter Monaco - Tudor Investment Corporation Carl Kirst - Credit Suisse Gary Stromberg – Lehman Brothers Raymond Deacon - BMO Capital Markets Brooke Mullin - JP Morgan
Operator
Welcome to the Willams Companies’ first quarter 2007 conference call. This call is being recorded.
At this time, for opening remarks and introduction, Mr. Travis Campbell, head of investor relations, will speak.
Go ahead, Sir.
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Travis Campbell
Thank you very much. Good morning everybody.
Welcome to our first quarter earnings call and thanks for your interest in our company. As usual today you’ll hear from Steve Malcolm, our Chairman and Don Chappel our CFO.
Also, Ralph Hill, who heads up the E&P group and Alan Armstrong who heads the Midstream business will say a few words. Other leaders, including Bill Hobbs and Phil Wright are here and available for questions after the prepared remarks.
Before I turn it over to Steve, please note that all of the slides, both those used in the presentation and the appendix are available on our website at www.williams.com in a PDF format. The press release and accompanying schedules are also available on the website.
For slides two and three, titled Forward Looking Statements, Detailed Risk Factors and Uncertainties Related to our Business, please review those and the information on those slides. Also, slide number four, titled Oil and Gas Reserves Disclaimers, are also very important and you need to read that as well.
Also, included in the presentation today are various non-GAAP numbers that have been reconciled back to generally accepted accounting principles. Those schedules follow the presentation and are integral to the presentation.
With that, I’ll turn it over to Steve.
Steve Malcolm
Thanks Travis. Good morning and welcome to our first quarter conference call.
For those of you who appreciate concise, snappy, earnings calls, I think you’ll like today’s call, because we’ll be able to move through our only thirty-three slides pretty quickly this morning. Turning to slide six please.
The headlines from the first quarter summarize a solid start to what I expect will be a great year for Williams. We produced a double-digit increase, 12% in our recurring income from continuing operations after mark to market adjustments.
Our E&P development efforts yielded larger double-digit increases in our natural gas production. We produced 28% more natural gas in the first quarter this year than last.
And in the Piceance phase growth rate is still higher, as we discussed in the past. The Piceance is an extraordinary growth engine for Williams, and we’ve significantly accelerated the pace of our development there.
In the first quarter this year, our Piceance production was 37% higher than the first quarter of ’06, an outstanding accomplishment. Our increased activity and continued success also means that we are continuing to grow our reserves.
Ralph will provide an update on our 3P reserves, speaking here about proved, probably and possible, which increased even as we produced 300 BCF last year. And Ralph will also share an update on the very significant growth in our total resources potential.
In our Midstream business, we continue to enjoy the benefit of a very strong NGL margins. But more importantly, our entry into the Piceance basin, with the new Willow Creek plant, will provide a new, exciting large-scale growth platform for our Midstream business.
Through gas pipes, in the first quarter, we benefitted from increased rates on our Northwest and Transco systems. Northwest rates went into effect on January 1, 2007 and Transco subject to refund on March 1, 2007.
Also in this business segment, Williams has been recognized as the top major pipeline in an annual industry-wide customer survey conducted by (inaudible). As well, our Northwest and Transco systems both received individual recognition for customer service in the survey.
Clearly this is a point of pride but it’s also meaningful from a business expansion standpoint. In this business segment, expansions are driven by demand from what the survey tells us is a base of customers who think very high of our service.
And we also continue to grow our dividend. The latest increase is our fourth in less than three years.
Turning to slide seven, during last quarter’s call, I said that our management team was sharply focused on the crisp execution associated with several catalysts of value creation during 2007. And as you will hear this morning, we’ve already made strong progress.
You’ll note the checkmark next to the growing segment profit. Recurring consolidated segment profit for the first quarter is up 10% over year ago levels.
Checkmark next to growing natural gas reserves and production, as I mentioned, we grew those reserves at the same time we increased our US production by 28%. Checkmark, we did put into effect, new higher rates on our Northwest and Transco pipelines.
Checkmark next to capturing more Midstream projects, in the Midstream business we announced will enter the Piceance basin with a $450 million a day processing plant. And that plant will connect NGL’s to market through the Overland Pass pipeline, a project in which we have an interest.
This all adds up to an exciting term for Williams. And now let me turn it over to Don Chappell.
Don Chappel
Good morning. Please turn to slide number nine, Financial Results.
As you can see our reported net income per share was $0.22 flat with the prior year. However, non-recurring earnings and more importantly, mark to market effects, distorted the true economic results.
The last line in the schedule, you can see our key earnings measure. Recurring income after mark to market adjustment was $0.29 per share, up from $0.26 the prior year or about 12%.
Overall, we’re pleased with our first quarter results and they’re stronger than planned and up 12% from first quarter ’06. Importantly, our E&P production is up sharply, they’re providing a new higher base of production as we enter the second quarter and the balance of the year.
Our Midstream business continued its very strong performance and gas pipes are now benefiting from those new higher rates and (inaudible). Turn next please to slide number 10, Recurring Income from Continuing Operations.
This slide details the non-recurring items included in the quarter. The relatively few are detailed on this schedule.
I’ll say no more on that point. The next schedule, number 11 please, Recurring Income from Continuing Ops after Mark to Market Adjustments.
I’ll just walk quickly through the reconciliation from recurring to recurring after mark to market. Again, we start with recurring income of $128 million or $0.21.
We make some mark to market adjustments related to our power business. First we reverse forward unrealized mark to market losses that occurred during the quarter, which we view as non-economic.
And we add-back realized gains from mark to market previously recognized for total mark to market adjustments pre-tax of $79 million as compared to $34 million in the prior year. Tax affects that and after tax adjustment $48 million positive this year as compared to a $21 million positive adjustment in the prior year.
A $27 million change. Again, the after mark to market earnings is $0.29 verses $0.26 for the previous year.
The next slide please, number 12, first quarter segment profit. We display this both on a report and a recurring basis, so I’ll limit my comments to the recurring side of the schedule.
Note the bolded line near the bottom of the page, segment profit after mark to market adjustments, $482 million, up $44 million, or about 10% from the former year. And you can see the detail by each business and again what powered the bottom of the page, after eliminating the mark to market effects.
Take a look at each of the business units which are detailed in the Appendix, as well as full detail in the 10Q. E&P increased its domestic production volumes by 28% and total production by 25%.
That realized prices, $5.32 were 13% higher. DDA was up $41 million with $26 million related to increased volume and $14 million related to increased unit costs.
Operating expenses were up $14 million with $9 million related to increased volumes and $5 million related to increased unit costs. SGA was up $15 million, however $5 million of that increase were related to extra expenses recorded in the quarter that were related to the prior periods.
Looking at Midstream’s results, Midstream once again delivered very strong results that were somewhat above planned levels and were comparable to the strong first quarter of 2006. Midstream continues to enjoy strong NGL margins as well as higher volumes in the West.
Overall, NGL liquid margins increased $30 million over the first quarter of 2006. Deepwater volumes declined somewhat from higher than normal levels last year and expenses were somewhat higher.
Gas pipeline recurring segment profit was up $150 million was up $17 million or 13% from the prior year. New higher rates related to our rate cases contributed $33 million of the increase which was partially offset by higher costs principally rated to insurance and DD&A.
Note that Northwest Pipes' new rates went into effect on January 1. Transco's rates went into effect March 1, thereby we didn't have a full quarter effect, and Transco's rate cases remain open.
Next slide please, number 13. I guess that I'll turn it over to Ralph.
Ralph Hill
Thank you Don. I'll share our strong first quarter results for you today.
I'll talk about some basin highlights and also a little bit deeper into our performance versus industry in the areas of finding development costs, organic drill bit growth, and discuss our 3P and potential reserve as Steve mentioned. Slide 14.
First quarter '07 total production was up 25% compared to first quarter '06. Our segment profit was up also 27% compared to first quarter of 2006.
We continued to upgrade our rig fleet in the Piceance Basin in particular and our neighbors' rigs are shipping out this month in May, the first of four new what we call “Super Sundown,” our rigs will be coming into the field later this month. We've had successful winter drilling at the Highlands in Trail Ridge area which is one of the areas we were doing to see if we could do that on an operational aspect and so far it's been successful.
And we've had significant major road infrastructure to the Highlands have been completed. We just had some final touches in a few areas there so all of those things should set the stage for better growth and more rapid growth in the Highlands in the future.
Don talked on it briefly but looking just on the investor relations sheet, the LOE for first quarter 2007 was $0.574 versus first half quarter of 2006, $0.505, that's up about 14%. Several factors affecting this were the new basin impact of our Fort Worth activity.
It's a higher area to operate in, although it's doing very well for us. We had numerous facilities expansions I've told you about in the Piceance in the past that we're building now to be ready for this rapid production growth we continue to have.
And if you compare it on an apple to apples basis, the second quarter of '06 actually had some cost in its numbers which should have been in the first quarter of '06. If you look at that, our actual first quarter '07 numbers for LOE on a (inaudible) basis are slightly down from the first quarter '06, so good performance by the team there.
And Don mentioned the ST&A side of the world. If you adjust out the prior year first quarter SG&A, $0.071 has hit us this quarter.
We actually have about $0.05 on our SG&A which is exactly in line with what we thought would happen with the increased staffing we had. So on our cost basis we believe we're right on line with where we thought we'd be and where we should be.
Now turning to slide 15. Basin highlights very quickly.
Steve talked about the total Piceance is up 37%, this divides it into two areas in the Piceance with the valley itself up 34%. Our net production is $453 million per day in the valley.
Twenty-two rigs are operating and our simultaneous operations, which we talked about before, where we frag, perforate, drill, and produce on the same pad, continued to do very well and improve our cycle times. In the Highlands we have three rigs operating.
Our production is up over 100% from last year at $25 million a day and our well performance is meeting expectations and as I mentioned we are doing significant work on infrastructure in that area and most of the major work is nearing or at completion. Powder River continues to do very good for us.
The Big George is driving its production. Big George is up almost 90% year-over-year.
The little graph to the right of the Powder River shows how the Big George is becoming an ever increasing part of this basin's production. Overall our production in the Powder is up 29% and we have 12 rigs operating in the Powder River.
Slide 16. San Juan, the mature basin team continued to do well.
It's up 7% over a year ago. All of our optimization efforts that led to the oil and gas Investor Field Rejuvenation Award last year continued to pay dividends this year as you can see from our performance.
And our newest basin, the Fort Worth basin, we’re up almost threefold from a year ago. We're very pleased with this year's drilling program, as you can see in our expectation and our many, many deals out there.
The smaller, what we'd call the more Volton sized deals that are out there and also we have increasing well digging that getting to hopefully impact our growth to the positive side. Slide 17.
Looking at the three-year F&D for the industry, this chart reflects evaluate energies, top 20 US gas producers. It's a three year F&D average.
Williams' $1.47 average is definitely in the top quartile as you can see here and as this chart will show is possible the industry leader if not the industry leader. So on a comparison basis we are much lower, our $1.47 on a three year basis, than the 520 producer's average of $2.77 per Mcfe.
We believe that's the right way to look at it, on a three year basis, because it smoothes out potentially high exploitation and development costs or acquisitions that could happen in any one year, so you smooth that out in a three year look. But if you do look at it on a one-year basis, we do have some numbers on that aspect that's not on the slide.
If you look at Harold's 2006 US Industry one-year F&D company average for the top 75 companies, that average was $5.18 per Mcfe on the F&D. If you take Evaluate Energy's one-year average based on the companies on this chart and just look at one year instead of three years, that one year average was $3.50 per Mcfe on an F&D and our one year average, as you recall from last call, was $2.14 per Mcfe.
So looking at a one-year basis or three-year basis, we are at least a buck better than our competition and we're making our reserves more productive, so our PDPs are increasing each year as a percentage while we're also growing these reserves rapidly and with lower costs. Turning to slide 18.
Again according to Evaluate Energy these statistics. Williams was the 13th largest gas producer in the nation last year and is the sixth fastest grower of growing and production of the 20 largest gas producers in the country.
And many of those that grew above us on the chart as you can see on the right hand side, many of those companies had significant acquisitions in 2006 which obviously impacted their growth rates, and we did not. Slide 19.
Looking at the leader in grower and reserves organically is something we talk about quite a bit. This chart shows us faring very well on reserve additions.
We are ranked number seven out of the top 20. And as this table shows, most of the leading reserve replacement numbers of the people ahead of us were driven by acquisitions.
As you can see there is a far right column that talks about acquisitions percentage and then additions. Some of the companies were significant in that percentage and ours were not.
Ours were organic. Only two companies exceeded our reserve replacement rate via the drill bit.
And as to the previous slide six displayed, neither of those companies could match our production growth rate. And as you recall from slide five, we achieved this high level performance while maintaining the lowest three-year F&D costs of any of the Top 20 domestic gas producers, so we feel very good about our performance in 2006.
Slide 20. As we mentioned last call our pre reserves are up 8% over the previous year.
Our 3P reserves are now 10.8 Tcfe and our resource potential which we talked about previously last year in the 12-15 Tcfe range on our potential now has a reserve potential of up to 22 Tcfe. Looking at our 3P reserves we have reaffirmed and increased our 3P level to 10.8 Cfes even after we produced approximately 300 Bcfe production last year, obviously more than replacing that production that we have.
Our current 3P reserves exclude the new areas of exploration such as Marcus Creek, and other areas. We have land positions and they also exclude significant unrisked potential reserves in our existing basins, such as Piceance.
These areas include where we are utilizing new technology for advancement in the Piceance we're using longer lateral reaches. We have cut off our 3P reserves to lateral reaches about 2,000 feet lateral reaches.
That's where our 3P reserves estimate cuts off. However at this time, we've already exceeded the 2,000 lateral reaches in a number of areas in the Piceance, we just have not yet moved those reserves into the 3P category.
Slide 21. In addition to moving the 1.6 Tcfe approved last year.
I'd like to continue to stress that our (inaudible) develop producing percentage of the total pre reserves is increasing as this slide shows. Our PDP percent is now 53%, that's up from 43% in 2003.
That means our assets are generating more productive capacity also while they're in the industry leading side of the costs for the industry. And finally I'm very proud of our team.
They continue to do very great strength and production growth, cost efficiencies, reserve replacement through the drill bits. Our strategy remains to rapid development of this industry, we have a long term inventory as you all know.
High drilling success, low finding costs, so we continue to do everything we can to increase its productive capacity in a safe and efficient manner. So looking forward to this year and exciting new opportunities at the bottom, we have some other areas we’re drilling as you know about.
Barton’s Creek, Paradise Basin, Fort Worth, and others, so we look forward to sharing those results later this year and early next year with some of those new areas. I’ll now turn it over to Alan Armstrong.
Alan Armstrong
Thanks Ralph. I’m just going to highlight some of the growth within midstream that we’ve got looking forward as Steve mentioned, we have started into our Willow Creek project and gives a little more detail on that.
So we are moving forward to the best (inaudible), possibly $350 million over the next two years, to install 450 million (inaudible) in gas processing in a CO2 treating facility, along with a lot of pipeline investments in the area that will gather and collect the residue gas into this interstate grid into the area. We’re extremely excited about establish this platform out here that is so well supported by our E&P reserves and their efforts in the area.
Piceance is one of the top three midstream plays in the US, and this investment will also provide further value to the resources that E&P is doing such a fine job of monetizing as Ralph just got through describing. Recognizing the growth potential in the area, Williams Northwest pipeline unit is completing the construction of a 30 inch gas pipeline from the Parachute plant up to the emerging Greasewood hub, and our Willow Creek plant will add even more utilization for this infrastructure.
So this really is a great example of Williams’ integrated model, and the way we’re really bringing all the skills and all the expertise that we’ve got in the company to bear, and really to monetize the streams in this area. So, some tremendous opportunity here, and again, we’re just starting this first train.
We do expect operations at Willow Creek to begin in the mid-2009. Initially we’re covering an additional 20,000 barrels per days of natural gas liquids from Williams Gas Production, and we expect peak productions from this first train to reach nearly 30,000 barrels per day.
The recovery of these high value liquids and transportation to new markets will maximize the value of Williams E&P and our future customers’ natural gas production that today really goes un-recovered in the area. If you look back at 2004, 2005, 2006, there’s been a lot of value left to be captured here, so we’re really excited about making this investment to be able to capture that.
The Overland Pass pipeline which is a joint venture between Williams and One Oak has recently announced plans to construct and operate 150 mile lateral down from the (inaudible) area into the Piceance and into Willow Creek. And this is going to provide both for our own liquids and for our customers ready access to some of the strong markets in both Conway and Bellevue.
Probably a note that needs to be made here as well, is very key, this is also going to provide an outlet an additional 180,000 dekatherms per day of production that would otherwise require natural gas transmission capacity to get out of the area, so helping relieve some of the basis pressure from this growing basin and eliminating some of the gas on gas competition. So, not only does it allow us to monetize these streams, it also provides us initial takeaway out of the area.
We’ve built a combination of these assets provided a true industry solution to maximize these values and efficiently reaching markets that are not accessible today, and doing it in a manner that best serves the industry and the environment. Truly, if it wasn’t for Overland Pass line and our E&P’s such strong reserves in the areas, this project would not be on the drawing board today.
This focus on the development operation of this large scale plan is what allows us to the make necessary investment in people and assets for safe and reliable services in the area, and it is our belief that these efforts are being recognized more and more by our customers. So, we’re very excited about some of the discussions we’ve got going on out here with parties outside of our own Williams’ business, but certainly that provides the platform and support for the business.
So, we see this as a great platform and great example of our strategy coming into play here. On the next slide here, these are pie charts that we’ve shown before, and the bottom line is that we’ve continued to have success with moving projects to the right in this graph.
And the way this works is starting there on the left are projects when they are in the development and proposal stage, then in the middle you see the under-negotiations so as we become more certain about the chances of a project they move into that bucket, and then finally, if we’ve contracted or it’s been approved by our boards, we move it over into guidance there, and so as projects mature, they move to the right. And the good news is, is that we’re continuing to move projects over into the right there.
You’ll note that in our capital guidance that that’s come up significantly, primarily driven by the Willow Creek project, and partially driven by some changes in capital timing in particular, in the Perdido Norte project. So any additional capital in that project is moving in terms of timing into ’08 and ’09.
In looking to the middle pie chart for under-negotiations, we did move Willow Creek into guidance and we included in the under-negotiations some exciting new opportunities that we are closing in on in the deep water Gulf of Mexico. So we’re hoping to be able to announce that next call.
In our business, we’ve got capacity for expansion in the strategic Canadian Oil Sands area that we’ve got in here in the development and proposal stages as well. As we noted in the last call, the Canadian Oil Sands is another area that provides tremendous growth potential via the processing oil sands off gas.
We’re extremely well positioned with our assets there today, and in fact, we’re the only processors of off-gas in the area, and we also have the only splitter that can take and make valuable product out of the liquids that are extracted out of the sands there. A range of capital spending for these under-negotiations projects remains unchanged even though we have some things coming in and some things going out.
The pie label of in development and proposal reflects some changes in our real development pipeline as projects become more concrete or shift to the right. Examples in this include removing a potential deep water project from this category and adding in a new gas processing capacity in the western US.
Certainly we are hoping that the first train that we’re putting in Willow Creek will not be the last, and we certainly don’t expect it to be. So, we see a lot of potential coming down the road in the western US as this reflects.
And with that, I will turn it over.
Don Chappel
Thanks Alan. Next slide, number 27 please; 2007 forecast guidance.
Let’s focus on the bottom line. Our key earnings measure is diluted EPS.
Using a recurring basis after mark to market adjustments, we’ve increased the guidance somewhat from our February call to a range of a $1.15 to $1.50 up from a $1.10 to $1.50. As Midstream raised the lower end of its segment profit guidance by $50 million, note that the wide range is principally the result of factoring in a wide range of energy commodity price possibilities into our forecast.
These assumptions are summarized on slide number 75. Additionally, natural gas hedges are in place and are summarized on slide number 52.
Let’s turn to the next slide, number 28, please, 2007-08 segment profit. Just walk down to the slide.
E&P, you can see strong increases with very strong production. Midstream and gas pipelines are up somewhat as well, and at the bottom of the slide, you can see power after factoring out mark to market adjustments is also up somewhat and expected to produce cash in the range of $50-125 million in 2007 and then $50-200 million in 2008.
Total recurring segment profit after mark to market adjustments could you just take the midpoint there of $2.175 billion in 2007 and $2.550 billion in 2008 is up about 17% year over year. The next slide please, number 29.
Capital spending. Midstream has raised its guidance as Alan mentioned to include now the Willow Creek project in the Piceance basin.
And that was the only change in our consolidated guidance. I would also note again, that we expect CapEx to increase in future quarters as we continue to seize attractive opportunities that deliver strong returns and increases in EVA.
Each of our business leaders has highlighted either during this call or in past calls many of these opportunities. The next slide please, number 30.
We continue to forecast cash flow from operations in the $2-2.3 billion range this year and $2.4-2.8 billion in 2008. Again, CapEx has increased and we expect it to increase even further as we move through the year.
Operating free cash flow is expected to be negative. It is currently forecast to be positive next year, but again the caveat was increase capital spending.
And note the operating free cash flow is before minority interest dividends, debt retirements, and other working capital changes. The operating cash flow deficit in 2007 will be funded with the excess cash that’s currently on hand.
Also note that additional dropdowns of assets to the NLP WPZ which are not included in our guidance but are part of our strategy will continue to provide a low cost source of equity capital to fund growth. Next slide please, number 31.
Again, just a refresher, again our strategy is to drive and enable sustained growth and EPA and shareholder value. The NLP continues to provide some terrific benefits like low cost equity capital as a source for growth and we also are beginning to see more and more value in our GP value.
Just a couple of comments on that. With our recent increase in our GP distribution to $0.50 a quarter or $2 annually, we’re just below the high split level that requires a distribution of $52.5 per quarter or $2.10 annually and above that level we will move from a 25% sharing to a 50% sharing level on further increases above that $2.10 level.
Also, just a reminder that companies that have public GPs are trading at a range of 20-27 times EBITDA on that GP valuation. So again, we think, a great source of low cost equity capital and also growing GP value will continue to maintain and improve our credit ratings and ratios which are important to us as we continue to raise capital including the capital we’ve raised at the WPZ level.
We continue to reduce risk in the power segment and we continue to be very opportunity rich and we are very much focused on seizing these additional opportunities. With that I’ll turn it to Steve.
Steve Malcolm
Thank you Don. Concluding with slide 33, we will continue obviously to focus on these catalysts.
As Ralph Hill has described, the outlook is very bright for Williams to continue to grow natural gas production. Of course we have already settled the Northwest pipeline case and we’re working towards finalizing the Transco case.
Alan Armstrong described an exciting list of potential projects that we’re pursuing. In our power business we remain focused on continuing to make meaningful progress towards contracting more of our megawatts beyond 2010 and Williams continues to have more potential for drop-downs as Williams’ partners.
So clearly, we have the assets, the talent, and the growth opportunities to create significant shareholder value in the future. So with that, we’ll be happy to take questions.
Operator
Thank you, the question and answer session will be conducted electronically. If you would like to ask a question you may do so by pressing the Star key followed by the digit One on your touch tone telephone.
If you are using a speakerphone, please make sure the mute function is turned off. We’ll take as many questions as time permits, once again its Star One if you have a question.
We’ll take our first question with Shneur Gershuni with UBS.
Shneur Gershuni - UBS
Hi good morning guys. Just two quick questions here, I was hoping that we could clarify Ralph’s comment earlier about full time acquisitions.
Are we talking about $100 million or $200 million type acquisitions or are we talking something in a different neighborhood?
Ralph Hill
Well, I was just talking primarily at that point, and basically what we see there is more like the $25-75 million type range.
Shneur Gershuni - UBS
Oh, OK, thank you for that clarification. My other question is just with respect to power and so forth.
Kind of wanted to get your thoughts on contracting beyond the 2010, 2011 timeframe. There have been a lot of challenges with generation in the past couple months including the environmental issues and so forth, and would you clarify, the markets looking a lot brighter than it has in the last couple of years.
Bill Hobbs
Yeah, this is Bill. We’re certainly seeing more interest in contracting longer term, especially in TJM and West Coast.
The big continent markets are not as far out but we’re seeing markets develop into the 2010 range, but I have to characterize it as we are optimistic that by the end of the year we will be announcing additional transactions, probably both in the Northeast and on the West coast.
Shneur Gershuni - UBS
OK, and just one last final question. Towards the end of the call you spent a lot of time talking about the value of the general partners that would potentially be doing an IPO on the general partner as a sort of new source of cheap plastic capital that we will see in the near future?
Bill Hobbs
That’s always a possibility. Certainly we have no plans in the near term to take such action.
We have a very substantial pace of assets that are MLP qualifying and are able to be dropped down and raise capital and drive the GP value even high, that option will always be open to us, so its one that we’ll keep an eye on but right now we think that the drop-down strategy would be first in our minds.
Shneur Gershuni - UBS
Great, thank you.
Operator
Next we’ll hear from Craig Cheer with (inaudible) Capital
Craig Cheer – (inaudible) Capital
Hi, couple questions. Don, how are the rating agencies viewing the capacity markets relative to your power book and credit?
And as a part of this first question, Bill, do you have any views on California (inaudible) market?
Bill Hobbs
Maybe I’ll just kick off Craig, I think the ratings agencies have certainly become more positive in terms of our power business in the markets more generally for power. I think the deals that we’ve been able to contract and particularly the latest large transactions with SCE is certainly something that got their attention and I think was one for them to have even more confidence in our ability to continue the contract forward at attractive prices.
So, substantially improved but we still believe its lagging somewhat.
Don Chappel
And Craig, as far as developing vast markets in California, it’s tending to plod along ultimately I think it will get there, probably 2008 at the earliest. Our contracting strategy has been more to bundle the capacity and the energy and market that as a bundled product like we did with the SCE deal.
But we are seeing some of the financial players looking to capacity only deals beyond 2010. But as far as functioning capacity market in developing California, it’s certainly moving slower than PGIM.
Craig Cheer – (inaudible) Capital
All right, and the second question, Steve or Don, how are you all thinking about the deployment of free cash flow including MLP drop-down. Don, you noted the likely increases in creative account back over time.
Do you keep your powder dry for more creative accounts back opportunities or are you considering share buybacks?
Steve Malcolm
I would say right now we have some very attractive cat backs opportunities on the horizon, but to the extent that we do have excess cash, we will certainly look at all the possibilities including share re-purchase as a possibility.
Craig Cheer – (inaudible) Capital
Great, thanks a lot.
Operator
Next we’ll here from Sam Brothwell from Wachovia Securities.
Sam Brothwell – Wachovia Securities
Hi, good morning. I have a question for Ralph and a question for Alan.
Ralph, with your growth in resource potential can you maybe give us a little more color on how you, what drives your decisions as you update your 2P-3P and Alan, the first quarter mid-stream seemed a little bit like, compared to what some of us were thinking, maybe we were being a little bit too optimistic, but I see you nudged the lower end of your guidance for the year. Can you maybe give us more on what’s driving that?
Is it timing issues?
Ralph Hill
This is Ralph. On 3P what we do is basically the (inaudible) and are usually the way it’s looked at.
One location away from a PUD is the way we look at that. So I think it’s a good look at what we have currently.
We do not go out and aggressively say, even though we are doing for example, longer (inaudible), we do not book additional or add additional reserves from that year. We expect that the classification into the 3P category this year.
We want to make sure that we continue to be successful in those lateral reaches as we have been so far, and expect will be. But there's just no reason to do that at this time.
And as we look for other resource potential, we just have new areas that we're in now that we weren't in last year that could ultimately bear some fruit for us, we would think. But we don't know that, so that's when you get into areas such as Barcus Creek and Paradox, Uinta and just other land areas, areas where we have land that we're just starting to either continue to accumulate land or begin some exploratory drilling out in those areas.
So that basically, on the resource potential, it says the definition we have, I think, on slide four. So it just shows that it's out there, it's a potential, but again, a lot has to happen for that to bear fruit.
We're very consistent with the way we did it last year on the 3P side, and the 4P side, the same way as we did last year. So we have some new areas that we could add to that 4P.
Steve Malcolm
OK, great. Sam, on your question, first of all, first quarter, we did in general (inaudible) in the NGO margin we had a soft January for the frac-spread, it was getting down to almost $50, and gas prices did not move with that.
So January was pretty soft for us in terms of NGO on a frac-spread basis. We had some other things that helped us drive that, including volume coming out of the Opal TXP-V plant.
Looking into the second quarter, the NGO margins for April and May, and it's looking like June, are extremely strong, just in terms of looking at the broad markets and looking at the basis differential out West. So we have a lot of confidence, if you will, in the current NGO margin.
In addition to that, in the first quarter, as we usually see, we had quite a bit of volume shut-in out West from a lot of weather issues both in the San Juan and Wyoming area, and we've got a tremendous well-connect program going on as we speak that is really going to be adding to our volumes for the balance of the year. So those two things give us quite a bit of confidence about the remaining year.
???Unidentified Analyst
OK, thanks. That's very helpful.
Operator
Faisel Khan with Citigroup has our next question.
Faisel Khan – Citigroup
Good morning. One comment to the power book for a second.
I know you always talk about the power book, the power business, as kind-of managing the risk of that business over the long run, but I guess given the type of opportunities that we see on the power side and on the gas-marketing side, when do you think you could make a decision on actually moving away from managing risks to actually investing capital in that business?
Steve Malcolm
Good question. As you know, our strategy with regard to power continues to be focused on reducing risks and creating more cash-flow certainty.
And in the near term Faisel, I think that's where we're headed. We're not looking to expand our footprint in any way.
Faisel Khan – Citigroup
OK. In terms of, because we're looking at the Big George, or Ralph, when does the Big George kind of turn into the Wyodak?
You can see that growth continuing for the long run, or is there a point in time when that growth becomes mature?
Steve Malcolm
Clearly there will a point in time when that becomes mature, but it's much better than a Wyodak. If you look at the first five years of growth in the Big George, versus the first five years of growth in the Wyodak coming on, the Big George is probably three to four times more production than the Wyodak had.
So it's really exploding for us, i.e. we have approximately 7,000-8,000 locations left that we have, between us and our partners, drilled.
So that's obviously long-term inventory. The key in the Powder continues to be water management, and we have many different ways we manage that, and we're happy to have our new partner has a water pipeline, which could help up do some great things there with water removal.
But the Big George is, and I don't have a slide with me today, but I have a slide that shows the Big George growth is far superior to Wyodak, and I think it's got a very bright future ahead for it.
Faisel Khan – Citigroup
OK. Then, on the gathering side, I just wanted to ask the question on the volumes.
If I look at the first quarter of '07 versus the fourth quarter of '06, gathering volumes were actually down. Is there any reason that would be the case?
Steve Malcolm
Well, a couple of things. Again, as I mentioned, we had quite a bit of shut-in production in the first quarter in the San Juan basin, where roads were impassable for pretty long periods of time.
Producers were not able to get to their facilities and unload their water and resume production, so that hit us pretty hard, in the first quarter as well as we had some freeze-offs. So overall, things are looking pretty good, and we did see some decline from the deep water, particularly the areas around east breaks, and that's just a matter of production coming back on as, now Anadarko gets back into some of the wells out there.
So, some pretty promising volumes out there, but we did see some decline in the east breaks area in the deep water that also caused some decline in volumes.
Faisel Khan – Citigroup
Steve, one more question on the power side. Are you saying that if the opportunity were to present itself to invest in a project that would give you positive EVA, you still wouldn't look at that sort of deal?
Steve Malcolm
I would say that we have such extraordinary opportunities in our other asset-based businesses, that that's where we want to focus our capital.
Faisel Khan – Citigroup
Alright, thanks.
Operator
Now we'll hear from Gordon Howald with Calyon.
Gordon Howald – Calyon
Thanks. A question for Ralph, if you could.
You touched on this with Sam's question, but being just a humble pipeline guy, could you give me a little more color on your comments about possibly increasing the 3P reserve based on your longer lateral reaches. You know, when could be this be reflective of 3P reserves, why hasn't it been already, what potential that represents to that 22 Tcfe number that you through out there.
Ralph Hill
Well, I won't be able to give you the potential, just because we don't do that, but when a lot of this will be firmed up this year on the lateral reaches. As I mentioned, we are already doing it for a number of wells, but we always believe that we should just make sure it's working with all wells.
We've had it work with every well we've done, and we just feel like we haven't done enough. But clearly we have the technology with the H&P rigs and with these new neighbor rigs that will be coming on here later this month, so we believe we have the ability to reach out farther.
So I think at lot on the lateral reaches will be firmed up this year. And then if that's true, which I think it will be, then that would be reflected for next year in our 3P.
And the other areas, the exploratory areas, things like that, they'll take a little longer. But Barcus Creek, for example, where we're drilling right now, which is just to the north of Ryan Gulch, that could add to the 3P and actually, some (inaudible) reserves next year because we're actively drilling in that area.
Gordon Howald – Calyon
Gotcha. If I could add one other question, maybe for Alan.
Venezuela, this filled in a lot of continued uncertainty there in some actions taken recently in Venezuela. Could you talk about your perception of the risk you have for your midstream business in Venezuela, just given recent circumstances?
Alan Armstrong
Sure. Well, first of all, so we're clear on what we do there, we are a service provider there and provide gas compression and some gas processing there to re-inject into the oil fields there.
So we're not in a position of taking any of the oil or any of the commodities. We're not a producer in any way, and so don't take any rights or title to the product there.
And so far, the efforts today of the government has been clearly focused on getting control of oil supplies. So we do not, right now, have any discussion or pressure being applied there.
We continue to be a very reliable service provider there. And we think that (inaudible) very much values that.
They've got some consumer facilities in the area, and so they understand the difficulties and the performance that we're providing to them. So we're pretty well positioned in that regard.
Gordon Howald – Calyon
I ask this question all the time, and there are no changes, essentially, since the last time we spoke last quarter or the quarter before.
Alan Armstrong
That is correct.
Gordon Howald – Calyon
Thanks, guys.
Operator
The next question comes from Brian Olson with Luminous Management.
Brian Olson - Luminous Management
Good morning, guys. I just have some follow-ups on power questions that were asked earlier.
Just wondering, how do you guys plan on capitalizing on the strength of the capacity of markets for your eastern assets? And then also, with regards to not expanding the footprint, but having the ability to invest capital in the business, is there any opportunity to reinvest in some of your existing assets?
Bill Hobbs
This is Bill Hobbs. I'll answer the capacity question and Steve can deal with the second part of the question.
With the regional pricing model, RPM option that came out, we are very pleased with the capacity prices that originated from that. I think it sends a strong signal that the Northeast, especially the Eastern PJM is getting very tight on capacity quickly.
So we certainly are talking to counter parties, to those located in PJM, utilities about longer term sales capacity, as well as the transmission expansions as I’ve mentioned in the previous calls that’s going to take Power into the Long Island, New York markets, there’s interest in contracting long term. Certainly in discussions, and I’m hopeful before the end of the year we’ll be making some announcements around those deals.
Again, if I’ve got your question right, we’re not seeking to expand in the power space, it’s very much a continuing strategy around reducing risk and maximizing cash and creating more certainty around cash flow certainty and selling end of the market beyond 2010. That is a clear focus in the Power space.
Brian Olson - Luminous Management
Would there be an opportunity to actually extract cash from the Power book? For someone else that would see an opportunity in some of your assets to capitalize on an opportunity and invest a little cash now?
Is there a way to cap some of that out then?
Steve Malcolm
As we’ve also continued to say, we are very open minded about how we proceed in the Power space.
Brian Olson - Luminous Management
Thank you
Operator
Next we’ll hear from Peter Monaco from Tudor Investment Corporation.
Peter Monaco - Tudor Investment Corporation
Good morning, guys. Thanks for your time.
As you’ll look at a couple of years, clearly this is an incredibly cash flow generative company even after the purchases. Can you talk about, Don, if you would the right capital structure for the company down the road?
Separately, not the beat a dead horse, but with respect to the Power Book, if it’s clearly non-core, and in light of the incredible interest in Power generating assets, especially those that represent something of a call option on Power prices and (inaudible) down the road, will you divest it? Thanks.
Don Chappel
Peter, on the capital structure, I will restate our prior guidance. We believe returning to an investment grade rating is the right strategy for Williams at this point and time.
Our high grade adventures restrict us from some of the actions that some investment grade companies have. So we don’t have the flexibility that some of the investment grade companies have.
I think that we would be effective, more efficient as an investment grade company. So we’ve been focused on returning to an investment grade but doing it at such a pace that continues to allow us to seize the opportunities rather than reduce that or take some other action.
In terms of the Power Book, I just restate Steve’s comment that we are certainly open minded but our strategy in the nearer term has been focused on gross production.
Peter Monaco - Tudor Investment Corporation
Thanks guys.
Operator
Our next question will come from Carl Kirst with Credit Suisse.
Carl Kirst - Credit Suisse
Good morning, everybody. I’d like to go back to the non-proof reserves for a second.
You mentioned that we were previous to this we were at 12-15 Tcfe of resource potential. I think the Delta over the 3T was primarily around 3 Tcfe in the Highlands.
I was wondering if you could confirm whether or not this is still the case or as, say for instance, if the production in the Highlands has doubled in the last year you can actual see greater resource potential in the Highlands. And perhaps between that 12-15 and 22 as we look at that Delta areas, and you mentioned a number of areas, is there one area more material than the other that is representative of that resource potential?
Steve Malcolm
I think the resource potential in the Highlands is in the same area we talked about. We like what we see obviously and we continue to have more and more success.
I think through last year we were about 75 wells drilled in the various areas we call the Highlands and each one of those have continued to delineate areas of the field we like, areas of the field that we may not like as much, but they give us good ability to say our resource potential is very strong in those areas. But I don’t think it’s gone up significantly.
What we’re looking at for the difference to go above the 15 and up to the 22Ts, a lot of it is in the new areas. I would say that as we continue to evaluate our (inaudible) in core areas such as the Valley and the Highlands, that does add some to our opportunities to make our income potential higher.
So some of it is up in that area. But the other areas its up is just new areas we’ve been quietly accumulating acreage in and continue to and that’s (inaudible), doing new deals such as those things.
And we’ve actually increased, not near on the scale as the total 22, but we’ve increased our presence in the new basins, in the Fort Worth basin which obviously adds to this too. It’s kind of a combination.
We haven’t really increased the income potential in the Highlands significantly though it’s probably up some. And a lot of the other resource potential is just because we’re spending in new areas.
Carl Kirst - Credit Suisse
Are any of the other areas as material as the Highlands?
Steve Malcolm
They could be.
Carl Kirst - Credit Suisse
Could you break out on the 2P, 3P or at least the probably of impossibles, how much of that is coming from the Piceance?
Steve Malcolm
I think I said last year and I would say probably 60-70% of that is coming from the Piceance. We still have a big 3P piece in the Powder, don’t forget.
Powder is a big piece, also, but mostly from the Piceance then followed by the Powder.
Carl Kirst - Credit Suisse
Thank you. Don’t know if Phil or Don are on the phone.
If not, looking at the pipeline guidance, could you help us out with what you think is the largest Delta in the guidance, with a pipeline obviously, it’s not going to be commodity prices like everything else. Clearly insurance costs are higher this quarter than what we were expected.
So I was just trying to get a sense, are we seeing rising cost pressures above and beyond the rates cases? Insurance costs, something like that, moderates going forward.
I’m just trying to get a better sense of the dynamic.
Phil Wright
On the top line side, I would say that revenue wise the short term firm out on Northwest and the interruptible on Gulf Stream can’t be a variable. We’d like for that to vary obviously to the up side.
But we have our marketers working those markets and attempting to capture those revenues fulltime. So that is a source of potential variance.
On the cost side of the equation, while we have a pretty good fix on maintenance capital, that is an area that does vary somewhat based on our findings with respect to our internal inspections. Some of that will fall into capital, depending on how many dig outs and that sort of thing, you have to do following inspections and the like, will fall in the zone of a maintenance expense.
So there’s some variance there along with the miscellaneous types that are probably too extensive to mention in the course of the call.
Carl Kirst - Credit Suisse
So, no one single variable if you will?
Phil Wright
No.
Carl Kirst - Credit Suisse
Lastly, Bill. On the Power side, looking at the profit range for this year, as we’ve had a strengthening in the market, on the volumes that are non-contracted, would you say that thee is with what can you see there’s upside potential of that Guidance range, or would we just kind of be at the higher end of that range perhaps as the market continues to strengthen?
Bill Hobbs
We’ll largely, we’ve hedged a significant part of our portfolio for 2007 we’ll stick within that Guidance range.
Carl Kirst - Credit Suisse
Thanks, guys.
Operator
Gary Stromberg from Lehman Brothers has our next question.
Gary Stromberg – Lehman Brothers
Ralph, not to be a dead horse, but the 3p number, is 3p sensitive to natural gas prices? How sensitive is it because we know gas prices were pretty strong at the end of 2005 versus 2006.
Ralph Hill
No, we are slightly sensitive to it but really we are in the resource potential type place, those are actually known quantities of gas and the probable location is one location away from a CUD and then the possible is probably a one more location away from CUD. So there is really not, although there was a significant decrease in prices year in 2006 versus year in 2005, we have never felt like our reserves even in the 3p area or since that.
Really what we are looking at it, is continuing to make sure that the technology we need to get to these areas is there and we believe that is happening and its just we didn’t quite book it at this stage yet. We understand that the hurdles that we need to go over, reach the topographical situation, landowners those kinds of things, we’re just being very diligent in booking those reserves and establishing in our 3p area.
It really wasn’t both in our approved side and our 3p side wasn’t really affected on a very small amount on our different in price.
Gary Stromberg – Lehman Brothers
Cash flow from the operations in the quarter was a little bit lighter than we were looking for, any unusual items there? And guidance to $2.2-2.3 billion versus 300 in the first quarter?
Is there going to be some backhand catch up?
Ralph Hill
I think seasonally the first quarter has been relatively light the last couple of years. I don’t think there is anything unusual so we expect to catch up.
Gary Stromberg – Lehman Brothers
OK thank you.
Operator
Our next question will come from Ray Deacon with BMO Capital Markets.
Raymond Deacon - BMO Capital Markets
I have a question for Ralph. I was just curious what’s the status of the run plateau and is that an area where you could see yourself expanding given the growth you’ve had in the last four five years in the Piceance?
Ralph Hill
I’m not sure, I know there has been a draft. I mean let’s not call it a draft but lots of comments on the EAS.
They had five different potentials and I think the one that they were leaning towards was one where like 80% of the validity and surroundings areas has to be developed first before you go up there which I think is very inefficient. So I think it’s on a warm stand by.
I would say with our work that we’ve done and the Highlands area and particularly Highlands point area and the infrastructure we have built that on an infrastructure basis, we probably have a great leg up on that area and obviously we feel that anything that goes on with Piceance we have a very good knowledge of that so we also think we have a good technical and operational advantage. But at this point, I’m not even sure and I haven’t checked for a while what the status is if they are going to come up with a final word that talks about the (inaudible) developed first.
They also talked about only one operator up there which might be an advantage to us obviously if we would be in that area but that also I think would be inefficient because it’s a big area and it’s a lot that could happen up there. Just a strange initial draft that came out or comments, but I would say if you just look at the Roman plateau and look where we are drilling and look at the Allen Point area in particular.
We have a good if not better than everybody else operational and infrastructure advantage.
Raymond Deacon - BMO Capital Markets
Right, thanks a lot.
Operator
Our next question will come from Brooke Mullin with JP Morgan.
Brooke Mullin - JP Morgan
My question has been asked, thank you.
Operator
At this time we have no more questions. Mr.
Steve Malcolm for the additional closing remarks.
Steve Malcolm
Yes, as always thank you for your interest. We were pleased with the first quarter results.
We have strengthened our growth platform and are excited about our prospects for 2007 and beyond. So we look forward to talking to you next time.
Operator
Thank you that does conclude today’s conference call. We thank you for your participation and have a nice day.
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