Duke Energy's Viewpoint on Gas Infrastructure

Merrill Lynch Power & Gas Leaders Conference
Rick Priory
Chairman, President and CEO
Duke Energy

New York, NY

Good morning. It’s a pleasure to be with you today, and to share this panel with my good friend Bill Wise of El Paso.

We’ve been asked to lead the discussion on gas infrastructure. You know us both well enough to realize that we’ll probably get into some other topics as well, but we are very happy to share our perspective on the gas market.

There’s a new definition of wealth today: Anyone who has five million dollars in stocks, three million dollars in real estate, one million dollars in bonds—and a full tank of gas! And with today’s prices, that could be gasoline or natural gas!

I know that this is an audience keenly interested in wealth creation, so I’m going to talk about the robustness of Duke Energy’s fuel tank ? in terms of gas, power, trading and marketing, merchant development and international expansion.

And I’m going to structure my talk around the fundamental economic principle of supply and demand, and the unique capabilities Duke Energy has in leveraging both sides of that equation.

Let’s start with natural gas.

As you know, gas demand is expected to grow from a 23 trillion cubic feet per year market in 1999 to a 30 trillion cubic feet per year market by 2010. The majority of this growth is being driven by the electric generation market. New gas power plants are being built to serve growing electric demand and to replace older, less efficient units.

Interestingly, I did see a recent report that lamented the slower growth of gas due to the use of highly efficient combined cycle generators! I guess it’s all a matter of perspective...

We have been very disciplined and strategic in realigning our gas transmission assets for growth over the last 18 months. We have transformed our pipeline system focus from a widespread presence in several markets and basins to a concentrated ownership effort in high-growth Eastern markets. We also rent capacity in markets where supply is abundant.

That realignment is based on the fact that pipelines are locational vehicles. To be profitable, their configurations must conform to the basic elements of supply and demand. Very clearly, Duke Energy’s gas transmission system meets that requirement.

Duke Energy Field Services allows us to further leverage our gas position through the gathering, processing, transport, marketing and storage of natural gas and the production, transport and marketing of natural gas liquids. DEFS is one of the nation’s largest natural gas gatherers, the largest producer of natural gas liquids and one of the largest NGL marketers.

Last month, DEFS, through its partnership Dauphin Island Gathering Partners, announced the completion of two projects that significantly expand natural gas service in the Gulf of Mexico. The projects significantly increase the partnership’s presence in the primary supply basin serving the growing natural gas markets in the southeastern U.S. and Florida.

DEFS is also expanding its Canadian presence. Earlier this summer we announced the acquisition of the Gordondale Gas Processing Plant and Gathering System from Transcanada Midstream. The Gordondale assets in Northwestern Alberta include a sour gas plant with current capacity of 80 million cubic feet per day, 115 miles of gas gathering lines and two field compressors. The plant is licensed for up to 100 million cubic feet per day and is readily expandable.

As we look forward, we see tremendous opportunities in the East and Southeast that come about through the combination of market growth, new supply sources, and escalating demand for new gas-fired generation.

• On average, natural gas demand in the Northeast market is expected to grow at 2.5%, which is considerably higher than the national average of 2%.
• The Southeast and South Central regions have enjoyed growth of 2.6% historically, and demand is expected to grow by 3% going forward.
• Florida has enjoyed a growth rate of 4.5% over the last several years - but demand is expected to double in the state through 2010.

We’ve been working hard and fast in recent months preparing our gas transportation infrastructure to meet escalating demand.

The Buccaneer Gas Pipeline, a joint venture between Duke and Williams, represents our keen interest in the Florida market. The 674-mile pipeline will extend across the Gulf of Mexico, transporting natural gas from the offshore Alabama area to the state of Florida.

We recently achieved a positive milestone on the project, when the Federal Energy Regulatory Commission issued the draft Environmental Impact Statement for the project, concluding that the project is environmentally acceptable. We now look forward to timely approval, and if all proceeds on course, to shipping natural gas to central Florida by the spring of 2002.

In March, we completed our acquisition of the NiSource’s natural gas salt cavern storage. Just two and a half months later, we interconnected our East Tennessee and Texas Eastern lines, providing customers access to our diverse natural gas supplies from the Gulf Coast. The interconnections also provide access to the southeast United States, a region of exceptionally high gas consumption growth.

At the end of last month, we announced our intent to purchase NiSource’s natural gas salt cavern storage business. This new line of business will add 23 billion cubic feet of storage capacity with significant expansion capability to our pipelines business.

Entry into this business greatly enhances our natural gas position and our ability to assist customers in meeting load swings.

The location of the existing storage facilities - Texas and Louisiana - will provide additional supply security. Two other high deliverability salt cavern storage facilities are being developed in Mississippi and Pennsylvania.

Merchant generation projects are being developed across the nation. And what we like most is that a large number of those planned facilities are siting near our pipelines.

Our Gas Transmission group has been successful in attracting and attaching new gas-fired electric generators to our system. Providing fuel supply to these facilities is becoming a big part of our load.

More significantly, most of that load is off-peak, which allows us to increase throughput and add revenue without large capital additions. To date, we have signed contracts on 16 projects:

• 7,800 MW of generation capacity
• Approximately 1.6 Bcf/d of potential gas burn

We also have 55 additional projects under negotiation.

• 32,200 MW of new generation capacity.
• 6.4 Bcf/d of potential gas burn.
• Included in this list are 6 DENA projects with a potential gas burn of 700 MMcf/d.

Power projections for North America call for an additional 200,000 megawatts over the next 12 years. 90 percent of the new capacity is expected to be gas-fired combustion turbine.

Duke Energy’s North American Wholesale Energy Group is prepared to meet that growing demand. We own, operate or have under construction 10,300 megawatts. We have another 13,500 megawatts in advanced development that will be operational by 2003.

Just within the second quarter of this year, we delivered four new merchant plant facilities to market. To our knowledge, no other company has ever delivered four facilities within that timeframe. In 2001, we will bring on six facilities. In 2002 and 2003, we will deliver 10 to 11 facilities - each year.

You’ll note that our regional approach allows us to connect gas supply, power generation and trading and marketing capabilities, increasing the value we’re able to deliver.

Our merchant generation portfolio has grown 72% over three years. In 1997 our portfolio consisted almost entirely of our regulated generating plants in the Carolinas. (19,900 MW gross). Since then we’ve grown dramatically - and strategically.

Our merchant power plant business is based on a portfolio management strategy through which we buy or build, manage and sell energy products and assets in much the same way investors manage their investment portfolios. Selling positions is critical to capturing value and aligning our business with market realities, so you’re seeing lots of movement within our portfolio.

Last week we announced the sale of Attala, a 500 MW combined cycle gas plant under construction in Mississippi. As with the sale of the Hidalgo facility in Texas, we are able to realize the inherent value of being first to market when presented with the opportunity to sell assets at a favorable return.

On this graph, the merchant and regulated distinction is based on our expectation that deregulation will move forward in the Carolinas in 2001.

Through our trading and marketing capabilities we are able to multiply - many fold - the value within our regional energy businesses. We capture intrinsic and extrinsic value that a pure generator or pure trader alone couldn’t capture.

Consider this: for every megawatt of generation we operate and control, we trade eight times as much power.

Our trading and marketing group continues to grow its volumes, and ranks in the top three in both gas and power trading.

Power markets in California have been particularly volatile in recent months. So have politics and public opinion! And we’ve all heard the talk about the possibility of “re-regulation.”

But the deregulated genie is out of the bottle, and progress toward a fully competitive electric market is in the best interest of consumers everywhere. Power shortages in California - and the West in general - are due to a lack of generation supply.

Price caps put into effect in some states, and considered by others, would reverse much of the progress toward building an efficient free market. Price caps send artificial signals through the marketplace - a throwback to the age of strict regulation.

California is a state that for the last decade hasn’t built any meaningful generating capacity, despite the fact that the demand for electricity has risen 10,000 megawatts. Instead, California has relied on power from surrounding states - states that are also experiencing population growth and the associated increase in demand by their own native load customers. In a free market, when you’re short capacity, electricity gets expensive. We saw much higher prices in the Midwest last year, and in the Northeast the year before.

That’s when the market responds. In the case of the Midwest, Duke Energy built two 500-megawatt plants that went into service this summer. Several other companies built plants as well, and the result of that market responsiveness has been more moderate power pricing in the Midwest this summer.

Price caps are not the answer to high power prices and market volatility. The real answer lies in creating a market that facilitates the construction of new generation, provides equal access and opportunity for all participants. Deregulation and true competition at the wholesale and retail level is what we need to strive for.

We’re doing that - in the Carolinas, where we’re working with the legislatures and study commissions to determine the best course of action. That includes sharing and learning from the lessons of California. We are dedicated to moving deregulation forward in our home states at a pace that allows customers and investors the greatest level of performance and value.

And we’re working to be a part of the solution in California. We proposed to Governor Davis the delivery of 3,000 megawatts of new supply and a five-year, fixed-price supply contract to incumbent utilities.

We continue to be bullish on the California market, and are planning to expand two of our gas-fired plants there - Moss Landing and Morro Bay - for an additional 1,250 megawatts. These expansions are expected to be on line for the summer of 2002.

We are replicating our successful domestic merchant plant strategy in three key international regions.

In Asia-Pacific, we see a power consumption growth rate of 3 percent in Australia and New Zealand, reflecting advanced industrial development in the region.

The natural gas consumption growth rate for the region is around 3.6 percent per year. That growth is being driven by increasing industrial gas use, use in peaking power plants, and connection of natural gas to significant new market areas like Sydney.

In Latin America, we’re seeing a power consumption rate of 4.5 percent and gas consumption rate of 5 percent. These higher energy growth rates reflect decades of relatively high population growth, increasing economic prosperity and stability, as well as grid expansion.

In Europe, the regional natural gas consumption growth rate is 4 percent per year, two times that of the U.S. Growth is driven largely by increasing use of natural gas for power generation, and the fact that gas is incrementally replacing older units.

Power consumption growth in Europe is around 2 percent per year, slightly lower than the U.S.

The extraordinary potential of the Latin American markets has brought Duke Energy into Argentina, Belize, Bolivia, Brazil, Ecuador, El Salvador and Peru. In these countries, we are well on the way to integrating markets and opening up countless opportunities for customers and investors.

Our activities in Latin America include energy trading and marketing, hydroelectric and thermal generation, electric and natural gas transmission.

We have controlling interest in 5,100 MW of generation capacity, and we will soon begin building our first gas-fired generating plant in Brazil.

We’re doing a great deal of gas infrastructure work in Asia Pacific. In fact, Duke Energy is proud to play a role in the Summer Olympics in Australia. On August 16, Duke Energy International completed its 495-mile Eastern Gas Pipeline in Australia, bringing competition to that country’s natural gas market for the first time.

Through agreements with Duke Energy Australia Trading and Marketing, the pipeline will supply gas to Energy Australia to fuel the Sydney Games and the Olympic torch, the international beacon of competition.

As Australia’s gas supply infrastructure continues to grow, competition in the market will spread. Our wholesale gas supply management expertise will position Duke Energy as the region leader.

Duke Energy International is targeting key regions of the world where free markets prevail, so Europe is our logical next focus.

Earlier this year we established ourselves as an energy trading and marketing company in Europe with the purchase of the leading independent gas and marketing company in the Netherlands. We will quickly build upon this initial platform and offer additional energy and risk management services to meet the changing needs of energy customers throughout Europe.

Let’s return to where we started - supply and demand. Because that’s where wealth creation comes from - the ability to know the cycles, act on them and capture value.

At Duke Energy, we’ve had clear success in maximizing value. The fact that our integrated businesses span both supply and demand gives us a definite edge. As you have seen today, we represent a substantial part of the demand growth. At the same time, we’re processing, delivering and storing.

Looking forward, we see tremendous opportunities and upside potential.

I’ve pledged that we’re going to deliver on our earnings promise of 8 to 10 percent growth. And we will. Our second quarter earnings were strong:

Earnings were up 14 percent over last year. Earnings before interest and taxes increased 47 percent for the quarter. Revenue for the quarter increased 133 percent to $10,926 million. In the second quarter, our high-growth Energy Services businesses posted EBIT of $199 million for the quarter, a 665-percent increase over the same period last year.

And we’re going to continue delivering the growth and shareholder value to which we’ve committed. Our merchant strategy is working because our people work hard and work smart. They know energy and markets, they integrate to maximize results and returns, and they move quickly to create value.

DUK share price has increased 49.25 percent year-to-date. Our total return year- to-date is 58 percent.

We are pleased that our stock price is enjoying an upswing. I hope you are, too! But we’ve only just begun to tap the enormous potential that resides within our company. Our tank is full - and we’re raring to go!