Williams Prompts Look at Integrated Model

HOUSTON (Dow Jones Newswires), November 25, 2008

Integrated natural gas companies, long seen as safe bets when energy markets turn volatile, could reshape themselves in the face of falling commodity prices and tightening credit markets.

Williams Cos. has steadfastly advocated that its combined set of businesses - including pipelines, natural gas gathering and processing, and a growing exploration and production business - would continue to create value for shareholders. But earlier this month, after watching its market value plunge by more than half since early July on falling commodity prices, economic turmoil and the credit crisis, Williams said it would study the possibility of spinning off its businesses to boost value for shareholders.

The move represents a departure for the company that long contended that the sum of its businesses created greater value than they did separately, with the fee-based pipeline business providing cover when volatility in commodity markets might roil the exploration and production business.

Williams Chairman and Chief Executive Steve Malcolm said during the company's third-quarter earnings conference call that the integrated business has performed well, generating 128% total shareholder return for the three years ending December 2007.

But the market punished Williams along with nearly every other energy company as commodity prices collapsed from their early July peaks, with natural gas plunging by more than half on a boom in U.S. production, just as economic difficulties raised concerns about future demand. The front-month gas contract was recently trading at $6.395 a million British thermal units on the New York Mercantile Exchange.

Williams shares recently traded at $15.33, after trading around $40 in early July. The shares trade at a forward-year price-earnings ratio of about 6.8, compared with 9.6 for the oil and gas pipeline industry, according to FactSet Research.

"I thought there would be perhaps some gravitation towards safety, and the safety Williams offered by virtue of its integrated model," Malcolm said on the call. "We have not seen that occur." He added that the company would evaluate a number of factors before making a decision on whether to split up, and would be "ready to move" when the markets improved.

Sam Brothwell, an analyst with Wachovia in New York, said the market isn't recognizing the value of Williams or other integrated companies.

"The notion that the integrated model provided a measure of protection in a declining commodity environment is being called into question," he said.

The market conditions that have led Williams to explore a change could also entice other companies to restructure as well. Energy companies such as Equitable Resources Inc., El Paso Corp. and Questar Corp. have integrated business models and could be under pressure if Williams decides to pursue a restructuring and executes it successfully, analysts said.

Bruce Connery, a spokesman for Houston-based El Paso Corp. said the company's management and board of directors regularly reviews the possibility of changing its business model.

Questar has examined the possibility of spinning off its business units but said the option didn't make sense in the current environment, though it may make sense in the long term.

"When investors are more focused on the company and valuations are more rational, they are more likely to give you credit to creating value through a restructuring," said Martin Craven, treasurer and investor relations director for Questar.

Equitable Resources declined to comment.

Becca Followill, an analyst with Tudor Pickering Holt & Co. in Houston, said the integrated models can be confusing to an investor betting on energy.

"The market gets confused when you have a commodity-sensitive business with a fee-based business. It's two different types of investors," she said.

The combination of businesses often means that integrated companies, or hybrids, will trade at a discount to other energy companies that are focused on one area of the industry. Investors could be lured away by the strong performance of an exploration and production company when commodity prices are high or they could pursue the stability of a regulated utility or pipeline company when prices fall.

"You may have investors saying, 'Let me make my commodity decision,'" Brothwell said.

Still, the integrated model isn't without its fans.

John Olson, co-managing partner of the hedge fund Houston Energy Partners, said that he is a "real believer in the integrated gas story," because those companies have historically performed well, despite the recent falls in stock prices.

Between 2002 and 2008, companies like Questar, Williams and Equitable Resources posted big returns and didn't become overvalued like some exploration and production companies, Olson said.

Williams also has never been shy about questioning its structure. It has created a pair of master limited partnerships to own and operate natural gas assets. The company could drop down assets to those companies, although Olson points out that those MLPs are not performing well in the current market either.

Regardless of what tack Williams pursues, Olson said the company has always been adept at overcoming challenges. It could decide to make no changes at all.

"I give them an 'A' for creativity," Olson said. "What sort of grade we give them for execution will depend on the outcome of this study."

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