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Overview
Company Description
Thesis Summary
Catalysts
Risks
Thesis Detail
o Macro Case: Natural Gas
o Micro Case: Williams Companies
Financial Statements and Operating Assumptions
Modeling Notes
Overview
The Williams organization is composed of two publicly traded entities: Williams Companies (WMB) and
Williams Partners (WPZ). WMB consists of a diversified natural gas exploration and production (E&P)
operating comany and also owns natural gas pipelines and midstream businesses, mostly through its
general partner (GP) and limited partner (LP) ownership of Williams Partners L.P. (WPZ) and Williams
Pipeline Partners (WMZ – which is part of WPZ). In essence the company can be thought of as a
convertible bond tied to the price of natural gas, with the pipeline and midstream assets as the bond and
the natural gas E&P as the “option” to which the business has exposure to. Given this framework, it is my
contention that: 1) At the current market value for WPZ plus estimated values for WMB's GP interest and
other midstream businesses (worth $18-30 share), you are getting its E&P business for free. In other
words, the 'convertible bond' is trading below the bond floor as the midstream/pipeline businesses are
worth more than the market value of WMB. 2) The E&P business has substantial upside, and is worth at
least $10-22 given my belief that natural gas price risk is more to the upside than the downside at
current levels (near $3.40/mmbtu). Thus, the stock is a good value on both of these accounts and the
company has a number of incremental tailwinds at its back.
Company Description
Williams is engaged in 1) Exploration & Production (E&P), 2) interstate natural gas pipelines (housed in
WPZ), and 3) midstream services that include natural gas gathering/processing and natural gas liquids
(NGLs) fractionation/ transportation (also housed in WPZ). Assets are spread throughout the United
States and Canada, primarily in the Pacific Northwest, Rocky Mountains, Gulf Coast, Eastern Seaboard
and the Alberta province in Canada. Revenues and earnings breakdown roughly as follows. Note that E&P
results are highly dependant on natural gas prices:
($ in Millions) 2009 2010 2011E Total %
Revenue
E&P 3,705 4,077 4,006 37%
Pipeline 1,591 1,614 1,739 16%
Midstream and Liquids 2,921 4,197 5,252 39%
Other 780 995 947 9%
100%
Operating Profit
E&P 400 325 146 16%
Pipeline 601 613 672 35%
Midstream and Liquids 663 759 898 43%
Other (1) 164 192 7%
100%
Thesis Summary
Williams today represents a company being valued for a fraction of its cash flow generation potential or
the separate value of its parts. It is also a free call on the price of natural gas.
Valuation is attractive. At today‟s market prices you get the entire E&P segment for free. This
creates substantial upside depending on one‟s assumption for natural gas prices. Upside can also
be achieved if you assign the WPZ and Midstream assets full market value. The company is
relatively inexpensive vs. some of its peers on an earnings or EV/EBITDA basis.
Logical reasons exist to explain undervaluation. These reasons include an overwhelming
anti-natural gas consensus in the markets, negative EPS headlines, a formerly unpopular
CEO/Chairman, and a business which lacks of a strong investor base today due to its
structure/complexity. Catalysts to alleviate these factors have and will take place over time.
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Macro case is compelling: This report provides a comprehensive view that current natural gas
prices under $3.50 are unsustainably low. Prices compared to other energy commodities are at
multi-decade lows. The supply side of gas is constrained and current prices do not justify future
investment. Also, demand in the current economic and weather environment is recovering.
Micro case is compelling: Williams' assets are well positioned. The company has a number of
areas where it can excel going forward. The complexity and scope surrounding the company,
combined with a weak natural gas environment, has made it easy for the buy side to forget a
number of growth and pricing areas which provide tailwinds to future cash flows.
Catalysts
There are a number of logical catalysts for the company:
Higher natural gas prices. Higher natural gas prices are one of the most basic ways to renew
investor interest in the name. My analysis suggest higher prices are coming in 2011 and 2012.
Higher NGL prices and margins. This will highlight the value of the midstream assets. Given near-
$90 oil prices, this catalyst is already underway.
Asset sale of remaining midstream assets into WPZ. This will continue to lower parent debt and
simplify the business structure. This is partially complete with the $782 mil Piceanse asset drop
down. Other midstream assets like 26% of Gulfstream, will probably undergo similar treatment.
E&P expansion in Marcellus, or into new areas such as Eagle Ford, Bakken and Niobrara.
E&P spin-off. Today the E&P assets are being valued at nothing. A spin off (or partial spin-off)
would give the market a chance to value these assets more fairly. The remaining WMB would a
pure holding company - with low debt, little capex and high dividends. In today‟s income craving
investment world, this company would likely find a natural investor base.
Management-induced discount continues to close as market gains satisfaction with new CEO and
new Chairman.
Risks
Macro Risks
o Volumes (driven by economic growth). Volume demand supports pricing, production, and
infrastructure needs, while lower demand will drive lower infrastructure construction and
earnings growth. On a relative basis, the Pipeline operations are least impacted.
o Natural Gas/NGL Prices. Williams E&P and Midstream segments have direct commodity
price exposure. Lower natural gas prices would lower the value of the E&P assets in
excess of the benefit to midstream. While I do not believe the market price of WMB
affords any value to the E&P assets, my estimation of value of the other businesses could
be too high. If that is the case, then this risk would become more important. Williams
Gas Pipelines segment has limited direct sensitivity to commodity prices, but sustained
lower or higher commodity prices could have a second-order effect on the need for
infrastructure.
o Regulatory. Based on my initial research into the industry, it seems like potential
regulatory risks abound. Risks for the sector include diluting or eliminating the tax-
advantaged status of MLPs, increased safety and integrity requirements that raise costs,
environmental restrictions which delay or alter construction or result in monetary
penalties, E&P drilling limitations, and adverse decisions by regulators in a rate cases (in
the pipeline business). Some of these risks could structurally increase energy prices,
which would have an off-setting positive impact on the business.
Company Specific Risks
o Financial Leverage. Williams‟ Pipeline segment can generally operate at higher leverage
metrics due to its more stable cash flows. However, Williams‟ commodity-sensitive
segments (E&P / Midstream) are subject to earning volatility, and leverage is a risk.
Luckily, Williams is relatively underleveraged compared to its Peers.
o Execution and Operational Risks. Issues around safety and integrity on existing assets
can increase costs, and reduce volumes and revenues due to unplanned downtime.
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Williams Thesis Detail
Valuation is attractive. At today‟s market prices, one can buy WMB‟s entire E&P segment for
free. This implies over 60% upside (varying based on your assumptions, especially natural gas
prices). In all but a depressionary crisis, the company looks attractively priced. WMB is also
appears relatively inexpensive as compared to some of its peers.
o Absolute Valuation Based on Sum of the Parts and DCF. As a diversified holding company
with high commodity sensitivity, near term consensus GAAP EPS is a weak basis to judge
value.
In the midstream and pipeline segment, value can be determined by cash flows (DCF),
which are more stable and easier to predict; asset value; or market value. My projections
in this segment use volume and pricing assumptions below management expectations
but in line with the Sell Side. There is upside to these numbers, but the outcome of
pipeline expansion projects and rate cases are areas that I do not take a strong view on.
Given that WPZ is freely traded and that an investor in WMB could hedge out this
exposure, market value is the most transparent way to assess this segment.
In the E&P segment, long term commodity prices (determined marginal cost and
supply/demand – discussed in depth in the natural gas section) are the key to projecting
earnings and determining value. This is why sensitivity is so crucial.
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The Williams Companies, Inc.
Discounted Cash Flow Analysis
($ Thousands, Except Per Share Data)
2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E
EBIT + Equity Income (Pre Tax) 1,799,000 2,070,325 2,102,641 2,351,025 2,798,543 3,184,463 3,403,250 3,669,538 3,944,134 4,079,945 4,277,060 4,553,395
- Adjusted taxes 575,680 662,504 672,845 752,328 895,534 1,019,028 1,089,040 1,174,252 1,262,123 1,305,582 1,368,659 1,457,086
NOPLAT 1,223,320 1,407,821 1,429,796 1,598,697 1,903,009 2,165,435 2,314,210 2,495,286 2,682,011 2,774,362 2,908,401 3,096,309
% change nm 15% 2% 12% 19% 14% 7% 8% 7% 3% 5% 6%
EBITDA 3,268,000 3,556,712 3,714,901 4,047,047 4,576,217 5,043,475 5,343,923 5,692,200 6,049,122 6,267,605 6,547,747 6,907,472
% change nm 9% 4% 9% 13% 10% 6% 7% 6% 4% 4% 5%
+ D&A 1,469,000 1,486,387 1,612,260 1,696,023 1,777,674 1,859,013 1,940,673 2,022,662 2,104,988 2,187,661 2,270,687 2,354,076
- CAPEX 2,400,000 3,452,000 2,983,000 2,940,000 2,919,250 2,928,731 2,938,450 2,948,411 2,958,621 2,969,087 2,979,814 2,990,809
+ Change in NWC (69,000) (183,795) (24,824) (37,428) (32,505) (8,505) (8,173) (9,851) (10,927) 468 (2,673) (6,142)
Unlevered Free Cash Flow (UFCF) 223,320 (741,587) 34,232 317,291 728,928 1,087,212 1,308,260 1,559,686 1,817,452 1,993,404 2,196,601 2,453,434
% change nm nm NM 826.9% 129.7% 49.2% 20.3% 19.2% 16.5% 9.7% 10.2% 11.7%
Free Cash Flow Per Share $0.38 ($1.26) $0.06 $0.54 $1.25 $1.86 $2.24 $2.67 $3.11 $3.41 $3.76 $4.20
Average # of Shares Outstanding 589,385 586,479 584,744 584,744 584,744 584,744 584,744 584,744 584,744 584,744 584,744 584,744
Year count - 1 2 3 4 5 6 7 8 9 10
Discounting factor 0.25 0.93 0.86 0.80 0.74 0.69 0.64 0.59 0.55 0.51 0.47
Discounted Unlevered Free Cash Flow (UFCF) (185,397) 31,763 273,165 582,286 805,841 899,733 995,269 1,076,093 1,095,132 1,119,711 1,160,414
o Valuation Sensitivities. Sensitivity analysis allows the valuation and the earnings to be
sensitized to varying factors. It can help an investor 1) understand how the market is
implicitly valuing the company, 2) envision what a disaster scenario could look like, and
3) quantify the potential upside behind base case assumptions. To that end, I have
created 5 commodity price scenarios as follows.
1 - Calendar Strip Price
Commodity Prices Crude Natural Gas Basis
2010 $80.00 $4.35
2011 $90.00 $4.28 4.0%
2012 $91.00 $4.64 3.5%
2013 and Beyond $95.00 $5.25 2.0%
2 - Bull Case
Commodity Prices Crude Natural Gas Basis
2010 $81.00 $4.50
2011 $98.18 $5.20 4.0%
2012 $108.00 $6.00 3.0%
2013 and Beyond $114.00 $7.02 1.0%
3 - Base Case
Commodity Prices Crude Natural Gas Basis
2010 $79.00 $4.30
2011 $85.00 $4.40 7.0%
2012 $90.00 $5.00 6.0%
2013 and Beyond $95.00 $5.85 4.0%
4 - Bear Case
Commodity Prices Crude Natural Gas Basis
2010 $77.00 $4.20
2011 $70.00 $3.50 10.0%
2012 $70.00 $4.00 10.0%
2013 and Beyond $70.00 $4.10 8.0%
5 - Great Depression
Commodity Prices Crude Natural Gas Basis
2010 $75.00 $4.20
2011 $65.00 $3.20 10.0%
2012 $55.00 $3.00 15.0%
2013 and Beyond $65.00 $3.45 20.0%
I also adjust the valuation parameters (for the SOTP) in each scenario. For example, in
the Bear and Depression cases I apply to steep discounts to the current market value of
Williams‟ holdings (WPZ and Apco).
1) Understand how the market is implicitly valuing the company. My bear case with a steep discount on WPZ
approximates how the market may be valuing the Williams. (E&P – using $4.10 long term natural gas with
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elevated basis vs. Henry Hub; Midstream and Pipeline – using a 35% discount to market value). The
market may also be using a higher debt number as debt may grow as the company spends on expansion
projects in upcoming quarters.
2) Envision what the disaster scenario could be. This disaster could take many forms. One possibility is a
liquidity crisis combined with an economic depression where: a) the value of WPZ and Apco slides to half
of current value; and b) the market assumes long term natural gas prices near $3 and the price basis of
over 20% for WMB‟s nat gas production. To top it off, assume higher debt and much lower earnings and
multiples for the WPZ GP and other businesses. This could lead to a market value for WMB of $13-14. This
is consistent with the March 2009 lows, but note that today WMB is less leveraged.
The Williams Companies Sum of the Parts Disaster Case - Great Depression 2
WMB
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3) Quantify the potential upside. In my base case the stock is already worth 65-80% above current prices.
However, my base case assumes sub $5 natural gas prices for the next two years and long term prices
below $6, with a continuing basis penalty for WMB‟s realized prices. Many scenarios can be envisioned in
which long term natural gas prices are substantially higher. From December 2002 through January 2009,
natural gas averaged over $7/mmBTU, with an average of $8 for much of that period. Moreover, there is
evidence (described on pages 17-18) of this basis being virtually eliminated. The upside here is seems to
be over $50 per share, or more than 130% above current prices.
Industrial and Consumer Basket 14.1x 18.9x 16.7x 1.5x 10.6x 9.2x 8.2x 113.3% 3.3% 14.4% 3.8% 19.3%
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Logical and temporary/fixable factors explain undervaluation.
o Bad headlines and management perception. Over the last couple months we‟ve
seen multiple EPS misses/guidance revisions, including a major goodwill write-down, on
lower natural gas prices. The market has also seen some high profile management
changes. The former CEO/Chairman was very unpopular and this resulted in a discount;
the stock jumped 10% after he announced his retirement in October. Williams is splitting
the roles (of CEO and Chairman) and the market seems enthusiastic about the changes.
The stock may continue to appreciate as the revamped team gains investor credibility.
o Natural gas “glut” consensus. Both sellside and buyside seem stone-cold convinced
that natural gas will stay nominally cheap for at least the next 2-4 years. Due to
compacted investment horizons, “2-4 years” translates into “forever” in many investors‟
minds and has resulted in negative bias against the company and its peers. Please see
natural gas section for more.
o Business structure. Generally speaking, integrated businesses gain investor favor
when an entire sector is doing well. Separated operations gain favor when one business
is doing well while another segment struggles. Today, Williams is seen as a confusing
structure of low risk pipeline assets and high risk E&P assets, which is perceived as
unattractive to investors.
During a period where investors have a bias against natural gas exposure and a bias for yield,
pipeline MLPs are being valued much more generously than natural gas focused E&Ps. The
availability of investible pure-play pipeline MLPs (and pure-play oil-focused E&Ps) has lead to the
undervaluation of the integrated, natural gas focused WMB.
William‟s structure is also confusing because while is not a pure-play E&P, a pure-play integrated
energy company, nor a pure-play pipeline company, it is also not yet a true holding company. It is
essentially an operating E&P with holdco assets in pipeline and midstream businesses. The company
is moving towards becoming a clean holdco. This will likely unlock value over time.
Macro case is compelling: Natural gas is attractive and historically cheap. The bullet point
summary is below, followed by in depth analysis on the natural gas market.
o Natural gas is historically cheap on a relative basis to energy commodities
o The bearish case for natural gas prices is the consensus, with every major Wall
Street firm onboard.
o This case has major holes in it:
Supply/demand does not support low prices over the long term.
The shale gas bubble will not last forever. Production has peaked.
The demand factors that pushed down natural gas usage in 2009-2010
should abate in 2011-2012.
Cost of production is too high for current prices. New natural gas
production depends on cheap financing and higher natural gas prices. Long term
nat gas prices will be determined by marginal cost, which is over $6/ mcf.
Shale/unconventional wells have dramatic decline rates which cause
production to seem prolific in the early years and negligible in the later years.
Companies are incentivized to over-state recoverable reserves.
o Shale gas production shows signs of a bubble about to peak. Contrary to bubbles
in demand, bubbles in supply cause low near term prices, over extraction, and huge price
increases over the long term.
o Environmental and regulatory risk is not priced into natural gas and may add to
marginal cost/ higher prices over the long run.
o Weather risk is not priced into natural gas. Recent weather has been depressive to
prices. As someone who covers agriculture I can attest to the fact that investors tend to
extrapolate recent weather patterns and ignore longer term trends and tail risks.
o Peak natural gas on a global basis is a reality. You can‟t argue with geology. There
may be no near term price impact but it is important to note and consider.
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Natural Gas Case Study (Macro Thesis)
Natural gas is historically cheap compared to oil and coal – it has not kept pace with
other energy commodities, and is at all time modern era lows on a relative basis. On a
standalone basis, it is at low price comparable to its average price over 1999-2010, especially
adjusted for inflation (note that charts are nominal). It trading in line with levels seen in 1999
- 2003 – before the energy price spike.
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Jun-99
Jun-00
Jun-01
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
One can also examine relative prices on a per mmBTU basis, leading to the same conclusion:
$20
$15
$10
$5
$-
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Jun-99
Jun-00
Jun-01
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
The bearish case for natural gas prices is well understood and is the consensus on
both the buy side and the sell side. We see this objectively by looking at recent research
headlines:
· Global nat gas: When will the flood ebb? (2/26 UBS)
· Lowering our price forecasts on the back of surging US production (7/16 GS)
· Natural Gas: Fundamentally Oversupplied (10/11 Morgan Stanley)
· Natural Gas: Weather Bearish Gas (11/3 Morgan Stanley)
· Navigating the gas downturn (11/4 Macquarie)
There bearish case is that storage levels are near all time highs, and that shale technology
and LNG proliferation will continue to drive production higher. The result is lower prices for at
least a few years. I have read a number of these bear natural gas pieces, and do not find the
analysis compelling. Analysis seems to be looking to support current prices which are very
depressed. Given that people have gotten hurt going long natural gas in the past 3 years,
there is not much love lost. The warm October/November weather is thus far providing more
short-sighted ammunition to this bearish bias.
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Major issues with the bear case:
Supply/demand does not support low prices over the long term. We can make
this point by looking at the supply side and noting that it is perennially constrained. The
scope of production increases from 1900-1971 is over. While there have been periods of
production recoveries (early „80s, late „90s, today), the inexorable fact remains that
production for has peaked. The shale bubble will not last forever.
U.S. Natural Gas prodcution (bcf/d) U.S. Natural Gas prodcution (bcf/d)
70 70
60 60
50 50
40 40
30 30
20 20
10 10
0 0
1930
1934
1938
1942
1946
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
Source: EIA
The demand factors that pushed down natural gas usage in Q4 2008- 2010 are abating.
These factors included:
1) The inventory-industrial drawdown which pushed industrial nat gas demand 2 bcf/d below trend. We are
on track to surpass trend by end of 2011. With agriculture industry booming, nitrogen fertilizer is one
demand area which analysts underappreciated. Moreover, at low prices, natural gas will continue to grow
its share as a chemical feedstock (vs. oil and coal). Low natural gas prices are causing US chemical
producers to earn far in excess of their cost of capital.
2) Weather supported high production (lack of threatening hurricanes from 2006-2010) and low demand
(three consecutive benign winters.). For more, see the weather section on page 12.
By 2012, the supply demand situation seems to point to higher prices. Also, none of this
analysis takes into account the optionality of a move to LNG/CNG vehicles or LNG
exports. IEA Director Nobuo Tanaka agreed, stating on Nov 1st that on a global basis,
surplus natural gas could “quickly disappear” due to demand from China.
65.0
60.0
55.0
50.0
US Supply US Demand
45.0
40.0
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
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New natural gas development depends on high natural gas prices and cheap
financing. Shale and horizontal drilling wells are capital intensive - many projects require
natural gas prices over $6 to earn a minimal rate of return, even at cheap financing
rates. Risks also exist to financing. If the 12-m strip continues to trade at its current sub-
$4.50/mmBtu level (spot around $3.50), producers will soon be forced to reduce their
drilling capex, and, in turn, their gas production if they want to earn their cost of capital.
$10.00
$6.00
$4.00
$2.00
$0.00
Piceance (Highlands)
Jonah
Haynesville
Marcellus Wet (core)
Nora (CBM)
Barnett (Tier 2)
Barnett (Tier 3)
Marcellus dry (tier 2)
Wattenberg (Core)
Uinta (Shallow)
Mannville (CBM)
Horseshoe Canyon (CBM)
Eagle Ford (Hawkville)
Deep Bossier (E. Texas)
Other industry sources have higher projections of cost as some incorrectly ignore the tax
benefits of depletion, and some, perhaps correctly, make less favorable production
assumptions. Williams makes a point that it is a very low cost producer compared to
other North American companies; generally #4 out of the 20+ major producers. We will
explore these contentions in the company-specific section (see page 15). If anything,
these contentions buttress the Williams investment case.
Source: Calculation methodology inspired by Gail E. Tverberg, Tverberg Actuarial Services, Inc. Revenues come from Annual Energy Report 3.2 Value of Fossil Fuel Production.
Cost of drilling is calculated by multiplying number of wells from Crude Oil and Natural Gas Exploratory and Development Wells, 1949-2009 by the average cost per well from 4.8
Costs of Crude Oil and Natural Gas Wells Drilled, 1960-2008, based on an annual API survey. The 2009 average drilling cost was estimated as the average of 2007 and 2008
drilling costs (multiplied the 2009 well count). .
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Shale gas is untested over long periods of extraction. More importantly these wells
have dramatic decline rates. Companies are incentivized to massively over-state
recoverable reserves as this is how they are valued by the market. It‟s a bluff they don‟t
have to own up for many years.
Here is a 2007 projection of output from the Barnett shale fields. Only a few months into
production, production falls far short of projections. In 2009, projections were updated to
conform to the reality that the parabolic curve of depletion is far steeper than expected.
Recent EIA data illustrates this point. Note below that 2010 saw flattening production from
Fayetteville and Woodford, and declining production from Barnett. The explosion in shale
production comes from an investment boom and the upfront nature of wells‟ production curves.
Shale Production by Basin, 2000-2010
3,000
2,000
1,000
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Natural gas companies are highly levered and depend on increasing reserve
estimates to justify more production and more debt. This acts to juice ROE and allows
companies to grow in an otherwise stagnant industry. Companies are incentivized to
hype discoveries and overproduce (similar to the credit bubble where financial
institutions were incentivized to over-lend, make rosy estimates on collateral and grow).
Yet, increasing reserves don‟t show up in production, which grows more slowly.
3000.0
CHK - Chesapeake Energy $16,000.0 3000.0
CHK - Chesapeake Energy 80%
$6,000.0
1000.0 1000.0 60%
$4,000.0
500.0 500.0 55%
$2,000.0
2002
2003
2004
2005
2006
2007
2008
2009
2010E
2010E
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Evidence of a bubble in shale development abounds, including language in the press:
A massive natural-gas discovery here in northern Louisiana heralds a big shift in the nation's energy landscape. After
an era of declining production, the U.S. is now swimming in natural gas. - U.S. Gas Fields Go From Bust to Boom,
Wall Street Journal, April 30, 2009
Natural gas from shale formations is the new magic phrase in the oil and gas industry, as new technologies have led
to stunning increases in potential resources and anticipated profits. – Is Shale Gas the Climate Bill's New Bargaining
Chip? New York Times, August 5, 2009
Private equity entry marks the summit?
KKR to Invest $400 Million to Develop Shale Gas in Texas, Wall Street Journal, June 13, 2010
Gas boom mints instant millionaires. CNNMoney.com November 2, 2010
The bubble in natural gas development is only accelerating depletion. Contrary to bubbles in
demand, bubbles in supply cause huge price increases over the long term. This fact escapes
many analysts. Over exploitation of resources leads to long term under-supply issues.
Environmental and regulatory risks are very real. The deeper and more
unconventional a deposit, the higher the potential for an adverse event. We have recently
seen major ruptures/blowouts in key shale fields, and subsequent calls for banning shale
drilling by mainstream politicians. Other politicians are calling for higher royalty taxes.
Considering the above, and in the aftermath of the BP Spill, regulatory hostility towards
energy exploration is bullish for prices. Here are some headlines to underscore the point:
Shale Gas Well Blowout Raises Specter of New BP, Bloomberg Markets, June 7, 2010
Sestak Issues call for Gas Drilling Moratorium, The Times Tribune, June 13, 2010
Governor Bans New Gas Wells on State Land, New York Times October 26, 2010
Group protests shale drilling convention, Pittsburgh Post Gazette, November 4, 2010
Weather risk is not priced into natural gas. Investors rarely attempt to understand or
think about weather. As someone who covers agriculture I can attest to the fact that
investors tend to extrapolate recent weather patterns and ignore longer term trends and tail
risks. Recent weather has been depressive to prices as we have seen low demand, benefited
by three consecutive benign winters, and high production, boosted by a lack of hurricanes
from 2008-2010. However, an analysis of weather trends indicates a high probability of:
1) An extremely cold 2011 winter in North America due to three enormous weather patterns colliding: a
strong La Nina in the Pacific, atmospheric debris from the Northern Pacific volcanoes combined with
negative Arctic Oscillation (AO), and the Atlantic Multidecadal Oscillation (AMO).
2) Major hurricanes in 2011 and 2012 due a persistent La Nina, a warm Atlantic (due to AMO), warm tropics
and an up-trending hurricane cycle.
The La Nina that formed this summer is extreme. Most climate models seem to indicate that
this cooling will continue into mid-winter. To measure all the aspects of La Nina, scientists
use the Multivariate ENSO Index. This index combines sea-level pressure, wind
measurements, sea surface temperatures, surface air temperatures and total cloudiness in
the sky. If all of these are combined, then the current La Niña is the strongest in over 70
years. It is almost as intense as the La Niña in the winters of 1955 – 56. It is currently almost
two standard deviations below normal and most models expect the phenomenon to intensify
over the next 3 months. La Nina is associated with cold winters and hot summers.
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Alex Flamm
From Russia to Alaska, the volcanoes of the North Pacific have been unusually active over the
past two to three years. Over the past few years, the debris from these eruptions has been
lingering in the air and blocking incoming sunlight. Last year, both Alaska‟s Mt. Redoubt
and Russia‟s Sarychev Peak had eruptions that were over 10 miles high. This year, Russia‟s
Kamchatka Peninsula has had up to 6 active volcanoes and two of them, Klyuchevskoy and
Sheveluch, have had small-to-medium eruptions all year long. As recently as mid-October,
Klyuchevskoy had an eruption 7.8 km (4.8 miles) high, strong enough to impact the
stratosphere. This year may not have had the same giant eruptions as last year, but there is
still a lot of debris in the upper atmosphere. How much of the cold polar air enters the US is
determined by the Arctic Oscillation (AO). When the AO is negative, the air pressure
differences are relatively weak, with not much difference between the polar low and the mid-
latitude high. This makes the winds very weak and the cold air escapes to the south. The
Arctic Oscillation has been negative most of this autumn and is negative now. At the time of
this writing, unusually cool and stormy weather is plunging south into western North
America, Western Europe and Northern China. One could expect negative AO to be frequent
this winter and to reinforce the cooling tendencies of La Niña.
Effects of the Positive Phase | Effects of the Negative Phase
of the Arctic Oscillation of the Arctic Oscillation
The long-term warmth in the Atlantic will also create weather conditions that will bring cold
weather. The Atlantic is in the warm phase of the decades-long Atlantic Multidecadal
Oscillation (AMO). The air pressure changes caused by the unusual warmth create a weather
pattern called a negative North Atlantic Oscillation (NAO). When the NAO is negative, which
is more frequent when the Atlantic is warm, it drives cool northern air masses deep into the
Midwestern and Northeastern US and Europe. This pattern may last only a few days at a
time, but when the Atlantic is this warm it occurs again and again throughout the winter.
Currently the Atlantic is 0.5° - 2.5°C (0.9° – 4.5°F) warmer than normal, with the greatest
anomalies around the Icelandic low. Due to flow of the Atlantic‟s tropical currents, we can
expect this warmth to continue and the NAO to encourage Arctic air to drop into Eastern
Canada and the US. At the same time, the warm marine winds off of the Gulf and Atlantic
should heat the Gulf and Eastern states. Normally this would set up a relatively warm winter
that would have sharp, wet, stormy cold spells. Regions where the cold polar air hits the
warm marine air would be explosively stormy. However, this winter, the alternating warm
and cold in the East is going to be complicated by the cooling impact of the volcanic dust/AO
effect and the huge La Niña.
When the La Niña, AO and AMO/NOA all combine this winter, it should create a complex and
stormy winter, particularly for the Great Plains, Midwest and Northeast. This winter will
probably produce some intensely cold and stormy weather concentrated in the Midwest
(which heats with gas) and usually the warmest weather appears along the East Coast
(which heats with oil). The last time we saw anything similar was the winter of 2007 – 2008.
Chicago and the Midwest endured 23 storms, 18 of them winter snow storms and 5 of them
warm weather thunderstorms. (In a normal winter the region experiences 7 - 8 winter
storms.) That winter, the price of Henry Hub natural gas rose from $6.75 to $9.50.
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Regarding hurricanes, with the elimination of any storm-suppressing El Niño winds this
summer, the probability of hurricanes and intense hurricanes increases. Historically La Nina
years are associated with more severe and numerous hurricanes. Also, the AMO cycle
(meaning a warm Atlantic) buttresses this trend too and has led to a general increase in
hurricane activity. While 2009-2010 has largely been a low hurricane environment, these two
trends are still in place and portend some upside risk to natural gas prices.
300
Hurricane Energy and Impacts 7
5
200
4
150
3
100
2
50 1
0 0
1950
1953
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
Source: International Research institute for Climate and Society Source: NOAA
Peak natural gas on a global basis is a reality. You can‟t argue with geology. There
may be no immediate price impact, but it is important to note that cheaply available
abundant natural gas production has peaked. While less imminent than peak oil production,
which seems to be taking place today, peak natural gas production is coming in the next 5-
25 years. Timing depends on the speed and aggressiveness of investment, and the level of
economic growth driving consumption. Natural gas production has already peaked in many
countries including the U.K., Romania, Italy, and the U.S. U.S. production has not
experienced a straight decline as the production graph on page 9 indicates. The ability to
maintain production has come due to a) high natural gas prices in the late 1990s and 2000s
(encouraging more expensive unconventional exploration), b) huge capital inflows directed
toward well development during the late 1990s and late 2000s and c) the advent of and
investment in shale properties in the late 2000s. Such measures extend the peak but
ultimately push up the cost curve and exacerbate decline rates. On a global basis, major gas
discoveries - the source of cheap natural gas - have also been declining.
Global Giant Gas Discoveries by Decade, Including Unconventional
Source: EIA
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Alex Flamm
Micro case is compelling: Williams' assets are well positioned. The company has a number of
areas where it can excel going forward. The complexity and scope surrounding the company,
combined with a weak natural gas environment, has made it easy for the buy side to ignore a
number of growth and pricing areas that provide tailwinds to future earnings.
o E&P:
Repeatable, low cost, high quality inventory deserves a premium
valuation. Assets such Piceance are low cost and high quality.
Declining Rocky Mountain basis improves revenue and profitability.
Analysts are still using basis estimates in excess of 25-30% in the valuation
models which is incorrect.
Growth opportunities are better than average. Williams owns substantial
acreage for growth in Piceance, Marcellus shale, PRB, Green River, Barnett shale
and the San Juan Basin. Williams also could announce a new high-profile
expansion into other areas including Eagle Ford, Bakken and Niobrara.
Proven adept hedger. While we can only value the hedges currently on the
books, history indicates that Williams has done very well with its hedging actions.
E&P spin-off might highlight undervaluation. Given that the market places
$0 value on the E&P segment using today‟s market value of WPZ, a publically
traded E&P company, housing WMB‟s assets, might close the valuation gap.
E&P: This segment produces, develops, and manages natural gas reserves primarily located in
the Rocky Mountain (primarily Colorado, New Mexico, and Wyoming), Mid-Continent (Oklahoma
and Texas), and Appalachian regions of the United States. It specializes in natural gas production
from tight-sands, shale formations, and coal bed methane reserves in the Piceance, San Juan,
Powder River, Arkoma, Green River, Fort Worth, and Appalachian basins. Over 99% of its
domestic reserves are natural gas. It also has international oil and gas interests, which include a
69% equity interest in Apco Oil and Gas International Inc., an oil and gas exploration and
production company with operations in South America. The Company‟s proved undeveloped
reserves, as of December 31, 2009, were 1,868 billion cubic feet of gas equivalent (Bcfe). As of
December 31, 2009, it had 42 gross (14 net) wells in the process of being drilled. Its properties
include Piceance basin, San Juan basin, Powder River basin and Mid-Continent properties. Its
other properties include interests in the Green River basin in southwestern Wyoming and the
Appalachian basin (Marcellus Shale) in Pennsylvania.
It is my contention that this segment has a lot of value – conservatively between $7 to $22 per
share depending on the long term price of natural gas. While one may be bullish on natural gas
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Alex Flamm
in general, it is also my belief that Williams' natural gas assets are better than average due to the
their low cost, improving pricing, and growth opportunities.
o Repeatable, low cost, high quality inventory deserves a premium valuation.
Below is a geographic representation of Williams‟ E&P assets with reserve, acerage and
production stats:
Williams has proven itself to be a low cost product producer on both the finding and
development side (F&D) and the production cost side.
Although current natural gas pricing will not support further investment in production
from many producers, most of William‟s properties, even at prices around $4, earn above
their cost of capital.
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Alex Flamm
Data from CS corroborates this contention and our belief that most properties will lose
money with $4 gas (but Piceance will earn in excess of cost of capital).
$2.00 -60.0%
$- -70.0%
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
$8.00 -30.0%
$6.00
-40.0%
$4.00
-50.0%
$2.00
$- -60.0%
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Lack of takeaway capacity can explain the formerly high basis charged to Rocky
Mountain producers. Essentially, from 2006 to early 2010, export volumes closely pushed
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Alex Flamm
up against available takeaway capacity in the region. Today capacity is plentiful and
future capacity addition are very bullish for William‟s realized pricing. While I model basis
to continue in the high single digits, there is a good chance it may go away entirely or
become positive (providing a tailwind to Williams' revenues and earnings).
o Growth opportunities are better than average. Williams has been investing in
growth, and, should natural gas prices improve, production and investment will likely
surpass my estimates substantially. In order to evaluate growth opportunities, let‟s take a
look at some of the areas:
Current existing production areas with potential growth include Piceance, PRB, Green
River, Barnett shale and the San Juan Basin. My SOTP analysis includes EUR of probable
reserves on a PV basis but does not value possible reserves or undrilled acres.
I estimate production growth of 3.2%, 4.5%, and 3.6% in 2011, 2012, and 2013.
Beyond that I have production growing at 2.4%. I believe there could be upside to these
numbers if natural gas prices (and economics) improve.
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Alex Flamm
o Proven adept hedger. While we can only value the hedges currently on the books,
history indicates that Williams has done very well with its hedging actions and there is
likely an unquantifiable value to this capability going forward. Here is the NPV of
William‟s hedge book at current strip prices.
The Williams Companies, Inc. - Hedge Book (Exploration & Production)
o E&P Spin-off might highlight undervaluation. Today the E&P assets are being
valued at nothing. A spin off (or partial spin-off) would give the market a chance to value
these assets more fairly. The remaining WMB would be a pure holding company - with
low debt, little capex and high dividends. In today‟s income craving investment world,
this company would likely find a natural investor base. Companies including Questar
(Ticker: STR) and Oneok (Ticker: OKE) have pursued similar strategies, shedding most
operating assets and becoming pure holding companies.
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Alex Flamm
Williams‟ Pipeline segment owns and operates a combined total of approximately 13,900 miles of
pipelines with a total annual throughput of approximately 2,700 trillion British thermal units
(TBtu) of natural gas and peak-day delivery capacity of approximately 12 million dekatherms
(MMdt) of gas. These assets are entirely housed within WPZ. Gas Pipeline consists of
Transcontinental Gas Pipe Line Company, LLC (Transco) and Northwest Pipeline GP (Northwest
Pipeline). Gas Pipeline also holds interests in joint venture interstate and intrastate natural gas
pipeline systems, including a 50% interest in Gulfstream. Gas Pipeline also includes Williams
Pipeline Partners L.P. (WMZ) which is owned by WPZ.
o NGL fundamentals are strong. Williams' NGL business benefits from increased natural
gas production (drives volume), a better cost position vs. oil-sourced NGLs (drives
volume) and higher oil prices (drives pricing).
Increased natural gas production driving volumes. The near term shale bubble-driven
increase in North American natural gas production provides abundant and cheap
feedstock for Williams‟ midstream natural gas processing and fractionation, and hence
NGL production.
Gas-derived NGL market share growth driving volumes. Assuming that natural gas prices
remain range bound over the next several years (which is the assumption in every case
in our valuation), natural gas producers will prioritize drilling in fields with higher NGL
content in order to capitalize on its higher, oil-correlated price. As a result, the market
share of natural gas-sourced NGLs should sustainably grow versus oil-sourced NGLs,
continuing a trend that began in 2007. Williams‟ natural gas processing and fractionation
assets should benefit from these sustained higher volumes and margins. Unless the
dynamics of oil versus gas change substantially over the next decade, this will continue
to cause a paradigm shift in how NGLs are produced. This gradual progression provides a
long-term, cash flow growth opportunity for NGL focused asset operators.
High oil prices driving NGL pricing. NGL pricing highly correlated to oil prices, and is
expected to increase in coming quarters. Given the high correlation between NGL prices
and oil prices, current high oil prices, and bullish expectations for future oil prices,
support pricing gains for NGLs.
$130
$110
$90
$70
$50
$30
Oct-07
Oct-08
Oct-09
Oct-10
Apr-07
Apr-08
Apr-09
Apr-10
Jan-07
Jan-08
Jan-09
Jan-10
Jul-07
Jul-08
Jul-09
Jul-10
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Alex Flamm
NGL Margins have been strong over the last four quarters. Today, oil prices are at 4 year
highs and margins should continue to improve.
Also note that Q3 production was negatively impacted by the (temporary) Golf of Mexico
drilling moratorium.
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Alex Flamm
o 760-mile NGL pipeline from Opal to Conway, along with 150- and 125-mile extensions into
the Piceance and DJ Basins in Colorado
o Nearly full now; expandable to 255,000 bbls
o Partnership will work together to facilitate expansions
Marcellus and Surrounding Region
o Own storage facilities and compressor stations in the Marcellus.
o Laurel Mountain Midstream
WPZ-Midstream has a 51% ownership interest in LMM
Operated by Williams
1,000 miles of intrastate gathering lines in Western Pennsylvania for Atlas Energy
and other third parties
Ultimately building 400 miles of 6-inch to 24-inch diameter gathering pipeline
targeting Marcellus production, providing LMM with over 1.5 Bcfd of capacity
Provides gathering service to anchor customer – Atlas Energy– for 4,620
producing wells
Atlas has announced a drilling program of approximately 1,000
horizontal wells over the next 5 years.
Current system has average throughput of approximately 105-120 MMcfd
Shamrock compressor station will add 60 MMcfd of capacity, expandable to 350
MMcfd
Ongoing evaluation of new project opportunities in the area of interestOwn
Laurel Mountain Midstream piece
o Springville Gathering System
Extends our existing Marcellus position into NE Pennsylvania and brings
additional volumes into Transco
Long-term agreement to provide high pressure gathering and transportation
services to Cabot Oil & Gas
Building a 32.5-mile, 24-inch natural gas gathering pipeline
100% of the right-of-way has been acquired
Initial volumes to be gathered from central delivery point from third-party low
pressure gathering system in Susquehanna County; will deliver to Transco
pipeline in Luzerne County
Expected in service in mid-2011
o Significant opportunities to service third-party producers as Marcellus production grows
o Identified more than 85 potential counterparties, mostly producers in the Marcellus
Approximately 30 confidentiality agreements in place
o Gas processing, NGL logistics and gas blending
o Keystone Connector Pipeline
Drive value to WPZ-Gas Pipeline
Gulf Of Mexico
o Perdido Norte
265 MMcf/d, 107 Mile, 18” Deepwater Gas Gathering
150 MBbls/d, 77 Mile, 18” Deepwater Oil Gathering
200 MMcf/d expansion at Markham Plant
Major customers
BP
Chevron
Shell
Eagle Ford
o Markham processing facility (off Transco) well positioned to capture Eagle Ford Shale
volumes via McMullen lateral pipeline extension
o Increased demand for and value of natural gas infrastructure provides a tailwind
to the parent company. Given that permitting, sighting, and building energy
infrastructure assets has become increasingly difficult in recent years, Williams‟ pipeline
infrastructure assets and its growth opportunities are unique and increasingly valuable.
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Alex Flamm
o Provide 50% of firm contract capacity into New York City
o Rate base $2.9 billion (RP 06-569)
o New pipeline and storage interconnects totaling 18.8 Bcf/d (2006 - 10), including Barnett,
Haynesville, Eagle Ford and Marcellus shales
Transco expansion projects include Sentinel Expansion Project, Mobile Bay South Expansion Project,
Mobile Bay South II Expansion Project, 85 North Expansion Project, Mid-South Expansion Project, Mid-
South Expansion Project, Mid-Atlantic Connector Project and Rockaway Delivery Lateral Project.
85 North Phase II
o Expansion from Station 85 to markets in Zone 5 adding 218.5 MDth/d of
capacity
o Major customers: Southern Company, Progress Energy, Duke; Average
Contract term: 19 years
o Target in-service: May 2011 (Phase II); Total estimated cost: Approximately
$205.5 million
o Phase I (Constellation; 90 MDth/d; $34.5MM) placed into service July 2010
Bayonne Delivery Lateral
o Delivery Lateral from Transco mainline in Essex County, N.J. to the
proposed Bayonne Energy Center in Bayonne, N.J.
o Target in-service: June 2011; Total estimated cost: Approximately $20
million (Reimbursable)
Mobile Bay South II
o Additional expansion of north to south capacity from Station 85 to
Gulfstream of 380 MDth/d
o Target in-service: May 2011; Total estimated cost: Approximately $36
million
Northwest Pipeline is an interstate natural gas transportation company that owns and operates a natural
gas pipeline system extending from the San Juan basin in northwestern New Mexico and southwestern
Colorado through Colorado, Utah, Wyoming, Idaho, Oregon, and Washington to a point on the Canadian
border near Sumas, Washington. Northwest Pipeline provides services for markets in California, Arizona,
New Mexico, Colorado, Utah, Nevada, Wyoming, Idaho, Oregon, and Washington directly or indirectly
through interconnections with other pipelines. As of December 31, 2009, Northwest Pipeline‟s system,
having long-term firm transportation agreements including peaking service of approximately 3.7 Bcf of
natural gas per day, was composed of approximately 3,900 miles of mainline and lateral transmission
pipelines and 41 transmission compressor stations having a combined sea level-rated capacity of
approximately 473,000 horsepower. Assets include:
o 3,900 miles of pipeline and 41 compressor stations
o 2 storage facilities
o Rate base $1.5 billion (RP 06-416)
o 13 Bcf of capacity
o 709 MMcf/d of withdrawal capability
Northwest Pipeline expansion projects include Colorado Hub Connection Project and Sundance Trail
Expansion.
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Alex Flamm
Sundance Trail
o 16 mile, 30-inch loop between Green River, Wyo., and Muddy Creek, Wyo.,
compressor stations
o Upgrade and replace compression at the Vernal compressor station to
enhance system reliability
o 150 MDth/d capacity from Meeker/Greasewood, Colo., hubs to Opal, Wyo.,
hub for a contract term of 12 years
o Major customers: Williams Gas Marketing
o Total estimated cost: Approximately $56 million
o Target in-service: Nov. 2010
Jackson Prairie Capacity Expansion
o 1.2 Bcf of phased capacity (2007-12)
o Weighted average contract term: 33 years
o Major customers: Cascade Natural Gas, Terasen Gas, Idaho Power, Boeing
o Total estimated cost: Approximately $6.1 million
Gulfstream is a natural gas pipeline system extending from the Mobile Bay area in Alabama to markets in
Florida. Gas Pipeline and Spectra Energy, through their respective subsidiaries, each holds a 50%
ownership interest in Gulfstream and provides operating services for Gulfstream. 25.5% of that 50% is
owned by WMB directly. Assets include:
o 8 receipt points
o 1.26 MMdt/d capacity
o 745 miles of pipeline (436 miles offshore)
o 168,000 HP of compression
Expansion Projection (Phase V) includes:
o 20,500 HP of compression in service spring 2011
o Adds 35 MDth/d capacity
o Estimated cost: Approximately $50.8 million, of which WMB will pay $13 million and WPZ will
pay $12.4.
These assets are incredibly long-lived, with contracts often in excess of 20 years.
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Alex Flamm
Future growth opportunities, in addition to those above include the $53 million Cardinal
System expansion (45% owned by Williams, located in N.C. targeted for July 2012) and
two major interstate additions yet to be decided: the Keystone Corridor off Transco
through PA and WV into Ohio, and the Pacific Connector off Northwest through Oregon
to the California border.
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Alex Flamm
Financial Statements and Operating Assumptions
2007-FY 2008-FY 2009-FY 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2010-FY 2011-FY 2012-FY 2013-FY 2014-FY
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
Income Statement (WMB)
Operating Revenues
Exploration & Production 2,021,000 3,141,000 2,219,000 1,168,000 910,000 1,012,000 986,842 4,076,842 4,006,081 4,236,361 4,784,467 4,931,500
Gas Pipeline 1,610,000 1,634,000 1,591,000 407,000 380,000 409,000 421,876 1,617,876 1,751,298 1,817,287 1,848,728 1,885,759
Midstream Gas & Liquids 5,180,000 5,559,000 3,588,000 1,051,000 987,000 883,000 1,266,021 4,187,021 5,222,227 5,491,335 5,756,948 6,026,533
Gas Marketing Services 4,633,000 6,412,000 3,052,000 -
Other 26,000 24,000 26,000 278,000 262,000 238,000 216,580 994,580 946,996 1,229,161 1,229,562 1,229,706
Intercompany Eliminations (2,972,000) (4,585,000) (2,221,000) (308,000) (247,000) (238,000) (405,127) (1,198,127) (1,671,113) (1,757,227) (1,842,223) (1,928,491)
Total operating revenues 10,498,000 12,185,000 8,255,000 2,596,000 2,292,000 2,304,000 2,486,193 9,678,193 10,255,489 11,016,916 11,777,481 12,145,008
Equity earnings 137,000 137,000 136,000 40,000 39,000 38,000 49,000 166,000 196,800 197,616 198,448 199,297
Income (loss) from investments - 1,000 (75,000) - 13,000 30,000 - 43,000 - - - -
EBIT 2,163,000 2,820,000 1,706,000 603,000 512,000 501,000 447,219 2,063,219 2,083,434 2,353,579 2,827,415 3,012,478
EBITDA 3,245,000 4,130,000 3,175,000 964,000 878,000 875,000 832,606 3,549,606 3,695,694 4,049,602 4,605,088 4,871,491
Interest accrued (685,000) (636,000) (661,000) (164,000) (154,000) (158,000) (170,280) (646,280) (710,416) (744,306) (787,134) (803,136)
Interest capitalized 32,000 59,000 76,000 17,000 13,000 13,000 17,879 60,879 74,594 78,152 82,649 84,329
Investing income 120,000 51,000 (15,000) 39,000 55,000 68,000 49,050 211,050 11,250 11,250 11,250 11,250
Other income — net (8,000) (1,000) 1,000 (330,000) (120,000) (152,000) (100,000) (702,000) (188,000) (188,000) (188,000) (188,000)
Total other income (loss) (541,000) (527,000) (599,000) (438,000) (206,000) (229,000) (203,351) (1,076,351) (812,572) (842,904) (881,235) (895,557)
Earnings From Cont. Ops Bef. Income Taxes 1,622,000 2,293,000 1,107,000 165,000 306,000 272,000 243,868 986,868 1,270,862 1,510,676 1,946,180 2,116,921
Income Tax Expense From Continuing Operations 524,000 677,000 359,000 (95,000) 104,000 93,000 83,381 185,381 411,759 489,459 630,562 685,882
Effective tax 32% 30% 32% -58% 34% 34% 34% 19% 32% 32% 32% 32%
Statutory tax 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35%
Minority interest in inc. of consolidated subs. 90,000 174,000 76,000 47,000 37,000 37,000 30,907 151,907 165,449 196,669 253,366 275,594
Net Income (Operating) 1,008,000 1,442,000 672,000 213,000 165,000 142,000 129,580 649,580 693,654 824,548 1,062,252 1,155,445
Income (loss) applicable to common stock 990,000 1,418,000 288,000 (191,000) 183,000 (1,263,000) 129,580 (1,141,420) 693,654 824,548 1,062,252 1,155,445
Net Income per Share (Operating) $1.65 $2.43 $1.14 $0.36 $0.28 $0.24 $0.22 $1.11 $1.19 $1.41 $1.82 $1.98
Net Income per Share (GAAP) $1.62 $2.39 $0.49 ($0.33) $0.31 ($2.16) $0.22 ($1.95) $1.19 $1.41 $1.82 $1.98
Average # of Shares Outstanding 609,866 592,719 589,385 583,929 592,498 584,744 584,744 586,479 584,744 584,744 584,744 584,744
Basic # of Shares Outstanding 596,174 581,342 586,309 587,684 588,214 588,621 584,744 587,316 584,744 584,744 584,744 584,744
Period End # of Shares Outstanding 586,148 579,052 583,432 584,223 584,546 584,744 584,744 586,479 584,744 584,744 584,744 584,744
Dividend per share $ 0.39 $ 0.43 $ 0.44 $ 0.13 $ 0.13 $ 0.13 $ 0.13 $ 0.50 $ 0.50 $ 0.50 $ 0.50 $ 0.50
26 | P a g e
Alex Flamm
2007-FY 2008-FY 2009-FY 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2010-FY 2011-FY 2012-FY 2013-FY 2014-FY
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
Balance Sheet (WMB)
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
ASSETS
Current Assets
Cash and cash equivalents 1,699,000 1,439,000 1,867,000 1,644,000 1,601,000 1,015,000 75,000 75,000 75,000 75,000 75,000 75,000
Restricted Cash - - - - - - - - - - - -
Receivables, net 1,192,000 941,000 829,000 831,000 722,000 744,000 802,833 802,833 852,623 915,998 981,894 1,012,977
Inventory 209,000 260,000 222,000 221,000 279,000 270,000 264,721 264,721 272,272 279,353 289,647 295,798
Derivative assets 1,736,000 1,464,000 650,000 703,000 546,000 572,000 572,000 572,000 572,000 572,000 572,000 572,000
Other curr. Assets 702,000 307,000 225,000 190,000 211,000 202,000 202,000 202,000 202,000 202,000 202,000 202,000
Total current assets 5,538,000 4,411,000 3,793,000 3,589,000 3,359,000 2,803,000 1,916,554 1,916,554 1,973,895 2,044,351 2,120,542 2,157,775
Restricted Cash - - - - - - - - - - - -
Investments 901,000 971,000 886,000 888,000 881,000 1,317,000 1,317,000 1,317,000 1,317,000 1,317,000 1,317,000 1,317,000
Property, Plant and Equipment
Cost 22,787,000 25,936,000 27,625,000 28,030,000 28,497,000 28,699,000 30,861,000 30,861,000 33,844,000 36,784,000 39,703,250 42,631,981
Less Acc. DD&A 6,806,000 7,871,000 8,981,000 9,316,000 9,666,000 9,790,000 10,175,387 10,175,387 11,787,647 13,483,670 15,261,343 17,120,356
Property, plant and equipment — net 15,981,000 18,065,000 18,644,000 18,714,000 18,831,000 18,909,000 20,685,613 20,685,613 22,056,353 23,300,331 24,441,907 25,511,625
Derivative assets 859,000 986,000 444,000 376,000 309,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000
Goodwill 1,011,000 1,011,000 1,011,000 1,011,000 1,011,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000
Other assets and deferred charges 771,000 562,000 502,000 551,000 556,000 561,000 561,000 561,000 (39,000) (39,000) (39,000) (39,000)
Total Assets 25,061,000 26,006,000 25,280,000 25,129,000 24,947,000 23,848,000 24,738,167 24,738,167 25,566,248 26,880,681 28,098,449 29,205,400
Long-term Debt 7,757,000 7,683,000 8,259,000 8,615,000 8,358,000 8,002,000 8,002,000 8,002,000 8,002,000 7,402,000 6,402,000 5,402,000
Deferred income taxes 2,996,000 3,390,000 3,656,000 3,708,000 3,724,000 3,496,000 3,496,000 3,496,000 3,496,000 3,496,000 3,496,000 3,496,000
Derivative liabilities 1,139,000 875,000 428,000 304,000 251,000 165,000 165,000 165,000 165,000 165,000 165,000 165,000
Other liabilities and deferred income 933,000 1,485,000 1,441,000 1,443,000 1,469,000 1,460,000 1,460,000 1,460,000 1,460,000 1,460,000 1,460,000 1,460,000
Total long term liabilities 12,825,000 13,433,000 13,784,000 14,070,000 13,802,000 13,123,000 13,123,000 13,123,000 13,123,000 12,523,000 11,523,000 10,523,000
Minority Interests 1,430,000 614,000 572,000 1,389,000 1,393,000 1,151,000 1,181,907 1,181,907 1,347,356 1,544,025 1,797,390 2,072,984
Preferred Stock - - - - - - - - - - - -
Stockholders' Equity
Common stock 608,000 613,000 618,000 619,000 619,000 619,000 619,000 619,000 619,000 619,000 619,000 619,000
Additional paid-in capital 6,748,000 8,074,000 8,135,000 7,346,000 7,360,000 7,991,000 7,991,000 7,991,000 7,991,000 7,991,000 7,991,000 7,991,000
Retained earnings (deficit) (293,000) 874,000 903,000 646,000 758,000 (578,000) (554,530) (554,530) (285,479) 114,201 751,320 1,481,366
Accumulated other comprehensive income (loss) (121,000) (80,000) (168,000) 3,000 (63,000) 34,000 34,000 34,000 34,000 34,000 34,000 34,000
Less: Treasury stock (567,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000) (1,041,000)
Total stockholders' equity 6,375,000 8,440,000 8,447,000 7,573,000 7,633,000 7,025,000 7,048,470 7,048,470 7,317,521 7,717,201 8,354,320 9,084,366
Total Liabilities and Stockholders' Equity 25,061,000 26,006,000 25,280,000 25,129,000 24,947,000 23,848,000 24,738,167 24,738,167 25,566,248 26,880,681 28,098,449 29,205,400
Check - - - - - - - - - - - -
27 | P a g e
Alex Flamm
2007-FY 2008-FY 2009-FY 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2010-FY 2011-FY 2012-FY 2013-FY 2014-FY
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
Cash Flow Statement (WMB)
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
CASH FLOWS FROM OPERATING ACTIVITIES
Net income 990,000 1,418,000 288,000 (191,000) 183,000 (1,263,000) 129,580 (1,141,420) 693,654 824,548 1,062,252 1,155,445
Depreciation, depletion and amortization 1,082,000 1,310,000 1,469,000 361,000 366,000 374,000 385,387 1,486,387 1,612,260 1,696,023 1,777,674 1,859,013
Provision for def. inc. taxes / PPE, other assets 532,000 777,000 635,000 636,000 49,000 876,000 - 1,561,000 - - - -
Net (gain) loss on dispositions of assets and business 16,000 (36,000) (44,000) 4,000 (4,000) - - - - - - -
Minority interest in income of consolidated subsidiaries 90,000 174,000 76,000 47,000 37,000 37,000 30,907 151,907 165,449 196,669 253,366 275,594
Cash prov. (used) by chgs in curr. assets and liabilities:
Restricted Cash - - - - - - - - - - - -
Accounts and notes receivable (122,000) 329,000 67,000 (3,000) 118,000 (23,000) (58,833) 33,167 (49,790) (63,375) (65,896) (31,083)
Inventories 29,000 (48,000) 33,000 - (57,000) 8,000 5,279 (43,721) (7,551) (7,081) (10,295) (6,150)
Margin deposits and customer margin deposits payable (135,000) 88,000 4,000 11,000 (6,000) 1,000 - 6,000 - - - -
Other current assets and deferred charges (10,000) (76,000) (8,000) 26,000 (32,000) 11,000 - 5,000 - - - -
Accounts payable 26,000 (343,000) 5,000 (13,000) (76,000) 17,000 (16,990) (88,990) 24,302 22,789 33,134 19,795
Accrued liabilities (200,000) 7,000 (170,000) (280,000) 123,000 63,000 - (94,000) 9,313 9,407 9,501 9,596
Changes in curr/noncurr deriv. assets and liabilities (59,000) (121,000) 36,000 (8,000) (26,000) 4,000 - (30,000) - - - -
Other, incl. changes in noncurrent assets and liabilities (2,000) (124,000) 184,000 27,000 5,000 539,000 - 571,000 2,436 2,460 2,485 2,510
Net cash provided by operating activities 2,237,000 3,355,000 2,575,000 617,000 680,000 644,000 475,330 2,416,330 2,450,073 2,681,440 3,062,220 3,284,719
Net increase in cash and cash equivalents (570,000) (260,000) 428,000 (223,000) (43,000) (586,000) (940,000) (1,792,000) - - - -
Cash and cash equivalents at beginning of period 2,269,000 1,699,000 1,439,000 1,867,000 1,644,000 1,601,000 1,015,000 1,867,000 75,000 75,000 75,000 75,000
Cash and cash equivalents at end of period 1,699,000 1,439,000 1,867,000 1,644,000 1,601,000 1,015,000 75,000 75,000 75,000 75,000 75,000 75,000
Check - - - - - - - 0 - - - -
Min. cash balance 75,000 75,000 75,000
Net issuance of shares (627,000) 606,000 (193,000) (854,000) (57,000) 558,000 (106,110) (459,110) (424,603) (424,868) (425,133) (425,399)
Unrecorded Goodwill - - - - - - - - - - - -
28 | P a g e
Alex Flamm
2007-FY 2008-FY 2009-FY 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2010-FY 2011-FY 2012-FY 2013-FY 2014-FY
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
Barnett Shale 45 69 57 57 54 60 57 57 60 60 61
y/y growth 53.0% -24.0% -17.4% -14.3% -15.0% -17.7% 0.0% 5.0% 1.0% 1.0%
Other 26 26 29 29 26 30 29 31 33 33 34
y/y growth -1.0% 20.8% 11.5% 4.0% 5.0% 10.3% 10.0% 5.0% 1.0% 1.0%
Domestic total 1,094 1,183 1,102 1,110 1,135 1,200 1,137 1,172 1,227 1,273 1,314
Unhedged 589 586 558 503 528 570 540 612 1,117 1,273 1,314
Revenues $1,527,678 $901,808 $251,377 $199,525 $211,306 $167,153 $829,360 $914,885 $1,921,281 $2,609,803 $2,694,384
International
Net to WMB 50 54 54 58 55 58 56 59 60 61 61
y/y growth 7.5% 1.9% 9.4% 1.9% 5% 5% 5% 2% 1% 1%
Revenues $82,886 $24,349 $22,748 $21,657 $16,922 $85,675 $88,128 $103,518 $124,602 $125,848
Total Production volumes (MMcfe/d) 1,144 1,236 1,156 1,168 1,190 1,258 1,193 1,231 1,287 1,334 1,376
8.1% -5% -1% -3.5% 3.2% 4.5% 3.6% 3.1%
Gas Management revenue per Mcfe $0.48 $0.31 $0.37 $0.37 $0.38 $0.37 $0.37 $0.37 $0.37
Revenues
Production 1,725,000 2,644,000 1,974,000 571,000 510,000 530,000 484,990 2,095,990 2,017,605 2,151,166 2,609,803 2,694,384
Gas management 272,000 355,000 131,000 556,000 366,000 435,000 459,930 1,816,930 1,800,348 1,881,677 1,950,062 2,011,268
Hedge inef./MtM gains (16,000) 1,000 (3,000) 9,000 - 16,000 16,000 41,000 64,000 64,000 64,000 64,000
International 64,000 72,000 75,000 20,000 22,000 22,000 16,922 80,922 88,128 103,518 124,602 125,848
Other 48,000 49,000 42,000 12,000 12,000 9,000 9,000 42,000 36,000 36,000 36,000 36,000
Total revenues 2,093,000 3,121,000 2,219,000 1,168,000 910,000 1,012,000 986,842 4,076,842 4,006,081 4,236,361 4,784,467 4,931,500
Segment profit 731,000 1,240,000 400,000 157,000 82,000 (1,608,000) 13,227 (1,355,773) 145,581 155,667 446,536 445,154
Equity in earnings 25,000 20,000 18,000 5,000 5,000 5,000 5,000 20,000 20,000 20,000 20,000 20,000
Reported segment profit 756,000 1,260,000 418,000 162,000 87,000 (1,603,000) 18,227 (1,335,773) 165,581 175,667 466,536 465,154
Non-recurring adjustments 4,000 38,000 58,000 - 2,000 1,668,000 - 1,670,000 - - - -
Segment profit 760,000 1,298,000 476,000 162,000 89,000 65,000 18,227 334,227 165,581 175,667 466,536 465,154
29 | P a g e
Alex Flamm
2007-FY 2008-FY 2009-FY 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2010-FY 2011-FY 2012-FY 2013-FY 2014-FY
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
Operating Data (WPZ)
GAS PIPELINE
Northwest Pipeline
Throughput (TBtu) 769 179 157 153 185 674 708 724 736 751
Throughput (TBtu/d) 2.1 2.0 1.7 1.7 2.0 1.8 1.9 2.0 2.0 2.1
% increase year-over-year -19.9% -9.5% -7.8% -10.0% -12.3% 5.0% 2.3% 1.7% 2.0%
Avg revenue per transportation (MMcf) $ 0.565 $ 0.591 $ 0.658 $ 0.675 $ 0.546 $ 0.613 $ 0.647 $ 0.647 $ 0.647 $ 0.647
% increase year-over-year 18.2% 6.3% 4.5% 4.0% 8.5% 5.5% 0.0% 0.0% 0.0%
Avg firm reserved capacity (TBtu/d) 2.6 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8
Utilization % 80% 71% 61% 59% 72% 66% 69% 71% 72% 73%
Throughput (TBtu) 1,901 586 460 517 527 2,089 2,203 2,276 2,292 2,315
Throughput (TBtu/d) 5.2 6.5 5.1 5.6 5.7 5.7 6.0 6.2 6.3 6.3
% increase year-over-year 6.6% 9.2% 16.6% 8.0% 9.9% 5.4% 3.3% 0.7% 1.0%
Avg revenue per transportation (MMcf) $ 0.609 $ 0.512 $ 0.605 $ 0.590 $ 0.607 $ 0.576 $ 0.585 $ 0.591 $ 0.597 $ 0.603
% increase year-over-year -3.0% -18.4% -4.6% 5.0% -5.5% 1.7% 1.0% 1.0% 1.0%
Avg firm reserved capacity (TBtu/d) 6.8 7.0 6.9 7.1 7.1 7.0 7.1 7.1 7.1 7.1
Utilization % 77% 93% 73% 79% 81% 81% 85% 88% 88% 89%
Revenues
Northwest Pipeline 434,000 106,000 103,000 103,000 101,088 413,088 457,552 468,028 476,037 485,558
Transcontinental Gas Pipe Line 1,158,000 300,000 278,000 305,000 319,788 1,202,788 1,289,745 1,345,259 1,368,691 1,396,201
Other (1,000) 1,000 (1,000) 1,000 1,000 2,000 4,000 4,000 4,000 4,000
Total revenues $ 1,591,000 $ 407,000 $ 380,000 $ 409,000 $ 421,876 $ 1,617,876 $ 1,751,298 $ 1,817,287 $ 1,848,728 $ 1,885,759
Equity Earnings 35,000 9,000 10,000 10,000 10,000 39,000 40,800 41,616 42,448 43,297
Segment profit $635,500 $169,000 $148,000 $161,000 $176,590 $654,590 $719,925 $748,055 $753,826 $761,269
Non-recurring adjustments (43,000) (5,000) (5,000) - - (10,000) - - - -
Segment profit (recurring) $592,500 $164,000 $143,000 $161,000 $176,590 $644,590 $719,925 $748,055 $753,826 $761,269
EBITDA $926,500 $249,000 $227,000 $245,000 $257,556 $978,556 $1,068,456 $1,107,995 $1,127,276 $1,149,855
30 | P a g e
Alex Flamm
2007-FY 2008-FY 2009-FY 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2010-FY 2011-FY 2012-FY 2013-FY 2014-FY
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
Operating Data (WPZ)
NGL COGS
West
Ethane COGS $110,000 $48,000 $31,000 $28,000 $50,582 $157,582 $167,690 $184,459 $202,905 $223,196
Non Ethane COGS $142,000 $65,000 $50,000 $46,000 $63,227 $224,227 $239,400 $263,340 $289,674 $318,642
Gulf
Ethane COGS $26,000 $13,000 $10,000 $6,000 $7,797 $36,797 $37,165 $39,024 $39,999 $40,999
Non Ethane COGS $54,000 $20,000 $15,000 $13,000 $15,595 $63,595 $64,231 $67,442 $69,128 $70,857
Total NGL COGS $332,000 $146,000 $106,000 $93,000 $137,202 $482,202 $508,487 $554,265 $601,707 $653,693
NGL Margin
West
Ethane Margin $106,000 $54,000 $36,000 $25,000 $36,095 $151,095 $180,982 $225,702 $278,852 $330,584
Non Ethane Margin $277,000 $100,000 $103,000 $90,000 $81,587 $374,587 $444,231 $540,851 $654,893 $767,139
Gulf
Ethane Margin $24,000 $12,000 $7,000 $3,000 $7,071 $29,071 $33,611 $40,450 $46,982 $52,169
Non Ethane Margin $69,000 $26,000 $21,000 $18,000 $19,098 $84,098 $94,637 $110,947 $126,114 $138,272
Total NGL Margin $476,000 $192,000 $167,000 $136,000 $143,851 $638,851 $753,460 $917,950 $1,106,842 $1,288,164
31 | P a g e
Alex Flamm
2007-FY 2008-FY 2009-FY 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2010-FY 2011-FY 2012-FY 2013-FY 2014-FY
2007 2008 2009 1Q10 2Q10 3Q10 4Q10E 2010E 2011E 2012E 2013E 2014E
Operating Data (WPZ)
Equity Earnings 46,000 17,000 17,000 14,000 34,000 82,000 136,000 136,000 136,000 136,000
Segment profit $673,500 $245,000 $198,000 $182,000 $206,901 $831,901 $1,006,303 $1,180,746 $1,357,940 $1,536,942
Non-recurring adjustments (43,000) - (11,000) (7,000) - (18,000) - - - -
Segment profit (recurring) $630,500 $245,000 $187,000 $175,000 $206,901 $813,901 $1,006,303 $1,180,746 $1,357,940 $1,536,942
EBITDA $827,500 $294,000 $237,000 $226,000 $269,423 $1,026,423 $1,276,994 $1,479,466 $1,677,051 $1,873,756
Revenue drivers
Marketing margin 45,000 2,000 (5,000) 4,000 4,000 5,000 16,000 16,000 16,000 16,000
Margin/sales relationship 2% 0% -1% 1% 1% 0% 1% 1% 1% 1%
Production handling and transport / gal $0.049 $0.043 $0.040 $0.042 $0.034 $0.040 $0.033 $0.028 $0.024 $0.020
y/y increase -19% -24% -16% -16.1% -18.7% -16.1% -16.1% -16.1% -16.1%
OpEx & Other not included in gross margin $597,000 $147,000 $161,000 $146,000 $143,484 $597,484 $598,396 $662,405 $715,815 $764,634
Equity earnings (losses) $46,000 17,000 17,000 14,000 34,000 82,000 136,000 136,000 136,000 136,000
Reported segment profit $673,000 $245,000 $198,000 $182,000 $206,901 $831,901 $1,006,303 $1,180,746 $1,357,940 $1,536,942
Modeling Notes
o If you made it this far, thank you!
o I originally created a simple cash flow model (attached to the larger WMB Model file on
the last tab) to figure out the business model. Basically p x v = revenues, c x v = costs.
o I ended up adapting a much more detailed model from Morgan Stanley because it
essentially attempted the same approach but had much more historical data already
typed in. The assumptions have been edited and pricing assumptions are linked to the
Drivers/SOTP tab.
o Volumes drivers are embedded in the Financials tab (the actual model). Volume drivers
don‟t really move the needle on the valuation. My approach here is to be conservative.
Any production and volume gains in excess of what I model are upside to the equity.
o Please feel free to follow-up with any questions and comments.
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Alex Flamm