National Fuel Gas Co (NFG) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the National Fuel Gas Company's third quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS.] I would now like to turn the presentation over to your host for today's call, Ms. Margaret Suto, Director of Investor Relations. Please proceed, ma'am.

Thank you, Steven. Good morning, everyone. Thank you for joining us on today's teleconference call for a discussion of last evening's earnings release. Today's presenters are Phil Ackerman, Chairman, President, and Chief Executive Officer of National Fuel Gas Company; Ron Tanski, Treasurer of National Fuel Gas Company; and Jim Beck, President of Seneca Resources Corporation. At the end of the prepared remarks, we will open the discussion to questions.

Also, since this call is being publicly broadcast, we remind you that today's teleconference discussion will contain forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995. While National Fuel's expectations, beliefs and projections are made in good faith and are believed to have a reasonable basis, actual results may differ materially. These statements speak only as of the date on which they are made, and you may refer to the most recent National Fuel Gas Company Form 10-Q for a listing of certain, specific risk factors.

With that, we will begin with Ron Tanski.

Thank you, Margaret. Good morning, everyone. In our efforts to provide as much information as possible regarding our quarterly operations, I hope all the details in last night's earnings release did not obscure the fact that we had a pretty good quarter, where earnings from continuing operations for the quarter were at the high end of our previously-announced guidance. Because of the presentation of our check operations as discontinued operations at June 30th, comparisons to historical periods become a bit more complicated. That's why we put together the chart on page six of the earnings release to somewhat categorize earnings for the first two quarters, the current quarter, and give revised guidance for the fourth quarter.

To further complicate matters, during the continued winding up of our Bulgaria and Italy power projects over the next year, the minor expenses that we may need to incur there will be included in our Corporate and All Other category. Because we have no actual operations in Bulgaria or Italy, our accountants had some concerns about classifying the activities as discontinued operations. However, we don't expect the spending to be large, and it's not expected to have any significant impact on future earnings.

Apart from the noise due to the change in the presentation of the check operations and excluding the tax entry relating to those operations, performance in most segments was generally in line with our expectations. However, continued strong commodity prices in the E&P segment, and the lower-than-projected loss in what was formerly the International segment were the primarily -- primary factors that helped us reach the high end of the earnings guidance range.

During the last teleconference, I mentioned that we had reached a settlement in our New York rate case. Last week, the New York Commission approved the settlement, and new rates will be going into effect on August 1st. While reconciling certain regulatory liability accounts in preparation for implementing -- implementing that settlement agreement, Utility recorded an out-of-period adjustment, noted on the second page of the earnings release. The adjustment essentially caught up the balance in that account and should have no impact on future earnings trends.

Now there are a number of additional steps that the settling parties agreed to undertake regarding furthering competition with marketers, a low-income program, and an economic development program. Those activities begin in August with collaboration discussions among the parties covering those topics. However, the results of those discussions are not expected to have any appreciable impact on the earnings projections that I'll cover in a few minutes.

Since the Pennsylvania settlement has been in place since April 15th and the New York settlement will be effective next week, let me repeat the major components that you can factor into your earnings models. For Pennsylvania, utilize a rate base of approximately $270 million. For New York, you should assume a rate base of between 640 and $650 million. Now, each settlement was essentially a black-box settlement for most of the rate components, however, for your earnings models, you should factor in an approximate capital structure, as follows -- 45% long-term debt, at a cost rate of 6.65%; 5% short-term debt, at a cost of 3.5 to 4.5%; and a 50% equity component, with an implied rate somewhere between 10 and 11%.

Our press release announced preliminary earnings guidance range of $1.95 to $2.10 per share for fiscal 2006. I'll spend a little time to lay out the expected segment contributions to those earnings. On the regulated side, the utility rate settlements will be in effect for all of fiscal 2006. Very broadly, our preliminary expectations are that the utility segment will generate earnings of between $0.58 to $0.64 per share. Earnings in the Pipeline and Storage segment next year will continue to be affected by preliminary spending on our Empire Millennium Connector and Tuscarora extension projects. Because of our conservative posture on development expenses, we expect to fully reserve against these preliminary costs until our pipeline certificate application process is well underway.

In addition, the non-recurring sale of Ellisburg base gas that produced $0.03 of earnings this year will not recur in 2006. As a result, earnings in the Pipeline and Storage segment are expected to be in the range of $0.54 to $0.57 per share. Overall, on the Regulated side, we're looking at preliminary guidance of $1.12 to $1.21 per share. In our Exploration and Production segment, Jim Beck will provide a lot more details in a few minutes, but with the same production range as last year, the falling off of some old hedges and continued strong commodity prices, we expect earnings in this segment to be in the range of $0.75 to $0.81 per share. The Marketing segment is forecast to contribute approximately $0.02 per share, with approximately $0.05 coming from the Timber segment, while Corporate and All Other will contribute $0.01.

Our preliminary capital expenditure forecast for fiscal 2006 is expected to be as follows -- in the Utility segment, the budget is $56 million; in the Pipeline and Storage segment, we've budgeted $35 million; and in the E&P segment, the 2006 budget is between 110 million and $115 million; finally, minor amounts in Timber and Corporate and Other, totaling approximately $2 million are projected, for a total of between 203 to $208 million. At June 30th, our balance sheet has improved to show an equity component of over 53%, and the cash we've received from the sale of United Energy will allow us to finance the bulk of the injection of our storage gas without need to tap our commercial paper or bank lines. We're in the process of renewing our syndicated credit facility, which we expect to move along smoothly, so we're quite comfortable with our liquidity situation. At the current dividend rate of $1.16 per share, divided by the projected earnings, gives you a reasonable payout ratio of approximately 57%.

Now let me turn it over to Jim to discuss more details about the Exploration and Production segment.

Well, thank you, Ron, and good morning, everyone. Seneca had a very positive quarter, as the strength in our commodity markets continued to support our aggressive drilling program. In addition to discussing the hows and whys of our quarterly results, we will provide you with a detailed review of our 2006 forecast, a complete summary of Seneca's financial results, and a 2006 forecast can be found in yesterday's press release on pages 16 to 18.

Earnings for the quarter were down 7%, while production was down 11.6%. Commodity prices, after hedging, increased nearly 18% for gas and 4% for oil. Our U.S. production decreased 2.2 Bcfe from last year's level. In our East and West divisions, production was nearly flat, thanks to our successful drilling programs. As expected, Gulf production declined nearly 30% to 4.9 Bcfe. New production scheduled to start in 2006 at East Cameron 213, Viosca Knoll 77 and 432, Eugene Island 320, and Vermilion 96, and potentially High Island 37, should help to mitigate the Gulf's decline rate. The good news for the quarter came from Canada, where production was up 22% and we are entering our most active drilling quarter right now.

Seneca remains very active in California. The new waste gas scrubber there will require some modification to improve its efficiency, and it'll be early fiscal 2006 before we see its full benefits. Seneca also committed to drill an additional 20 wells in the fourth quarter in California, as the rig we are using will be under contract to another company for two years, once it's finished its drilling for Seneca. We've also seen a continued improvement in California heavy oil basis differential to NYMEX. During the quarter it decreased from an average $12.38 in April to an average $11.16 in June.

Other notable operational items for the quarter were covered in yesterday's press release. Our key areas for future exploration activity remains Canada and the East division. We continue to see renewed interest in the Appalachian Basin, and the fact that Seneca controls nearly 1 million acres there has placed us in an enviable position. We anticipate a big increase in activity in this area over the next five years. The only limitations to our expanding our programs are the very tight rig market and the staffing needed to develop more drilling activity.

Seneca continues its onshore exploration and development activity. We will achieve our goal of over 200 wells in 2005. National Fuel's Board of Directors recently approved increasing Seneca's capital budget to 139 million, to cover development of facilities in the Gulf, increased spending for a 3-D seismic program, two additional wells, and a pipeline in the Sukunka area in Canada, and the additional drilling in California.

Looking forward to our expectations for the fourth quarter, production should be between 12 and 14 Bcfe. We are allowing for at least two shutdowns for hurricanes before October. If that occurs, production will be slightly lower than that of each of the first three quarters of this year. However, we are still on target to reach our annual production goal of 50 to 55 Bcfe.

Looking ahead to fiscal 2006, here's a breakdown of our forecast. A summary of this guidance can be found on page 18 of yesterday's press release. Production will be in the 50 to 55 Bcfe range, with it comprised of 58% gas, 42% oil. This is the same range as 2005, and this guidance does not include any production from any new offshore wells that will be drilled next year, nor does it include any production from the Sukunka well, which is currently drilling. Capital spending will be in the 110 to $115 million range. While the expected spending by division is included in yesterday's press release, we maintain a living budget, and we will move the capital dollars to the division where we are achieving the best results.

Pricing used in the forecast is NYMEX-based as of a price of May 17th, 2005. The basis-adjusted average prices for 2006 used in the forecast are gas, $7.10 per Mcf and oil, $41.68 per barrel. This compares to our 2005 nine-month actual, unhedged basis-adjusted prices of gas, $6.49 per Mcf and oil, $41.59 per barrel.

Next is our breakdown on our dollars per Mcf cost basis. We are keenly aware that as production decreases, our unit cost per Mcf will increase, and we are making every effort to bring our expenses in line with production. Looking at, first, DD&A will be in the range of $1.70 to $1.80 per Mcfe. This is nearly flat to 2005 expected results in actual dollars, but an increase on an Mcf basis due to Canada and the Gulf. LOE, including taxes, but excluding other operating expenses, will be in the range of $0.97 to $1.10 per Mcfe. This represents an increase from our 2005 year-to-date actuals. We are starting to see across-the-board increases in costs for all services, and it is expected that this increase -- to see an increase even more, as many supplies and services are in short supply.

Now, a quick comment about the other operating expenses listed on page 18. These are mainly for the gas plant and accretion expenses.

Moving on to G&A expenses for the year we’ll be in the range of 22 to $24 million. This range is flat to 2005 actuals. We continue to emphasize cost control, despite an ever-increasing demand for experienced personnel, and the continued expansion of our East division staff. Hedging for 2006 can be summarized as follows -- we have 12.5 Bcf of gas production hedged at an average price of $6.79 per Mcf, and 1.9 million barrels of oil production hedged at an average price of $34.14 per barrel. Based on the average NYMEX prices we have just provided, the earnings sensitivity for -- to price change for the 2006 forecast is as follows -- for each $0.25 change in the average gas price for the year, earnings will change by $0.04 per share; for each $1.00 change in the average oil price, earnings will change by $0.01 per share.

For fiscal 2006, we have three key focus areas -- first is to live within cash flow, second is to continue to grow via the success of the drill bit, and, lastly, to continue to pursue an acquisition in Seneca's core onshore key areas.

At this point, then, I'll turn it back to Phil.

Thank you, Jim. The latest developments with our Czech Republic assets demonstrate that, once again, the people of National Fuel have done a remarkable job of seizing opportunities to generate cash and earnings. I dare say that few of our listeners would have predicted a $25 million gain on the sale of those assets on top of a $70 million dividend from them earlier in the year. I also want to remind you that we had a non-recurring pickup in earnings in the December quarter a year ago associated with the change in the Czech income tax rate. Also, earlier this year, we had a non-recurring gain from the sale of some base gas, which Ron mentioned, which paved the way for increased sales of storage service.

Overall, we have a conservative accounting philosophy. For example, we expensed or reserved for all project development expenditures in Italy, Bulgaria, and the Empire and Tuscarora expansion projects. Thus, whatever value we realize for Italy and Bulgaria should result in further positive, non-recurring items. While I don't expect that value to be huge, I do think it says a lot if non-recurring items tend to be positive as opposed to negative. In my view, non-recurring items generally mean that recurring reported results have failed to reflect economic reality. This is frequently the result of accounting rules, which, after all, are supposed to be conservative. But nevertheless, I think positive non-recurring items tend to mean that the economic reality of other periods was better than the GAAP numbers, and negative non-recurring items tend to mean that the economic reality of other periods was worse than the GAAP numbers.

All in all, beginning with a $100 million gain on the non-recurring timber sale in 2003, I'd like to remind everyone that these positive, non-recurring items have added to our consistent history of providing solid returns from our traditional operations. I hope to continue our string of pleasant surprises in that regard.

Now that the energy bill is virtually within our grasp, there seems to be a lot of renewed speculation about the impact of PUHCA repeal. My take on it is that the impact today is a lot less than it would have been several years ago, since in those several years, the SEC has been more flexible and lawyers have been more inventive in getting transactions done, which PUHCA might have otherwise stymied. Furthermore, also in those several years, the stock prices of many companies have advanced, and state commissions have become more aggressive in demanding the lion's share of savings from synergies, making the fundamental economics of paying premiums more difficult. Still, in all, I expect that there will be a round of renewed interest, analysis, and discussion, and that a flurry of deals will be struck in the next 12 months, whether or not they ultimately prove to be beneficial for shareholders.

More important for all gas companies, are those provisions of the energy bill, which will serve to enhance gas supply, since gas supply is the life's blood of the industry. And while the energy bill is a step in the right direction, we cannot afford to be complacent, since more access to drilling is still a long-term need. Finally, I'd like to pat the National Fuel team on the back for crafting a win-win rate settlement in New York, for concluding a successful sale of the Czech asset, for bringing in another quarter of production consistent with our guidance, and for continuing to provide safe and reliable service for all our customers.

With that, Operator, we'd like to take questions at this time.

[OPERATOR INSTRUCTIONS.] And our first question comes from Mike Heim of A.G. Edwards.

Thanks. Ron, I'm just looking for a little bit more details on some of your comments about the adjustments related to the New York settlement. Can you just go a little bit more in detail and explain why there was a need to make an adjustment to the regulatory liabilities, in specific?

Sure, Mike. The -- kind of going back a number of years, when New York changed its methodology of taxing utilities, from the gross receipts methodology to an income tax methodology, the -- and the higher gas prices that we've seen over the years, National Fuel was in a position where it over-collected on gross receipts tax as compared to the amount that it needed to accrue for the income tax. The balance in that account -- well, the agreement with the Commission provides that the balance in that account should have interest accrued on it, at which we had agreed with the Commission through the years as to the calculations, although, were some minor differences. Nonetheless, the -- we had failed to make an entry for some of those interest expenses through time. And we caught that during our reconciliation process while we were implementing the settlement.

Okay. That makes sense. So just to repeat, it's not that the over-collection went through the income statement, it hadn't, but we just maybe didn't account fully for the interest on that over-collection?

Exactly right.

Okay. That makes sense. Thank you. That was my only question.

[OPERATOR INSTRUCTIONS.] And we have a question from Faisel Khan of Citigroup.

Yes. I just wanted to follow up on the question of the settlement with the New York division. The adjustments to the regulatory liability of 3.5 million and then the 0.6 million of additional sharing expense that needed to be taken out of earnings, that's not something we should see going forward? That's just some that happened this quarter and, essentially, it's kind of an unusual -- unusual item, is that right?

Faisel, yes. It's -- as we described it in the earnings release, it's an out-of-period adjustment.

Right.

And that shouldn't affect us, the trends going forward.

Okay. And then if I can just ask a question on the production. The Vermilion 225 that's at an average rate of 3.5 Mms a day, what was the cost to drill and complete that well? I'm just trying to back into, kind of, an F&D -- an F&D number.

That well, we've actually drilled for that objective, and we had seen so many pay, we did take that well deeper.

Okay.

And as I remember, I'll have to verify it for you. I'm thinking it's somewhere in the 5 to 7 million range.

Okay.

But I'll get you an exact number.

Okay. Fair enough. And the -- you talked about the -- a rig in California that is at the -- is up at the end of the year. Can you just elaborate on that again? I didn't quite -- I didn't quite get the information on what was going on over there.

Yes. The situation for the rig, we use that rig almost exclusively for all our drilling, and it's been working for us for almost four years.

Okay.

And they advised us that when they finish drilling for us this year, they had a contract with another company that was going to take two years.

Okay.

And they would not be available for any drilling. And they said if we wanted to extend our drilling program, they gave us that option. So we went to the Board and said here's an opportunity that we're going to drill more wells this year than we had planned, but once that rig leaves, it's going to be very difficult to find a rig to drill our wells. So the Board approved us spending more money this year to drill those extra 20 wells. And, then, once that rig leaves, we won't be able to get it back for two years.

Okay. I got you. And if I can just go to the timber -- the timber business for a second. The -- I remember that you spent about $17 million last quarter, I think, on the timber side. Have you been able to firm up at all what the economics are on a transaction like that, what we can expect, kind of, the -- a return on invested capital standpoint from that business?

Well, ultimately, what the economics turn out to be depends on what happens with the timber prices. But -- and we haven't made any isolated disclosure with respect to the value of that transaction. And to some extent, that's a matter of our competitive position in that world. We don't really, necessarily, like to talk about our costs or our economics transaction by transaction, since these things are competitively bid.

Okay.

But I think over time, we've been pleased with the kinds of returns that we've made on our timber investments. And so far, we don't have any reason to think that we should regret having made that investment. And we have started to cut that timber already, since the purchase, and we'll continue to cut on that particular tract.

Have you seen a softening in pricing for some of that product? I've heard that the market's kind of getting a bit soft. Is that correct or is that something you're seeing?

Oh, I -- no, don't confuse the market for the kind of hardwood that we deal with, with the general market for pulp wood or construction dimension type lumber. The market for cherry and soft maple, which are our dominant species, continues to be very good.

Okay. Thank you.

[OPERATOR INSTRUCTIONS.]

Steven, do we have anyone on the line?

Yes, we have a question from Kathleen Vuchetich of W.H. Reeves.

Good morning. I was just wondering, Phil, given some really astronomically strong prices seen for the sale of E&P assets, what you guys think about monetizing some of your E&P properties and businesses? And what would prompt you to, if you're not looking at it now, what it would take to prompt you to consider it?

Well, we consider it regularly, every time that we hear some astronomical price reported for a transaction in an area where we have production, we will generally extrapolate those prices into what we would receive for our production. But at the moment, we don't have a particular requirement for incremental cash flow. And, generally speaking, we could achieve the same kind of economics, or better, by a more aggressive hedging program. But we do consider it regularly. We haven't been able to strike a deal for a price that was irresistible yet.

Have you talked to anyone about selling these properties, Phil? Is there anybody who has floated a price to you? Or is it still in the more theoretical stage?

Oh, we've talked to a number of people about a number of properties and discussed specific prices.

Okay. Thanks, very much.

Our next question comes from George Frelinghuysen of CHIPCO Asset Management.

Yes, good morning. Could you tell me when the Sukunka well is currently drilling, and when that will be down, and when the operators told you that would be down, when the results will be reported?

I think we've announced that we expect that well to be down this quarter.

Down this quarter?

Yes.

Towards the end of the quarter?

It's really their call. They have 80% of that well, and so they make the decision and just let us know they're -- when they've decided to stop. And, so, if and when that happens and they get a test, we will, of course, announce it right away.

And how far is it from the 60-E well?

This well is, let's see, it's probably 13 to 14 miles away.

I see, okay. So is this trying to delineate the formation, or the size of the field?

Well, the way this works, one of -- I think, we have shown in the annual report that we have the 93-D well, which we are going to drill, which is going to be a delineation well.

Right, okay.

This is actually a wildcat, the one that we're drilling now.

Okay, great. Thanks. One more question. You mentioned a million acres that you have in Appalachia. Talisman has a big operation there. Have they expressed any interest in farming in on those properties that you have?

We've actually worked very closely with Talisman. In fact, they have -- they originally farmed in this those properties when they first moved into the area.

Oh, okay.

And, so, as part of that deal, that was the reason we got into the Monkman area with them, as a swap on properties. So we've worked very closely with them in the past, and are currently very close to working with them.

Okay, great. Thanks a lot.

And we have a follow-up from Faisel Khan.

Hi, just a quick question on the asset sale proceeds. Am I right to assume that the proceeds have been fully allocated into your businesses now? I think you said something along the lines that you're using those proceeds to purchase inventory for the gas utility, and you're not drawing on your bank lines. Is that right?

That's right, Faisel. Since we're still in the midst of our injection season, though, we have excess cash that is invested on a short-term basis. It's not until around about, oh, mid-September that we expect to utilize -- fully utilize all that cash for injection purposes. And then we will have to start tapping our commercial paper lines.

Do you -- at this point, do you think that you're -- with the proceeds from the asset -- on the asset sale, do you think you're properly capitalized now? Or do you think you have some -- you have more flexibility?

Well, we certainly have a lot more flexibility. I mentioned our equity component is higher than we can efficiently earn on in the Regulated segment, so -- and given the liquidity, next year, next spring, when all the inventory is liquidated, when we collect the winter gas bills from our customers, we will be in an excess cash position that we'll be looking at either repurchasing some of the debt or any of the other things that Phil has mentioned before.

So you would be looking to take the debt down further? Or do you think -- do you think that your long-term debt is kind of at a reasonable -- at a reasonable level right now?

Well, the long-term debt's at a reasonable level. It's in conjunction -- or, in comparison to our equity component, though, it's tough to rationalize increasing the equity component any more than that. But then, again, we're at a rather high share price as we speak, and it's a little tough to justify repurchasing shares at your 52-week high.

Fair enough. Thank you.

And we have a question from Michael Weinstein of Zimmer Lucas Partners.

Hi, I just wanted to make sure I understand about the California drilling program. It sounds like there won't be any drilling at all in 2006 and 2007, right, because the rig won't be available for two years?

Well, not exactly. We do have one other rig that we can use and we do have some deeper drilling, and this rig that we're losing is not going to impact that. So we do anticipate still being able to maintain and do some drilling, but it won't be as extensive as we had initially planned.

Okay. And just looking at how -- I think your forecast for next year for -- for '06 looks like it's about flat production-wise with '05, is that correct?

Yes, we gave the same range as last year.

Right. And is the reason for the -- I guess, normally, you would expect a decline, unless there's an increase -- a ramp up in production for some reason. It sounds like this might be the reason, that you're going to drill -- accelerated drilling program of 20 wells this year in California.

Well, actually, the reason for it is that we've drilled seven wells so far in the Gulf and had a very strong -- had a very successful program. And those are the blocks that I mention in there that's going to help offset the declines that we've seen. The reason we've seen the last few years of a consistent decline has been because of our transitioning out of the Gulf. And we had a couple of blocks that, at these high prices, were very economic to drill. We went ahead and drilled those. That will be new incremental production, which will help mitigate the decline that we have been seeing in the Gulf. Eventually, we're still transitioning out of the Gulf. It just eases it off. It won't be as dramatic as it was in the past. And, so, that's the big reason for the flattening of production going forward.

And, then, you said there was going to be at least one more acquisition you're targeting for next year?

We do -- we continue to look for acquisition opportunities in core areas, but with the current market, it’s so expensive. We're always out there. We are looking. But it's going to have to be on our terms, and the terms that we feel are comfortable before we do that acquisition. But we do evaluate anything that comes up for sale in any of our core areas, where we could increase our position.

Okay. Thank you.

We have a question from Becca Followill.

Good morning. With the successes that you've had in the Gulf this year, will you continue to bid at lease sales? Or are you going to continue to transition out of the Gulf?

The plan is to continue the transition. Where we see an opportunity, we may bid on one or two blocks because we do have that database that we've invested in, and we do look at it for each of the lease sales to see if there's anything unusual there. But we will -- we're not going to be an active, big bidder in the Gulf. We will still work on the transition out. It's just if we see a place where we can take advantage of the data that we already have and get it for what we think are reasonable prices, we may bid on one or two blocks. We have bid, I think, we bid on the last Louisiana sale. We did pick up one block. So where we see an opportunity, we would go ahead and do it.

Thank you.

[OPERATOR INSTRUCTIONS.] It appears there are no further questions.

Okay. Thank you, Steven. And we'll conclude our call for today. Thank you, again, to everyone for taking the time to join us this morning.

A replay of this call will be available in about one hour, on both our web site and by telephone. And both will run through the end of business on Friday, August 5th. Our web site address is www.nationalfuelgas.com. The telephone replay number is 1-888-286-8010, using passcode 60226570. This concludes our call for today. Thank you, and good-bye.

Ladies and gentlemen, this concludes the conference. You may now disconnect. Have a good day.