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: Nine months ended September 30, 2014

Business Overview: TGS operates in Argentina, primarily engaged in natural gas transportation and the production and commercialization of natural gas liquids (Liquids). The company also provides midstream services (gas conditioning, compression) and telecommunications. The financial statements are prepared in accordance with IFRS (IAS 34) and have been subject to a limited review by Price Waterhouse & Co. S.R.L.

Key Financial Metrics

Revenue and Profit (Nine Months Ended Sept 30, 2014):

• Net Income: Ps. 77.8 million (Increase of Ps. 28.8 million vs. Ps. 49.0 million in 2013).
• Operating Profit: Positive variation of Ps. 338.4 million, though the Natural Gas Transportation segment lost its operating surplus due to cost increases and tariff delays.
• Net Revenues:
  • Liquids Segment: Increased by Ps. 1,121.8 million (approx. 75% of total revenue). Driven by FX rates, higher international prices for propane/butane, and favorable weather.
  • Natural Gas Transportation: Increased by Ps. 56.3 million (approx. 18% of total revenue). Driven by new rate schedules (Resolution I-2852) and higher export/interruptible services.
  • Other Services: Increased by Ps. 135.5 million.

Expenses and Margins:

• Operating Costs: Increased by Ps. 959.8 million, primarily due to higher variable production costs (natural gas prices) in the Liquids segment, export taxes, and labor costs.
• Net Financial Expense: Increased by Ps. 304.1 million. Key drivers included a Ps. 264.4 million foreign exchange loss (due to 29% currency devaluation), Ps. 80.5 million loss on derivatives, and Ps. 72.5 million higher negative interest.
• Income Tax Expense: Ps. 39.6 million (vs. Ps. 31.2 million in 2013).

Cash Flow and Liquidity:

• Operating Cash Flow: Net increase of Ps. 198.5 million, driven by the Liquids segment.
• Financing Activities: Cash outflows were primarily due to the cancellation of financial debt principal in May 2014 and dividend payments.
• Debt: In early 2014, TGS refinanced debt by issuing 2014 Notes (US$255.5 million) to exchange a portion of 2007 Notes. The company maintains a U.S. dollar-denominated net liability position.

Material Changes vs. Prior Period

• Foreign Exchange Impact: The 29% devaluation of the Argentine peso significantly increased financial expenses and foreign exchange losses, negatively impacting comprehensive income despite higher nominal revenues.
• Tariff Adjustments: Resolution No. I-2852 implemented a progressive tariff increase (8% to 20%) for natural gas transportation starting April 2014. However, management notes this does not fully compensate for sustained cost increases or comply with the retroactive provisions of the 2008 Transitional Agreement.
• Segment Performance: The Liquids segment saw substantial revenue growth due to international price increases and FX rates. Conversely, the Transportation segment's operating surplus disappeared due to the lag between cost increases and tariff adjustments.

Outlook, Risks, and Contingencies

Management Commentary and Outlook:

• Tariff Negotiations: TGS has filed a motion for reconsideration with ENARGAS regarding the methodology to recover tariff increases retroactive to September 2008. The company continues negotiations with the National Government for the adjustment of the Charge for Access and Use (CAU).
• Operational Goals: Focus on restraining O&M costs, strengthening safety protocols, and managing natural gas supply for the Liquids segment.
• Expansion: Continued management of pipeline expansion works under the Gas Trust Fund Program.

Risks and Contingencies:

• Regulatory Risk: Ongoing disputes over tariff adequacy and the implementation of the 2008 Transitional Agreement. The company is evaluating alternative courses of action regarding the Integral License Renegotiation Agreement.
• Legal Claims:
  • Turnover Tax: Provision of Ps. 117.7 million recorded for potential turnover tax on natural gas used as fuel. Management believes this can be recovered via tariff increases.
  • Presidential Decree Challenge: TGS obtained a preliminary injunction against billing for certain charges (Decree No. 2067/08). If the injunction fails, the estimated net loss impact for the nine-month period would be Ps. 87.8 million.
  • ICSID Arbitration: The arbitration initiated by Enron Corp. and Ponderosa Assets against the Argentine Republic was suspended until January 12, 2015.
• Financial Risk: Significant exposure to foreign exchange fluctuations due to U.S. dollar-denominated debt and peso-denominated revenues.

Key Facts for Investor Verification

• Tariff Recovery Status: Verify the progress of the motion for reconsideration filed with ENARGAS regarding the retroactive application of the 2008 Transitional Agreement tariffs.
• Debt Refinancing Terms: Confirm the maturity profile and interest rates of the 2014 Notes issued to replace the 2007 Notes.
• Legal Provision Adequacy: Assess the sufficiency of the Ps. 117.7 million provision for turnover tax and the Ps. 20.0 million provision for sales tax contingencies.
• FX Sensitivity: Monitor the impact of Argentine peso devaluation on future financial expenses and the company's ability to hedge or pass costs to customers.
• Liquids Segment Volatility: Evaluate the sustainability of revenue growth in the Liquids segment, which is heavily dependent on international commodity prices and exchange rates.