National Fuel Gas Co (NFG) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2008 National Fuel Gas Co. earnings conference call. My name is Katina, and I will be your conference coordinator for today. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now like it turn the presentation over it our host for today's call, Mr. James Welch, Director of Investor Relations. Please proceed.

Thank you, Katina, and good morning, everyone. Thank you for joining us on today's conference call for discussion of last evening's earnings release. With us on the call from National Fuel Gas Co. are Dave Smith, President and Chief Executive Officer, and Ron Tanski, Treasurer and Principal Financial officer. Joining us from Seneca Resources Corporation is Matt Cabell, President. At the end of the prepared remarks we'll open the discussion to questions.

As this call is being publicly broadcast, I 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 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 last evening's earning release for a list of certain specific risk factors. With that we'll begin with Dave Smith.

Thank you, Jim, and good morning to everyone.

Before giving a brief update on the quarter and on National Fuel's operations, I'd like to take a moment to recognize Phil Ackerman, who, as you know, will be retiring at the end of the month. Over the course of his 40 years of service to the company, Phil consistently focused on building real assets and long-term shareholder value. Along with Bernie Kennedy and Lou Reeve, Phil was a principal architect of our integrated, diversified corporate model, a model and a strategy that we will carry forward and build upon. In the six and a half years since October, 2001, when Phil was named CEO, through the end of last quarter, National Fuel's stock delivered an annualized return of about 16%, nearly three times that of the S&P 500. By any measuring stick that's a record of which to be proud. Phil was and is also extremely proud of our impressive dividend record, including the payment of an increasing dividend for the last 37 consecutive years. We have no intention of breaking that streak any time soon. The company is in the strong condition it is today in large measure because of Phil, and we owe him a debt of gratitude. On a personal note, I worked for Phil for my entire 30-year career, and can say it's truly been a pleasure. I value the friendship and the guidance Phil has provided over the years and will continue to provide, and I wish him and his family the best in retirement.

Now on to the second quarter. Which was another excellent quarter for National Fuel. Our consolidated $1.11 per share of net income was yet another record for the company. Higher commodity prices and increased production from continuing operations and our E&P segment were primarily responsible for the 21% increase in net income. It's important to note that all of our major segments reported increased results over the prior year, second quarter. As a result we've increased our earnings guidance for fiscal 2008. Turning to some of the highlights of the individual segments in our pipeline and storage business, construction of the remaining 60 miles of the Empire Connector Project is expected to recommence next week. Site work is ongoing at the new Oakfield Compressor Station, and we expect to set two turbo compressor units in early June. Construction and material costs to date have totaled approximately $65 million. And we expect to spend about another $115 million to complete the project.

While that $180 million total is slightly higher than our previous estimate of $177 million, the team has done a wonderful job in today's pipeline construction environment of controlling costs. Our construction schedule has us on track for a November 1, 2008, in-service day, but obviously that is contingent upon the completion of the Millennium project. When Millennium is ready and all indications suggest they will be ready on November the 1st, we will be ready. Looking beyond the connector projects Supply Corporation's proposed west-to-east project continues to evolve. As you'll recall there are multiple sources of supply for that project. Output from the Rex, the Rockies Express, Appalachian production including that from the Marcellus shale, L&G Deliveries from Cove Point, and On-system Storage. Initially we expected that most of the interest for the project would come from direct shippers. But lately we're seeing significant interest in the market from other sources, as well. Rex continues to make progress toward Clarendon and we're optimistic that our project will ultimately interconnect with it. But, in the meantime it's certainly possible that the west-to-east project could be built in stages as market demand develops.

From Appalachian Production, Cove Point L&G, On system Storage, as these come, on, we will put in place our pipe. We remain optimistic and will continue to update you quarterly on the progress of this project. Regarding storage development. We continue to make progress on the expansion of our east branch and (inaudible) storage facilities. During the past quarter our engineering staff completed the rest of our analysis and concluded that approximately 7 bcf of incremental storage capacity could be provided without the need for any additional base gas. And open season for this capacity is planned for this summer, and assuming all goes well we will file an application for approval with FERC in the first half of 2009. Supply expects to market the new capacity from both fields as a single offering. Potentially at market-based rates. Turning to expiration and production segment.

As Matt will provide a detailed update on all of Seneca's operations, I'll briefly address the efforts in our east division. Aggressive development of our Upper Devonian acreage in Appalachia is continuing according to plan. Our year-to-date capital spending in that region was nearly double that of a year ago. And we are on target to drill 280 wells in 2008. These efforts are clearly paying off. For the first and second quarter, production from our shale of wells was up 34% over the same quarters last year. With gas prices where they are and are expected to be, we will continue to aggressively exploit the Upper Devonian. We are also excited about the potential of the Marcellus shale play. Our joint venture with DOG resources is proceeding at the pace called for in our agreement, but we're eager to accelerate not only the pace of the program but the development of our own internal expertise. To that end, a significant portion of the $41 million increase in Seneca's 2008 capital budget will be devoted to the Marcellus.

Growing at such a rapid pace is not an easy task. But our Appalachian team has done a terrific job of stepping up to the challenge. They've been busy hiring the technical staff needed to support this type and this level of activity. By the end of summer we expect to have doubled the east division's geological staff and tripled its field staff from last year's levels. As we speak, we're in the process of looking for office space that's twice the size of our existing facility. In summary, the exploration and development of our extensive Appalachian acreage remains a top priority. We clearly recognize its value, and intend to devote the resources that are necessary to maximize its potential.

Before turning the call over to Ron, I'd like to address some of our small businesses, including our landfill gas and our timber operations. Two years ago at one of our analysts' conferences, I indicated that we'd either grow the landfill gas pipeline operations or we'd sell them. Since that time, we tried our best to expand Horizon LFG's operations. But have had little luck in doing so. The methane gas that was once considered a nuisance by landfill operators is now seen as a major source of revenue. As a result, landfill operators are now marketing their own methane, and that's made it very difficult to expand the business at a price we find acceptable.

Thus, we are actively exploring the sale of Horizon LFG and have hired an investment banking advisor to help us with that process. Assuming an acceptable bid, it's possible that a sale may be closed by the end of the fiscal year. We're relatively early in the process, so it's too soon to project any details, but it's reasonable to assume that we'll have at least a modest gain if we sell the business. Likewise, we are actively exploring the sale of our 50% ownership interest in Energy Systems, North East, LLC. We call it ESNE. An 80-megawatt natural gas fired combined cycle independent power plant located in northeastern Pennsylvania. This is also early on in the process. So it's too soon to project any details. But again, it's reasonable to assume that we'll have at least a modest gain if we sell our interest in ESNE.

The timber business on the other hand is one we intend to keep at least for the foreseeable future. I understand that at first glance one might conclude that our timber holdings don't clearly fit and our well head to burner tip model. However, a closer look demonstrates numerous synergies with our exploration and production segment and our pipeline and storage segment. National Fuel owns the oil and gas mineral rights underlying 90% of our timber acreage including the Marcellus shale. Our ownership to surface rights facilitates drilling, gathering, processing, and transporting gas on that acreage. Our increased emphasis on Appalachia production makes our timber acreage all the more valuable to us. Additionally, the timber business occupies a very small portion of senior management's time, and the steady $0.05 averting it generates is a reasonable return on the relatively modest amount of capital we've committed to that segment. Consequently, we do not intend to sell our timber assets. With that, I'll finish and thank you for your attention. And I'll now turn the call over to Ron.

Thanks, Dave, and good morning, everyone. Last evening's earnings release provides the explanation of the period-to-period variances of earnings in each of the segments so I won't repeat them here. Recall, though, that last quarter I pointed out that a rate design change in the New York division of the utility would push some margin from the second quarter to the third and fourth quarters. That did happen as projected, and more than $6.5 million of revenue will be spread over the third and fourth quarters. So the differences that you see in the utility segment year over year don't reflect any major change in an earnings trend. Instead, you need to start a new trend line and establish a new base to compare future earnings in the utilities segment against. We also saw a slight uptick in our customer usage per account. We're studying the data and believe that due to economic conditions and high gasoline prices, people were not traveling and they were also driving less. Essentially, they were staying home, and they had their heat on. We actually expect the long-term trend of declining use per account to continue.

In our New York division, over 6,000 customers have already taken advantage of rebates totaling $1 million offered under the conservation incentive program. We will step up our advertising program over the coming weeks and we expect many more customers to explore more ways to conserve energy in the face of continued, high energy prices. From a consolidated company viewpoint, in early April we issued $300 million of new 10-year notes at a coupon rate of 6.5%. The proceeds will be used to refund a $200 million of notes that will be maturing later this month and the additional $100 million of funds will be used to fund our pipeline construction program. Regarding the company's buyback of its common shares, during the last quarter, the company repurchase 2.392 million shares, bringing the total repurchases through the end of March to 6,227,553 at a total cost of $241.991 million, and that's an average price per share of $38.86. Dave mentioned the increase in our earnings guidance.

As we pointed out in last night's release, that increase is due to the hedging of additional volumes of natural gas in two areas. The first is production in the exploration and production segment, and second, volumes of efficiency gas that the pipeline and storage segment plans to sell in the fourth quarter. Our original forecast included selling the efficiency gas volumes at an average LIFO accounting price of approximately $8.14 per decotherm. We now have some hedges layered in to sell that gas at an average price of $9.02 per decotherm. The details for the exploration and production hedging are on page 23 of the earnings release. If you assume annual production to be at the middle of our guidance range, we have -- now have approximately 65% of our natural gas production and approximately 55% of our oil production hedged for the remainder of the fiscal year.

Since we've locked in those higher prices we were able to increase the guidance range. And finally, because of the share buyback program, we expect to have a lower, weighted average number of shares outstanding for the entire year. The lower number of shares assumed in the revised guidance has the effect of increasing earnings per share by $0.04 per share for the entire year. Now I'll turn the call over to Matt Cabell.

Thanks, Ron. Good morning, everyone. Seneca's had another good quarter with production, revenue, and earnings up substantially. Production for the quarter was 10.4 BCFE, a 4% increase versus the second quarter of last year. This increase came primarily from the east division, where we produced 2.0 BCFE versus 1.5 BCFE last year. For the six-month period, our Appalachian production is up 34%. I expect fiscal year 2008 production for all of Seneca to be close to the middle of our guidance range of 38 to 44 BCFE. While production appears to be very much as originally forecast, we're now planning on an increase in fiscal '08 capital spending. We are revising our original budget of $154 million, up to a revised forecast of $195 million. The upward revisions include acquisitions of approximately $18 million, primarily in California, increased drilling and lease acquisition costs in the Marcellus shale in Appalachia, and increased development costs in the Gulf of Mexico due to our continued exploration success.

Moving on to some highlights by region. In California, we completed a trade of our interest in the Ohi field, plus $14 million. For additional interest in the Sesby field. This allows us to consolidate our position at Sesby and also increases our daily production by 200 barrels of oil equivalent per day and our reserves by 1.1 million barrels. In addition, we believe there's some upside potential at Sesby and we may ramp up our activity as soon as next year. In the Gulf of Mexico, we drilled another successful exploration well extending our streak of successful exploration discoveries to four. This discovery in Highland block 23-L was tested at 20 million cubic feet per day and 3,000 barrels of condensate a day. Seneca operates and holds a 55% working interest. We hope to have it on line by October.

Now for an update of our Marcellus shale activity. First of all, it is important to understand that while EOG is the operator of our joint venture, we are actively working the play internally. Over the last several months, we've added five geologists and two engineers to our Appalachian team. Including a very experienced engineer who spent much of his career working on horizontal drilling and completions. A geologist who previously consulted on -- on unconventional resources, and another geologist whose Ph.D thesis focused on the Appalachian Basin.

Our team meets with EOG regularly to review their program and provide our views of the best locations and operational plans. We have developed a thorough understanding of the regional geology. Based on our extensive well data base which includes numerous Marcellus penetrations. Regional mapping to date indicates that we have approximately 700,000 net acres that are prospective in the Marcellus. Within that prospective area we have hydrated approximately 425,000 net acres based on thickness, pressure, organic content, and thermal maturity. Our drilling program will delineate this area much more precisely as well as defining the resource potential and commerciality. Moving on to current operations, our partner EOG, has completed the drilling of another horizontal which will be fracked later this month.

As I have said in the past, EOG is an excellent partner, they are very experienced with shale exploration and development, and our teams have an excellent working relationship. However, drilling has proceeded more slowly than we had hoped. And although EOG will be bringing in a new rig this summer, in order to better execute the horizontal program, we are anxious to accelerate the progress of the joint venture. Therefore, we plan to propose additional activities which could include both additional drilling operated by Seneca, and recompletion of existing wells in the Marcellus formation. The intent of this additional activity is to evaluate the production potential of vertical wells, hydrate areas for future horizontal drilling, and build our data base of geological and petro physical properties across our extensive acreage. With the drilling that is planned between both EOG and Seneca, I expect that by December of this year, we will have a much better understanding of the ultimate potential of our Marcellus position. In summary, this has been another good quarter for Seneca. Production is on track, we've had further exploration success in the Gulf of Mexico. We have consolidated and added to our holdings in California and we are preparing to ramp up our activity in the Marcellus shale. That concludes our prepared comments. Operator, I'll turn over to you now for questions.

Thank you, (OPERATOR INSTRUCTIONS) Your first question comes from the line of Becca Followill, representing Pickering Please proceed.

Hi. On the Marcellus, Matt, are you guys going to bring in your own rig for this drilling? And --

Yes.

Okay. Just one rig, or are you going to bring in two rigs? Kind of what's the timing of that? Is it this summer this, Fall?

Just one, and the timing is anticipated to be this summer.

Okay. Perfect. Thank you.

Your next question comes from the line of Rick Showman representing GLG partners. Please proceed.

Hi, guys. How are you?

Good.

My question is with regard to just the infrastructure in place and infrastructure needs within Appalachia. I mean, you have -- I don't even know how many companies talking about not only drilling up current acreage that is proved but also all this Marcellus acreage now being drilled up and proven out. And there's -- hundreds of thousands if not, millions -- and even tens of millions of acres of this Marcellus that needs to get drilled. Is there -- how fast does that infrastructure get built? Is there going to be bottleneck and -- how much more is that going to wind up costing for you guys? And then who eventually winds up building out all the gas gathering and pipeline infrastructure and stuff like that?

Rick, let me take a shot at a few of those questions anyway. I think there are likely to be bottlenecks. I think you will see that with existing producers that are producing a fair amount of gas in Appalachia. With regard to who's going to build it, we have set up and we plan on -- on developing a midstream company. We have all the legal work done.

Our President of that company, Duane Wassum, has been spending a fair amount of time talking to a number of producers. Obviously those -- that's subject to confidentiality agreements. So we see it as a business opportunity for us to put gathering in to get to the pipeline. So -- and it will add a substantial -- substantially to the cost of getting the gas out of Appalachia. There's no question that -- that a lot of this Marcellus is in areas where there aren't significant pipelines. But at least from National Fuel's perspective, we're looking at it as a business opportunity, and we're actively pursuing that now.

I just have one more followup question. This a little more theoretical I guess just on your thoughts. But if more and more of this -- of these -- of our gas supply is going to wind up coming from these kind of -- these shale plays and that puts increasing upward pressure on costs for drilling and costs for pipe, then -- and costs for gathering systems, what -- that constantly raises the -- the overall floor price or -- or break-even price for gas which means that -- it will inevitably drive higher prices. Is that your guys thoughts, as well? How do you think about it?

I would look at it a little differently and say that you're right, it raises the floor. But -- but the current price environment is well above that floor. So -- so maybe what we're defining is a new floor on gas prices, at least sort of a long-term floor with ultimately some volatility that will drop you down below it occasionally.

And Rick, on just -- on the other side of that coin, we -- you have to be careful to -- to the extent that, we talk about all the gas coming into Appalachia. And -- you know, Cove Point and -- and Rex and -- and Appalachian production and shale. You know, we need to get the gas out of the area, or you could have a real basis issue there. So we're mindful of that, too. And that has -- that would have downward pressure on the price.

Fair enough. Thank you very much.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of [Mark Caruso] representing Millennium Partners. Please proceed.

Good morning. I just had a quick question. I noticed that you didn't -- you raised the CapEx, you didn't raise the production guidance. I understand you said that you're going to bring in your own rig to develop -- further develop the Marcellus. I was curious given by the lag in timing in your fiscal year, when -- when would you expect that we would begin to--- your drilling opportunity has come to fruition? Is it a Fallen have where we see the volumes kick -- it a Fall event, where we see the volumes kick in?

Yeah, Fall. We're talking about the additional proposed activities being maybe 6 to 10 vertical wells. It's not necessarily a substantial impact on immediate production. But is very important in data gathering and being prepared to drill the horizontal wells that will ultimately develop our resource.

Right. But those will be in addition to -- in the release I read, you'll be adding 20 wells a month in -- in Appalachia?

That's what we're doing now, and that's all in the plan.

Right. And these will be incremental to that?

Oh, yes, yes.

Got you. Thanks.

Yeah. For Devonian, Mark.

Right. Appreciate it. Thank you.

Uh-huh.

With no further questions in queue, I would now like to turn the call back to Mr. James Welch for closing remarks.

Thank you, Katina. We'd like to once again thank everyone for taking the time to be with us today. A replay will be available in about one hour on both our web site and telephone and will run through the close of business on Friday, May 9 To access the replay on line, visit our Investor relations web site at Investor.nationalfuelgas.com. To access by telephone, call 1-888-286-8010 and enter passcode 39987735. We would also like to remind everyone that we'll be making a webcast presentation at the American Gas Association Financial Forum on Monday, May 5, at approximately 9:05 a.m. Eastern Standard time. To listen to this webcast live or access the replay that will be available for one week following the presentation, please visit our investor relations web site. This concludes our conference call for today. Thank you and good-bye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day.