TGS

Business Context and Reporting Period

Company: Transportadora de Gas del Sur S.A. (TGS)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Year ended December 31, 2006
Business Overview: TGS is a major Argentine natural gas transporter and producer of natural gas liquids (NGL). Its operations are divided into three segments: regulated gas transportation, non-regulated NGL production and commercialization, and other services (midstream and telecommunications). The company operates a pipeline system connecting southern/western gas reserves to consumption centers, including Greater Buenos Aires.

Key Financial Metrics

Note: All figures are in millions of constant Argentine pesos (Ps.) unless otherwise stated.

Segment Performance (2006):

• NGL Production: Ps. 726.4 million (55% of total revenue); driven by higher international prices and a 17% production increase.
• Gas Transportation: Ps. 492.0 million (38% of total revenue); increased due to new firm contracts from the San Martín pipeline expansion.
• Other Services: Ps. 91.1 million (7% of total revenue); grew 56% due to midstream and telecom expansion.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 23% year-over-year. The NGL segment contributed Ps. 180.1 million to this growth, while transportation added Ps. 32.0 million.
• Profitability: Net income rose 65% to Ps. 358.1 million, primarily due to NGL performance and a reduction in foreign exchange losses.
• Debt Reduction: Total loans decreased by approximately Ps. 518 million (20% reduction) as the company aggressively paid down indebtedness restructured in 2004. Consequently, credit ratings were improved from B- to B by Fitch and Standard & Poor's.
• Financial Results: Net financial results improved by Ps. 20.1 million, driven by lower foreign exchange losses (due to reduced peso devaluation) and higher interest income, partially offset by higher interest costs on remaining debt.
• Operational Milestone: The company achieved a record three-day peak demand of 74.6 MMm³/d and obtained OHSAS 18001 certification for its safety management system.

Outlook, Risks, and Management Commentary

Management Outlook: TGS aims to become the leading manager of future gas transportation expansions. The strategy focuses on securing long-term gas supply agreements for the NGL segment to protect margins and consolidating midstream construction and maintenance businesses. The company plans to manage a new 7.0 MMm³/d expansion starting in 2007, financed by government trust funds.

Key Risks and Contingencies:

• Regulatory Uncertainty: The renegotiation of the gas transportation license and tariff framework remains stalled. UNIREN (the government renegotiation unit) has presented proposals deemed unacceptable by TGS. The lack of tariff adjustments threatens the economic value of the regulated business.
• Energy Supply Constraints: Argentina faces a critical energy deficit with supply failing to meet growing demand. The government is relying on trust funds rather than tariff adjustments to finance infrastructure, which management views as less sustainable long-term.
• Legal and Tax Disputes:
  • Turnover Tax: Pending disputes with the Province of Buenos Aires regarding NGL sales tax exemptions (provision of Ps. 28.6 million recorded).
  • Debt Taxation: A dispute with the CNV regarding the tax exemption status of notes issued in 2004; no provision recorded as management believes it has grounds to defend the position.
  • Provincial Taxes: Disputes with Santa Cruz and Río Negro provinces regarding turnover tax on fuel gas (provision of Ps. 16.2 million recorded).
• Debt Covenants: The company is subject to restrictive covenants limiting new debt, capital expenditures, and dividend payments based on debt-to-EBITDA and coverage ratios.

Investor Verification Checklist

• Tariff Renegotiation Status: Verify the current status of negotiations with UNIREN and the likelihood of a tariff adjustment that restores the economic value of the regulated transportation segment.
• NGL Price Sensitivity: Assess the sustainability of NGL margins given the reliance on international export prices for propane, butane, and natural gasoline.
• Debt Structure and Covenants: Review the specific terms of the 2004 restructured debt, particularly the "early cash surplus amortization" clauses and restrictions on future capital expenditures.
• Regulatory Framework: Monitor the Argentine government's "Gas Trust Fund" mechanism for financing expansions and its impact on TGS's role as a manager versus an owner of new assets.
• Tax Provisions: Track the resolution of pending tax disputes in Buenos Aires, Santa Cruz, and Río Negro, which could impact future cash flows.