National Fuel Gas Co (NFG) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the third quarter 2008 National Fuel Gas Company conference call. My name is [Carmen] I will be your coordinator for today. At this time all participates are in a listen-only mode. We will be facilitating a question-and-answer session during this conference. (OPERATOR INSTRUCTIONS) As a reminder ladies and gentleman this conference call is being recorded for replay purposes.

I would now like the turn the presentation over to your host for today's call, Mr. James Welch, Director of Investor Relations. Please proceed.

Thank you, [Carmen] and good morning everyone. Thank you for joining us on today's conference call for a discussion of last evenings earnings release. With us on the call are from National Fuel Gas Company 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 will open the discussion to questions.. We would like to remind you that today's discussion will contain forward-looking statements. 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 last evenings earnings release for a listing of certain specific risk factors. With that we will begin with Dave Smith.

Thank you Jim and good morning to everyone. The third quarter was another great quarter for National Fuel. On an operating results basis our per share earnings of $0.72 per 70% higher than they were in 2007. The increase being driven primarily by the E&P segment.

Seneca's production from continuing operations was up 10% over the prior year with more than half of that increase coming from our successful drilling program in the east. That increase in production coupled with higher realized commodity prices caused Seneca's quarterly earnings to more than double from the prior year. Earnings were also strong in the utility and in the pipeline and storage segments with each posting double digit percentage increases. Overall, it was a great quarter, in fact it was the third consecutive record quarter for National Fuel and we remain on track for a great year.

Turning to the individual segments, the third quarter was a busy one and I'd like to take a few moments to update you on recent developments. In the utilities segment we provided Anna [Marie Solano] to President of the distribution corporation. Anna Maria is a lawyer and a CPA who over the course of ore more than 25 years with the company has at one time or another overseen most every aspect of distributions business. Anna Maria is and has been focused on customer service but at the same time she keeps a watchful eye on spending.

Given the low growth nature of our utility service territory and given our desire to avoid rate increases requests, our ability to control requests will be critical to our future and I have every faith in Anna's ability to get the job done. We also promoted [Ron Kramer] to President of Empire. Ron who's an engineer, has managed the marketing, engineering and project development areas in the pipeline and storage segment. Obviously that experience and Ron's talents will be helpful as we continue to emphasize the growth of this business.

Construction of the Empire Connector project which has been Ron's project from the beginning, has been in full swing since early May, welding is complete on about 70% of the line and both of the turbo compressor units have been set at the Oakfield compressor station. Through the end of June, construction and material costs have totaled approximately $108 million and we expect to spend another $72 million by the time the project is completed.

Our total cost estimate remains at $180 million and while there may be some slight increases due to change orders and the like, most of the project costs are fixed and we don't expect any significant cost overruns. Our construction schedule has us on track for an in service date of November the first, 2008. But obviously the actual flow of gas is contingent upon the completion of the Millennium project. As I've said in the past, when Millenium is ready we will be ready.

We've also had some good news with regard to the existing Empire Line. Last month, two of empire's anchor shippers executed five year extensions of their firm transportation contracts. In total, the two contracts represent about 190,000 decatherms per day of capacity and about $12.5 million in annual revenues. In the E&P segment, Seneca's third quarter production of 10.3 BCF puts us on pace to be in the middle of our fiscal 2008 production forecast.

This division has done everything we have asked of us, increased drilling, increased production, increased reserves, increased URs and perhaps most importantly they put in place the fundamental building blocks to ensure steady annual growth. We are also pleased with our California operations and with the exploration success we've had in the Gulf of Mexico, largely as a results of our new more focused approach. Matt will provide a complete update on all of Seneca's operations.

Overall fiscal 2008 is shaping up to be one of the best years, actually the best year, in National Fuels History. Earnings are at record levels, our balance sheet is as strong as it has ever been and we have put ourselves in a strong position as we move forward. Looking to 2009, we intend to continue this momentum and to capitalize on the many opportunities that are before us, particularly those that are in our geographic foot print.

The E&P segment will continue to be a principal area of focus. Seneca's initial capital budge for fiscal 2009 is in the range of 195 million to 270 million, with the middle of the range being almost 20% higher than our 2008 budget. We plan to spend more than half of that amount in Appalachia, where Seneca will continue to exploit it's nearly one million acres of mineral rights.

Our agressive drilling program in the Upper Devonian will continue to grow. As we've previously announced, Seneca's goal for 2009 is to drill 320 upper Devonian wells. Exploration of the Marcellus Shale is also a top priority. Under the terms of our joint venture, EOG will drill at least ten development wells in 2009.

In addition, we anticipate drilling additional Marcellus wells in an effort to evaluate our overall acreage position. All told we plan to spend about $50 million in fiscal 2009 on the Marcellus program. While we are certainly excited about the exploration potential of the Marcellus, we also recognize the considerable opportunity it presents our pipeline and storage and mid stream businesses. Active producers in the region, including Seneca, are quick to point out the need for new gathering and new pipeline infrastructure to get anticipated Marcellus production to market. National Fuel is well positioned to help solve that problem.

Last month after numerous discussions with Appalachian producers, we announced the formation of National Fuel Gas Mid Stream Corporation. Headed by [Duane Wassum] who's a seasoned veteran of both National Fuel and the pipeline construction industry, this new company is focused on developing gather systems in the Appalachian region. Duane has been very busy talking with producers and while it's still very early, we are encouraged by the interest.

In addition, supply corporation continues to pursue it's west to east project, which as you'll recall would extend from the terminus of Rex, the Rockies Express, at Clearington, Ohio to Overback which is in Central Pennsylvania and ultimately on to Corning, New York where it would interconnect with the Millenium Pipeline. Though initially targeted at Rex shippers, we've seen considerable interest from producers, particularly those that are active in the Marcellus. In response to that interest Supply Corporation announced its new Appalachian lateral project and initiated an open season early this week.

Starting in Waynesburg, Pennsylvania, which is south of Pittsburgh, the Appalachian lateral would extend 135 miles directly through the Marcellus fairway to Overback. Where it would connect with the northern portion of the west to east project, which as I indicated, ultimately reaches Corning. While the project is in its early stages, there has been a great deal of interest, particularly from Marcellus producers and we are very optimistic.

Regarding storage development, we continue to make progress on the expansion of our east branch, [Gailbrith] and [Tuskarora] storage facilities. We anticipate that later this summer, Supply COrporation will hold an open season for 8.5 Bcf of incremental storage capacity and most likely in early 2009, file and application for approval with FERC. Before turning the call over to Matt, let me take a few moments to update you on our smaller business.

First we continue to make progress on the proposed sale of our landfill gas pipeline operations, which is carried out by Horizon LFG and we call it Toro. And our 50% interest in the energy systems northeast power plant or ESNE. WIth regard to Horizon LFG, last week we began sending information memorandums to interested buyers, all of whom have signed confidentiality agreements.

Assuming an acceptable bid and preliminary indications are positive, it is possible that a sale could close by the end of calendar 2008. As to our ESNE power plant, we've recently reached an agreement in principal to sell our 50% interest. We are still hammering out some of the finer points of that transaction. So, unfortunately at this time, we can't provide any specific details, but we do anticipate that that will close by the end of the calendar year. We expect that if ultimately sold both the Horizon LFG and the ESNE transactions will result in P&L gains.

I'd also like to briefly comment on the timber segment. As you can see from last nights release, earnings in that business are down from the prior year, simply put market condition are terrible. The down turn in the housing market and the we economic outlook have combined to create a lack of demand from the high end furniture, cabinetry and flooring markets, into which we seel our product.

As a result, we scaled back our operations rather than sell into a depressed market. We will resume normal operations, one the demand returns and in the meantime, our timber assets, not only continue to provide access to our underlying mineral right, particularly in the Marcellus Shale, they literally continue to grow in value.

With that, I'll turn the call over to Matt.

Thanks, Dave. Good morning everyone. We had another great quarter at Seneca with production, prices and earnings all up significantly. US production for the third quarter was 10.3 Bcfe as compared to 9.4 Bcfe for the third quarter of fiscal 2007. For the nine month period, our production is up 7% over last year.

I anticipate fill year fiscal 2008 production will exceed 41Bcfe. In the Gulf of Mexico, we drilled another successful exploration well. The Eugene Island 383 well found 70 feet of pay and will be subsea completed and tied back to a nearby platform. With first production in the second quarter of fiscal 2009. Seneca has a 30% working interest. Overall for the current fiscal year, our exploration program is three for four; we are in the process of plugging our first dry hole.

ANd that makes us five for six over the last 14 months. In California at our Midway Sunset field, we have now completed our second phase of drilling for the [Marvick] Sand adding another 230,000 barrels of proved reserves. While at [South Wast Hills] field we are continuing to develop our Monterey Shale play, drilling four wells this quarter. As a result of this program, we should boost our production at [South Wast Hills] by about 250 barrels equivalent per day.

We dont' often say a lot about California because not much changes there. It simply continues to run smoothly providing consistent production and cash flow. But with current high oil prices, the profitability and overall value of our west division have increase substantially. Such that the PV10 of our reserves in California at the end of the quarter, was over $2.3 billion.

Moving on to Appalachia. We've had continued success with our fiscal '08 Upper Devonian drilling program. With average estimated per well recoveries in excess of 110 million cubic feet equivalent. However, we have fallen behind a bit on our drilling schedule, such that we expect a final year end well count somewhere between 250 and 275. While the target for the year was 280.

East division proved reserve adds through the third quarter are over 20 Bcfe, more than three times production. In the Marcellus with our partner EOG, we have completed and tested another horizontal work. Due to drilling difficulties, this well has a lateral length of 1500 feet with a treatable Marcellus interval of only 1200 feet. It was flow tested for 30 days at an average rate of approximately 400,000 cubic feet her day. This well is currently shut in for pressure buildup tests.

We now have two horizontal wells completed and tested one of which we believe is not effectively fracked and another which has a very short lateral. While neither of these wells float at a high rate we do not believe they're representative of what we should expect from a development program. With the new rig that EOG has brought in for future horizontals, we plan to drill 3,000 to 4,000 feet laterally and consequently we expect to have much higher production rates.

We are currently drilling the first horizontal well with this new rig with a planned lateral of 4,000 feet, more than three times the lateral of the last well. We plan to have this well fracked in September and expect to see rates that are more representative of what we might see from a development program. In addition, we have finalized our plans for a Seneca operated program of six vertical wells which should begin in September. As I mentioned last quarter, the intent of this additional activity is to evaluate the production potential of vertical wells on our acreage and high grade new areas for future horizontal drilling.

Now for a first look at our expectations for fiscal 2009. Production should be about the same as fiscal 2008 in a range between 38 and 44 Bcfe. The biggest variable is the timing of first production from our three most recent Gulf of Mexico discoveries. If they come on ahead of schedule, it will be near the high end of our guidance. If we significant delays, we may be closer to the low end. In the most likely case, Gulf of Mexico production will be down 10% to 15% while Appalachia is expected to be up approximately 20%. And California nearly flat.

Although we've had good success in the Gulf this year we cannot expect to maintain our current annual production of nearly 15 Bcfe from the Gulf with our more modest level of investment.

In Appalachia on the other hand we are investing more than ever and production will continue to increase. The trade off of high rate, steep decline production from the Gulf or lower rate, long life production from Appalachia will naturally lead to an initial decline or at least a more modest increase, in the company's overall current production. Over the long term, we as we pick it up more in Appalachian we expect steady annual production growth for Seneca.

Regarding fiscal 2009 hedging using the middle of our range of production guidance we have approximately 44% of our fiscal 2009 gas hedged at an average price of $9.49 per Mcf and we have approximately 40% of our fiscal '09 oil hedged at a Midway Sunset price of $80.89 per barrel which equates to a NYMEX price of approximately 92.45.

Capital expenditures for fiscal 2009 are forecasted to be in the range of 195 to 270 million with more than half dedicated to Appalachia including approximately 50 million for the Marcellus shale.

And with that, I'll turn it over to Ron.

Thank you, Matt and good morning everyone. We really had a good quarter. There were no special or one-time items and all of the earnings drivers are covered in yesterday's earnings release. We are not expecting any unusual items in the fourth quarter either, so I am going to move ahead to discuss the assumptions built into our fourth quarter earnings guidance and then turn to our earnings guidance for fiscal 2009.

Fourth quarter earnings are expected to be in the range between $0.45 and $0.55 per diluted share. When you add the $2.65 of earnings for the first nine months, our earnings for all of fiscal 2008 are expected to fall in the range between $3.10 and $3.20 per diluted share. This guidance includes fourth quarter production volumes of approximately 10.1 Bcfe and incorporates approximately three days in August and three days in September of possible shuts ins of our Gulf of Mexico production due to hurricanes.

Looking forward to fiscal 2009, our preliminary estimate for consolidated earnings is in the range of $3.20 to $3.40 per diluted share. The increase in the earnings results primarily from increased commodity pricing at Seneca. While we were preparing our forecast, NYMEX futures prices were so volatile that we chose to utilize flat pricing in the base forecast. The pricing assumption built into our 2009 forecast is a NYMEX Henry hub gas price of $9.50 per MMBTU and a NYMEX WTI price of $115 per barrel.

Matt mentioned that we have approximately 40 to 44% of our expected production for 2009 already hedged. To the extent that NYMEX prices vary from our flat pricing assumptions, the impact of those pricing changes on our unhedged production will affect our earnings as shown in the sensitively table on page 27 of yesterday's release.

We have also set out preliminary capital budgets for each of our segments for fiscal 2009. Those preliminary budgets include 195 to $270 million of CapEx and our E&P segment that Dave and Matt referred to earlier. $62 million in our utility segment, $70 million in our pipeline and storage segment and $1 million for the rest of the company for an overall total in the range of 328 million to $403 million. In the pipeline and storage segment approximately $38 million out of the $70 million total is for the completion of the Empire Connector project.

We are currently in the process of reviewing the responses of shippers mostly producers who have interest in taking capacity from our midstream corporation for gathering their production and tying it into other pipelines. And over the next six months we will be preparing a budget for spending at the midstream company.

Dave mentioned our strong balance sheet. At the end of June, we have an equity component of approximately 59%. Using the middle of our earnings guidance range and a CapEx budget, our preliminary forecast for fiscal 2009 indicates the cash flow will be positive by a little more than $30 million before the maturity of $100 million of long term notes that mature next March.

Before we open up the line for questions I will mention a couple of items regarding our utility. In the Pennsylvania division of our utility, we are required to make quarterly filings to adjust our rates to reflect our expected cost of purchased gas. New rates that went into effect on August first were based on market data through June and our 33% higher than the prior year. During July, we saw such a drastic decline in NYMEX future prices, so this week we filed a request with the Pennsylvania Public Utility Commission to decrease our rates in light of the more recent market data.

Since the utilities passes along the cost of gas without marking it up, the interim adjustment should have no earnings impact to the company but heading into the fall, the decrease should make the bills for our Pennsylvania customers less stressful than they otherwise might have been.

In our New York division our customers are taking advantage of our conservation incentive program that we started during our last rate case. So far, approximately 9,500 customers have received rebates totaling more than $1.7 million for the installation of energy saving equipment. Our outreach and our advertising programs are in full swing. With the projected increase in winter heating bills, we expect thousands more to benefit from rebates under the conservation incentive program and continued savings in the fuel bills.

I will now ask the operator to open the line for questions.

(OPERATOR INSTRUCTIONS). We will wait one moment while questions compile. The first question comes from the line of Carl Kirst from BMO capital.

Hi, good morning everybody. Matt just a quick question with respect to the EOG joint venture, the first is and certainly understanding the first three wells here horizontals aren't representative, but can you tell us what the costs were on each of those three wells?

I guess, Carl I had rather answer that by saying that we expect the average cost of the horizontals going forward to be in the order of $3.5 million.

Okay. And then so we are going to spud the, spud the fourth well when now, you said September? That's already, or has that already spudded and it will IP in September?

We are actually drilling the horizontal section now. We expect to frack it in September, complete it in September.

Okay. And then just lastly, my understanding was there was also going to be a fifth well sort of a, a second here with the new rig regardless of the results of the fourth. Is there a sense of timing of when that would happen? Would it happen kind of immediately after the fourth well was completed or is that something where it is more, I guess the specifics around that fifth well will just be evaluated once we know the results of the fourth?

There should be another one pretty much right away, Carl. In fact I would say three more in the calendar year.

Three more beyond the fourth?

Yes, in the calendar year.

Okay. Thanks for the clarification.

The next question comes from the line of Shannon [Groshne] from UBS. Please proceed.

Hi guys it is actually Chris. I just have a couple of questions this morning. First could you speak to production guidance in 2009? WHile you E&P CapEx is up considerably, production guidance flat year over year. I know you spoke a little bit out GOM and Appalachia, but could you give a little bit more detail there.

Beyond what I said in the comments?

Yes, I mean the focus seems to be more on Appalachian but it is, it is a pretty sizable increase in drilling CapEx and I was just curious what the plans were in terms of timing and what not?

The main thing to understand, there's probably two thing to understand. One is again Gulf of Mexico will naturally be down just because we are not spending enough money to, to expect to maintain that 15 Bcf per year production rate. The other thing to understand is that we did have a good year in terms of the number of discoveries we had in the Gulf, but two of those discoveries won't come on until mid year because they require new platforms. So the timing of that new production is going to have a big impact of what our overall production is for the year. Meanwhile in Appalachia we expect to have at least a 20% increase year-over-year.

Okay. Okay. Great. Also on production guidance, on the cost side. The guidance for production costs illustrates a substantial year-over-year growth. Just wondering if you can give some color on that?

Sure. The biggest component to that increase is the cost of steam fuel for California. We will be increasing our steaming in California by something on the order of 15 to 20% so that adds substantially to our costs. Additionally, the cost of gas has gone up, we purchased gas from the Rockies and that cost of that gas has gone up substantially.

And really another thing to look at is even though it is only 15 to 20% total increase in steaming, the incremental cost of that gas goes up substantially because that is all purchased gas where as somewhere in the order of 30 to 50% of our current steam fuel comes from waste gas that is very inexpensive. Incremental increase is all purchased gast.

Okay. Great. One final question, with respect to on going exploration in Marcellus. EOG recently expressed some concerns about their findings there, EUR's and other. Just wondering what you are seeing outside of the -- I understand your initial comments on the horizontals but given these comments and I guess the seeming decline in interest in Marcellus from EOG would you guys consider potentially dissolving the JV you have with them?

First of all let's be clear about what EOG said. I don't think anything they said would say they're a decline in their interest. What they said is that the idea of three to four Bcf wells like some of our competitors may have suggested, seemed a bit rich based on the data. And I don't know that I would disagree with that, but 1.5 to two Bcf wells are highly economic in this play. I think EOG is still very much on board. They're still a very good partner and they're proceeding with [bro] program this year and I expect it to pick up a good bit next year. Now the way the agreement is written if they don't meet certain drilling requirement, the deal dissolves on its own.

Okay.

Now that's not to say that we might not renegotiate certain portions of the agreement. But that is all dependent on negotiation. There's nothing being done to date.

Right.

Yes but I think the other thing is remember that, I mean EOG pretty much said you won't see meaningful production from their perspective. Meaningful to EOG is, it is different to National Fuel than it is to EOG. So just keep that in perspective.

Okay. Thanks, guys. Compliments on the quarter.

You're welcome.

The next question comes from the line of Rebecca Followill [Toner Pickering Holt]. Please proceed.

Good morning. Several questions for you. On the 50 million CapEx on Marcellus, that includes the six vertical wells, what else is included in that 50 million?

Yes, Becca, the, that also includes our share of the development drilling by EOG.

Okay.

Okay. It includes some additional vertical drilling that we would likely operate beyond those six wells that has that is less certain in terms of where those wells will go yet, but we are planning some additional and it includes some leasing as well.

Okay. Can you tell us where you plan to drill the six vertical wells?

No, I guess I had just as soon leave that confidential for now, Becca.

Okay and does your guidance production guidance assume anything from Marcellus?

Nothing significant. The assumption is that the Marcellus development wells won't yield substantial production in fiscal 2009.

Okay. That's fair. Moving on to California the Monterrey area, how much acreage do you have that's perspective for the Monterrey shale?

Well, let's be clear here. South Lost Hills that's basically all we have produce from is the Monterey Shale. We have been for years.

Okay.

The Monterrey formation changes across California, across the San Joaquin from being primarily a shale when you are down near South Lost Hills to being an interval that is kind of interbedded sands and shales as you go further north. So up at Midway Sunset, the [Marvick] interval is actually part of the Monterrey but it is a sand there not a shale. I don't know that I answered your.

I guess just the four wells that you were talking about drilling in Monterrey, and there's a lot of data. I may have just missed it. Thought you talked about drilling four Monterrey wells?

We did.

Okay. That's just the same formation you have been drilling, its not anything new?

Right. It is the same Monterrey shale we've employed at South Lost Hills for a number of years.

Okay. And then on Gulf of Mexico, higher went to 23L. Is that still on target for October?

It is on target for October. Probably the biggest variable there is going to be the hurricane season as to whether that delays us any.

And your net production is, would be what?

Oh from 23L?

Yes.

Let me think about that for a second. Let me.

I can get with you later, I don't have to have it right now, just trying to get a feel for what can swing things one way or the other?

Let me put it this way, Becca. It is a single well that has to add I think 20 million a day and 3,000-barrels of condensate and we have a 55% working interest.

Okay. So it is unchanged. Is Eugene Island 383 kind of in that same range?

Yes, it is probably in that same general range.

Okay. Perfect. Thank you, guys.

(OPERATOR INSTRUCTIONS). And the next question comes from the line of Jim Harmon from Lehman Brothers, please proceed.

Hi. Good morning. Two quick questions related to the production affiliate. In the Gulf of Mexico, what type of decline rates are you seeing in first year and second year production in the wells you are drilling?

Well, Jim that varies from well to well.

Okay.

But, some of these wells that are in relatively small reservoirs could see their entire decline in 12 months while others might last for four years.

Okay. And with prices coming in specifically on the gas side, is there any price you might pull back more capital out of the Gulf?

Well, yes of course there is, but I think a better way to look at it is we are constantly looking at the opportunities available to us. And given our projections of gas prices, we, we determine what drilling program we are going to have. So even at a high gas price we might pull back on our drilling if we don't have the right opportunities available.

Okay. That's fair. And in Appalachia, the capital budget, is that all for drilling or is there, are there some infrastructure investments that you are making and maybe could you give us an update as to what infrastructure looks like where you are drilling, what it can support and whether or not there is infrastructure around the new wells that you are contemplating drilling?

Yes, there is some infrastructure cost in that capital but it is not a significant portion. When we look at our Upper [Devonian] program, generally the infrastructure is reasonably available but requires often times some upgrading. In the Marcellus program as Dave mentioned the our supply company and our midstream company are also looking at solutions to Marcellus for us and for the rest of industry.

Okay. Thank you.

We have no further questions at this time. I would like the turn the call back over to management for closing remarks.

We would like to thank everyone for taking the time to be with us today. A replay of this call will be available in about one hour on both our web site by telephone and will run through the close of business on Friday, August 15. To access the replay on line visit investor.NationalFuelgas.com and to access by telephone, call 1-888-286-8010 and enter pass code 23769429. This concludes our conference call for today. Thank you and good-bye.

This concludes the presentation for today, ladies and gentlemen. You may now disconnect. Have a wonderful weekend.