day, and welcome to the ONE Gas Second Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Brandon Lohse. Please go ahead.
Good morning, and thank you for joining us on our Q2 2018 earnings conference call. This call is being webcast live and a replay will be made available. We will be happy to take your questions upon completion of our prepared remarks. Reminder that statements made during this call that might include ONE Gas expectations or predictions should be considered forward looking statements and are covered by the Safe Harbor provision of the Securities Acts of 1933 34. Actual results could differ materially from those projected in any forward looking statements.
For a discussion of factors that could cause actual results to differ, please refer to our SEC filings. Our first speaker this morning is Curtis Dinan, Senior Vice President and Chief Financial Officer of ONE Gas. Curtis?
Thanks, Brandon. Good morning, everyone, and thank you for joining us today. Beginning with our financial results, net income for the Q2 2018 was $20,400,000 or $0.39 per diluted share compared with $20,600,000 or $0.39 per diluted share for the same period last year. As in the Q1, our 2nd quarter results reflect increases from new rates in Texas and Kansas that were approved in 2017. Higher sales volumes net of weather normalization, primarily from colder weather in 2018 compared with 2017 and higher volumes from transportation customers.
During the quarter, heating degree days were 29 percent colder than normal and 54% colder than the same period last year. Net margin increased $2,400,000 or $0.05 on an earnings per share basis compared with the prior year. Operating costs for the Q2 were $6,700,000 higher compared with the same period last year due to increased employee incentive accruals and medical plan expenses. Regarding tax reform. In compliance with the accounting authority orders in each of our regulatory jurisdictions, we have established a regulatory liability for the difference in federal taxes included in our rates that have been calculated based on a 35% statutory income tax rate and the new 21% statutory income tax rate.
The establishment of this regulatory liability resulted in a $9,200,000 reduction to our revenues in the Q2 2018 or $7,000,000 net of tax. This was partially offset by a $3,800,000 reduction in our income tax expense. This timing difference between the revenue deferral and the reduction in our income tax expense created a $0.06 negative impact to our results this quarter, partially reversing the positive $0.13 impact we experienced in the Q1. We expect most of the remaining $0.07 to reverse in the Q3. While the annual effect of tax reform is negligible, it will continue to impact the timing and distribution of our quarterly earnings profile.
Our earnings profile has some seasonality to it. So in quarters like this Q2, where seasonal earnings are lower, the impact of tax reform will be negative and vice versa. Earlier this month, the ONE Gas Board of Directors declared a dividend of $0.46 per share, the same as the previous quarter. This dividend is consistent with the company's guidance for 2018. As we have indicated previously, we expect the average annual dividend increase to be 7% to 9% between 20172022 with a targeted dividend payout ratio of 50 percent to 65 percent of net income.
We updated our 2018 net income guidance range to $167,000,000 to $178,000,000 Our updated guidance reflects the positive impacts from colder weather and stronger transportation revenues in the first half of twenty eighteen. Included in the guidance is a $5,000,000 increase to O and M expense and a $5,000,000 decrease to other expense. This change relates to the finalization of our pension and OPEB service and non service cost that was completed after we originally issued guidance, but does not change the total expense. Earnings are expected to be in a range of $3.15 to $3.35 per diluted share with an achieved ROE of 7.7 percent. We also updated our 2018 capital expenditures guidance to a range of $375,000,000 to $390,000,000 This increase relates to system expansions primarily in Oklahoma.
At June 30, 2018, our current authorized rate base, defined as the rate base established in our latest regulatory proceedings, including full rate cases and interim rate filings, was approximately $3,000,000,000 With additional investments in our system and other changes in the components of our rate base that have occurred since those regulatory filings, we project that our rate base in 2018 will average approximately $3,500,000,000 with 42% of that being our rate base in Oklahoma, 31% in Kansas and 27% in Texas. And now I'll turn it over to Pierce Norton, ONE Gas President and Chief Executive Officer. Pierce?
Thanks, Curtis, and good morning, everyone. I'd like to give you an update on the recent regulatory activity in our service areas and then we'll take questions after that. Beginning in Oklahoma, in March we filed our 2nd annual performance based rate change application since the general rate case that was approved in January of 2016. We identified a $5,600,000 credit to our base rates, which includes the impact of tax reform. We had a hearing before the administrative law judge on July 27th and we expect an order sometime in Q3.
Now to Texas. We received approval for the filings made under the Gas System Reliability Infrastructure Program or GRIP for all customers in the West Texas service area for an increase of $3,500,000 which took effect in July. This increase is offset by $4,700,000 decrease to rates due to the reduction in the federal income tax rate. A one time refund of $2,400,000 was distributed in May for changes to the tax rate for the period between January 1, 2018 to the date when the new rates were implemented. New rates also went into effect in July for all customers in the Central Texas service area after we received approval for the $3,300,000 increase made under the GRIP filings.
This increase is offset by $4,900,000 decrease to rates due to the reduction of federal income tax. A one time refund of $2,500,000 was made in May for changes to the tax rate for the period between January 1, 2018 to the date when the new rates were implemented. Now on to Kansas. On June 29, Kansas Gas Service filed a request with the Kansas Corporation Commission or KCC for a net increase in rates of 42,700,000 dollars reflecting investments in the system improvements and changes in the operating costs necessary to maintain the safety and reliability of its natural gas distribution system. The requested net increase in rates would result in an increase in the operating income of approximately $31,000,000 Since the last general rate case, Kansas Gas Service has invested $179,000,000 in its systems and facilities.
This request would increase the average residential customer's natural gas bill by $5.67 per month. Filing is based on a 10% return on equity and a 62.2% common equity ratio. For every 25 basis point change in our requested ROE, the impact on the operating income is approximately 2,200,000 For every 1% change in our requested equity ratio, the impact on the operating income is approximately 1,400,000 dollars The filing represents a rate base of $1,000,000,000 compared with a $947,000,000 included in our last rate case, plus previously approved GSRS eligible investments. The KCC has 240 days to consider Kansas Gas Services filing and new rates are expected to be effective sometime in the Q1 of 2019. To close, I would like to turn our attention to our 3,500 outstanding employees and thank them for their focus and commitment to safely and reliably deliver natural gas to our customers.
Operator, we're now ready for questions.
Thank And we will take our first question from Sarah Akers with Wells Fargo.
Hey, good morning.
Good morning, Sarah.
Can you just expand on the weather normalization mechanisms? Because it looks like the cold weather was in Kansas and Oklahoma, but I thought you had 100 percent weather normalization in place. So can you just walk through that?
So probably the easiest way to explain that, Sarah, is we do have weather normalization in 100 percent of our territories now in all three states. But weather norm works a little bit differently as it goes throughout the year. When you have extremely cold weather or extremely warm weather in the shoulder months, the weather norm doesn't act perfectly, meaning a one for one swap between what the weather would have given you in either way. So any time that you get it works really well for us for the you can get into a little bit of imperfection when you have the extremely cold weather.
Okay. And then can you talk about the drivers of the higher transportation volumes this year?
Well, part of it is actually due to weather.
Okay.
We have it's when you have the colder weather, you do have some weather sensitivity to our transportation volumes. And the other is just a slight amount of growth in the transportation volume arena.
Got it. And then lastly,
somewhere in that area, overall three territories. Okay. Percent, somewhere in that area, overall three territories.
Great. Thanks a lot.
Thank you, Sarah.
And next we will hear from Chris Sighinolfi with Jefferies.
Hey, good morning, Chris. How are you?
Good morning, Chris.
Just two questions for me. I think they're both for Curtis actually. One is, can you just remind me, I know that there was some reclassification of some of your expense guidance with the tax changes and I think it wanted to do with pension at the end of last year. And so with regard to the update in guidance between O and M and other, can you just remind me about what those moving parts are and how to best think about them?
Yes, Chris. So I think you might be referring to the pension standard that we adopted on January 1 this year. And what that does is it separates pension and OPEB costs between service costs and non service costs. Previously, all of those expenses were in the O and M line beginning January 1, only the service cost stays in O and M and the non service cost goes down into other expense. And so in last year's 10 ks, we provided what the pro form a for 27 would look like post adoption of that standard so that it's comparable in our actual numbers between 2017 2018 and going forward.
What happened in our guidance is we didn't have the final split between service and non service cost when we issued guidance earlier this year. And in this update, we have all that. And so it resulted in a little bit of that expense going back into O and M as opposed to being another expense.
Okay. So some of the guidance update did have to do with the interplay between those two items?
It did. No change in the total, just the geography on the income statement.
Okay. That's super helpful. Thanks, Curtis. And then the follow-up for me is, obviously, very strong results. You mentioned the weather dynamics and obviously the timing profile for the weather norm and the throughput obviously leading to some better transportation performance.
Just curious as I pivot to the cash flow statement, you guys had a very, very strong working capital benefit. I'm assuming it's related to that. But I guess two questions. 1, am I right in interpreting the benefit that way? And 2, what does that mean in terms of potential working capital needs or draws the back half of
the year? So a couple there's several moving parts going on in those totals. Part of it is Pierce in his comments talked about a refund of some of the taxes that were collected in the first half of this year. So we'll have that continuing in the back half. One of the bigger drivers though is with the colder winter that we had, we pulled much more gas out of storage.
And so we haven't yet returned to the our normal injection levels at this point. We're in that process now, but the difference is we're reinjecting gas at a lower cost than the gas we pulled out of the ground. So we have roughly 50 Bcf of storage that's leased. We don't put a full 50 Bcf in, but we still have more gas to put in the ground. So that will use some working cap in the last half of the year, just not to the extent we've seen the past few winners.
Okay. So more to fill relative to where you might have stood in past cycles just given how cold it was, but the price point per M going back in is lower than it was in inventory at to begin with. Is that in terms of understanding? That's correct. Okay.
Yes, exactly right.
Okay. Thanks a lot guys. This is very
helpful. Thanks, Chris. Thanks, Chris. Thanks, Chris.
And with no further questions, I'd like to turn the call back over to Mr. Lohse for any additional or closing remarks.
Thank you for joining us this morning. Our quiet period for the Q3 starts when we close our books in early October and extends until we release earnings in late October. We'll provide details on the conference call at a later date. Have a great rest of your day.
And that does conclude our call for today. Thank you for your participation. You may now disconnect.