National Fuel Gas Co (NFG) 2011 Q2 法說會逐字稿

Welcome to the second quarter 2011 National Fuel Gas earnings conference call. (Operator Instructions). I would now like to turn the call to over Mr. Tim Silverstein, Director of Investor Relations. Please proceed.

Thank you, LaTasha, and good morning, everyone. Thank you for joining us on today's conference call for a discussion of last evening's earnings release.

With us on the call from National Fuel Gas Company are Dave Smith, Chairman and Chief Executive Officer, Ron Tanski President and Chief Operating Officer and Dave Bauer, 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 teleconference will contain forward-looking statements. While National Fuels 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 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, Tim and good morning. The second quarter was a terrific quarter for National Fuel, GAAP earnings were $1.38 per share, up $0.41 quarter-over-quarter. Excluding discounted operations and excluding the gain on the sale of our landfill gas generation assets.

Recurring operating results were up $0.04 per share mostly due to higher earnings in our E&P segment, where a 55% increase in total production and higher crude oil prices, more than offset the impact of lower natural gas prices. Earnings in the regulated segment, though down from the prior year, were strong and consistent and in line with our expectations.

Given that performance, and given the very strong second quarter performance of Seneca, we are increasing our fiscal 2011 earnings guidance to a range of $2.83 to $2.98. Overall, it's been a very good quarter from a financial perspective and Dave Bauer will have more to say on actual and expected earnings later on the call.

But perhaps more importantly, it's also been a very good quarter from an operational and strategic perspective. One where we've continued to make progress in putting in place the building blocks, the foundation, if you will, for continued future growth. We made a great deal of progress in executing on our plans to divest our smaller non-core assets. We've been looking at this for the last few years, as you know.

The successful sales of Seneca's Gulf assets, which were high risk relative to our California and Marcellus assets, and Horizon Power's landfill gas generation assets essentially completes that process. They were good businesses but relatively small, with limited upside. With these divestitures, our attention is entirely focused on our existing businesses, with particular attention, of course, paid to our extraordinary growth opportunities in Appalachia.

As you know, many of those opportunities are in the Pipeline and Storage segment and we've made excellent progress on our expansion initiatives. Construction of Supply Corporation's Line N and Lamont Phase II projects are currently underway and we hope to commence construction on Empire's Tioga County Extension Project within the next few weeks. All three projects should be in service by the end of fiscal 2011 and in total add $30 million in revenue in fiscal 2012.

With numerous Marcellus fueled expansion projects on the horizon for 2012 and beyond, we expect growth in this segment to continue for the foreseeable future. And Ron will have more to say on these projects later on in the call. In the Exploration and Production segment, we continue to see great results from our California assets and from our Marcellus drilling program. As we bring additional Marcellus wealth online , our production continues to grow very rapidly. Seneca's second quarter Marcellus production of 9 Bcf, was up 53% from the first quarter, over 200% from the fourth quarter of fiscal 2010, and almost 600% quarter-over-quarter. We expect continued significant growth in the quarters to come as the Seneca operated portion of our Marcellus program rose from its current four rigs to six rigs by the end of the calendar year.

On a consolidated basis, we expect total production will grow by nearly 40% in 2011, and that's despite the sale of the Gulf, and by an additional 35% in fiscal 2012. On its own, this is a very compelling growth story, but we would like to grow at an even faster pace.

To that end, we continue to have discussions with potential joint venture partners and while I can't say much at this point, and I know you understand that, I can say that we've had serious offers. We're not quite there yet, but we're moving in the right direction. As we said at IPAA, we expect to come to a conclusion relatively soon. Probably by the end of June.

The good news is that given the production growth we anticipate, with or without a joint venture, we have a very compelling long-term growth opportunity. And Matt will provide an update on Seneca's operations later on the call.

In summary the second quarter was a great quarter for National Fuel Gas, earnings were up over the prior year, and as I said before, more importantly, our significant growth plans in the E&P and Pipeline and Storage segments are right on track. I look forward to seeing many of you at the AGA Financial Forum in Orlando later this month. With that I'll turn the call over to Ron for an overview of

Thanks, Dave and good morning, everyone. As Dave mentioned, we had a very good quarter and a good first six months of the fiscal year. In all of our operating segments, things are moving along as planned. While we did have a colder than normal winter, all of our Utility, Pipeline, and Storage Systems operated as designed, without any problems. Lower gas prices over the period benefited our utility customers and utility receivables dropped to the lowest level we've seen at this time of the year since 2002.

Regarding the pipeline expansion projects, there really is no update at this point to any of the target completion dates that we laid out in the last Investor Presentation posted on our website.

We are, however, a little behind on starting our Tioga Extension Project since we're still waiting for a FERC certificate before we can get going. We're expecting that certificate any day now. Seneca has four horizontal drilling rigs running in Appalachia, three are in Tioga County in our Eastern Development Area, and one is in our Western Development Area.

The Western Area rig just finished the drilling of a vertical Utica Shale test well. We took side wall cores from the Utica formation, and will be doing a lot of science work, but it will be months before we're in a position to say anything meaningful about the Utica Shale. The rig has since moved back to drilling targeted Marcellus wells, while we prepare another location for our next Utica test well. Seneca is also expecting delivery of a fifth operated rig in the Marcellus, sometime this summer.

Complementing Seneca's four operated rigs in Appalachia, EOG is operating two rigs on the EOG joint venture acreage. In addition to the activity in Appalachia, Seneca has two drilling rigs running in California, one in Midway Sunset, and the other in Sespe.

Before turning the call over to Matt, I would like to take a moment to emphasize the commitment of National Fuel and its subsidiaries to safety and to a clean environment. We've always focused on the safety of our employees, customers, contractors and communities where we operate. This past quarter, we've undertaken some significant initiatives to underscore that commitment.

In April, we began to post the contents of our hydraulic fracturing mixtures on the fracfocus.org website. Subsidiaries of National Fuel have been fracking wells for decades, and based on our years of experience, we believe it is a fundamentally safe practice. It's our hope that increased disclosure by the industry, will ultimately lead to a better public understanding of the issues.

In the wake of a number of natural gas pipeline ruptures in other parts of the US over the last year, our pipeline company is a member of the Interstate Natural Gas Association of America, has committed to work toward reaching a goal of zero pipeline incidents across the entire industry.

Finally, we recently announced the promotion of Jim Ramsdell, to Senior Vice President and Chief Safety Officer of National Fuel Gas Company. In that role, Jim will oversee our continued emphasis on safety across all of the Company's operations, including the utility, pipelines, storage fields, gathering systems and drilling sites. Previously, Jim was Senior Vice President of our Utility Operations. He's an industry veteran having worked at National Fuel for 35 years. I can think of no person better suited for this role.

I'll now turn the call over to Matt Cabell.

Thanks, Ron. Good morning, everyone. Seneca had a great quarter with production of 18.2 Bcfe, up 55% versus last year's second quarter, and earnings of $0.40 per share, up 21%.

Last week we closed our Gulf of Mexico asset sale. The sales price was $70 million, with an effective date of January 1st. In addition to the sales proceeds, we eliminated a $37 million reserve for off-shore abandonment liability. While the Gulf of Mexico was once a major component of Seneca's production and reserve base, it was no longer able to compete with our other two divisions.

We'll now focus our resources on our high margin California oil properties and on our outstanding Marcellus growth opportunity. Later today, we expect to close on the sale of a small, non-operating interest in a west Texas oil field for $8.5 million. This is a property we acquired when we bought the U.S. Oil & Gas assets of Ivanhoe Energy two years ago.

At that time we only attributed $1 million to the property, so we were capturing a nice margin on this deal. In California, we've begun our six well drilling program at the Sespe field. This program includes four stepouts intended to extend the field area, and two infield wells at five acre spacing. If successful, we could add significant potential for future drilling.

Also in California, we've now drilled 32 wells at South Midway Sunset. This has been a successful program, and we expect to see a total of 300 to 500 barrels of oil per day from these wells in six to 12 months, once we have achieved the full impact of steam injection.

In the East Division, our Marcellus production continues to grow. Seneca operated production is now approximately 100 million cubic feet per day from 32 wells. While in the EOG joint venture, we have net production of approximately 30 million cubic feet per day from 31 wells. We continue to be most active in Tioga County, where we have three Seneca operated rigs drilling.

We are about to bring on a three well pad and have 11 more wells on two pads to be fracked over the next couple of months. Other than a few initial exploration wells, all of our drilling is coordinated with our gathering and pipeline solutions. Such that we have very few wells completed but not yet producing.

In Potter County we float tested two new wells. The first was a Marcellus well, that had a 24 hour IP rate of over 4 million cubic feet per day. The second well tested the upper Devonian Geneseo Shale at a rate of approximately three million cubic feet per day. We're pleased with both of these wells. We expect to begin development of the Marcellus in this area in fiscal 2012. While the Geneseo well confirms the potential for commercial wells in this relatively unexplored interval.

In Western Tioga County we tested our first Marcellus well on track 007 at a somewhat disappointing rate of 2.1 million cubic feet per day. We will be studying this area regionally and considering changes to our frack design and our target zone, prior to full development. As I have mentioned at recent investor conferences, our two new well tests at Owl's Nest in Western Elk County were very encouraging. These wells tested at 4 million and 4.5 million cubic feet per day.

Most importantly, we are confident that we've identified the ideal landing zone in this area. And should be able to consistently drill and complete wells with 3-5 BCF EURs. Our next important Western Marcellus test will be a Beachwood in Eastern Elk County, where we will test one well in early June and two more later this summer.

Regarding the Utica Shale, as Ron mentioned, we've just finished the drilling and coring of a vertical well in McKean County. We will be analyzing core samples over the next several weeks and also plan to drill another Utica well further to the Southwest, later this year.

Looking forward to the third quarter, we expect continued growth in Marcellus production, to offset much of the production that we lost to due to our Gulf of Mexico sale. Even without the Gulf, our current US daily production rate is as high as it has been in the past ten years. In fact, despite the sale of the Gulf, we've increased our production guidance for fiscal 2011 to a range of 66 to 71 Bcfe. At the mid point, that is a 38% increase over fiscal 2010. This growth is based on a disciplined development plan that relies on efficient multi-well pad drilling and coordination between drilling and midstream.

Our extraordinary acreage footprint allows us to develop our position far more efficiently than most of our competitors. Our rigs are not chasing lease expirations, but rather are focused on maximizing our returns. With that I'll turn it over to Dave Bauer.

Thank you, Matt and good morning, everyone. Second quarter was another great quarter for National Fuel. Seneca in particular had a strong quarter, thanks to a 55% increase in production, and an almost $5 per barrel increase in crude oil prices after hedging.

Earnings in the Utility segment were solid mostly due to colder weather in Pennsylvania and lower than expected O&M costs. Pipeline and Storage earnings were down from the prior year due to higher O&M and decontracting at Niagara, but they were generally within our expectations.

As you read in last night's release, we revised our earnings guidance for fiscal 2011. We upped the midpoint of the range by $0.08 to reflect our strong second quarter results, and with the heating season behind us and the bulk of our regulated earnings on the books, we tightened the range by a dime. Our new GAAP earnings guidance is $2.83 to $2.98 per share.

When you back out the $.38 per share gain on the sale of our landfill gas assets, the range is $2.45 to $2.60. In keeping with our past practice, we've held our base commodity price assumptions constant at $4.00 for gas and $80.00 for oil. We've updated the sensitivity table in yesterday's release to give you an idea of the impact of changing commodity prices on earnings. Using those sensitivities and current commodity prices, say $4.25 for gas and $100 for oil, would add about $0.10 per share of earnings over our base forecast for the last six months.

Last week we closed on the sale of our off-shore Gulf of Mexico properties. Because the sale had an effective date of January 1, the $70 million sales price was adjusted downward for January and February's net operating cash flows. Cash received after that adjustment was $61.8 million.

Under full cost accounting rules the sales proceeds will be applied against the full cost pool and no gain or loss on the sale will be recorded. The sale of the offshore properties will have a modest impact on our per unit expenses. Going forward, we expect our per Mcfe LOE rate will decrease from our current $1.07 rate for the first six months of the year to somewhere in the range of $0.95 to $1.05.

The sale will have a small positive impact on our DD&A rate, but because of our oil drilling in California, which carries a higher F&D cost than our natural gas drilling, combined with increased completion costs in the Marcellus that we've discussed before, I don't expect our DD&A rate will be significantly different than our $2.17 per Mcfe rate for the first six months of the year. However, reserve additions at fiscal year end when we complete our reserve audit, could have a significant impact on the DD&A rate. We continue to be active with our hedging program, and have taken advantage of the recent jump in the Strip to lock in some attractive pricing.

Over the past few months, we added about 14 Bcf of natural gas trades for each of fiscal '12 and '13 at average prices in the range of $5.25 to $5.50 per Mcf. We also added an additional 3.5 Bcf natural gas layer for 2014 at $5.89 per Mcf and conditioned our regular process of layering in crude oil hedges.

Important to note that these hedge prices are at Dominion Southpoint, so we've also locked in the bases to NYMEX. At these prices the economics of our Marcellus wells are very strong and a typical $6 million well cost, 4 BCF EUR well pays out in about two years. For the last six months of 2011, we're about 54% hedged for gas and 62% for oil.

For fiscal 2012, our hedge percentages are roughly 45% for gas and 55% for oil. We're a bit more hedged for oil than we are for gas, and that's a result of our conservative approach to adding new positions. We generally don't let our hedge positions grow beyond the production we expect from wells that have already been drilled. As we drill additional well this is summer, I expect our natural gas hedge position will increase.

Turning to our spending plans, we're still comfortable with the $780 million to $895 million range for our fiscal 2011 Consolidated Capital Budget. Using the mid point of our guidance, we expect to be in a short-term borrowing position in the neighborhood of $50 million by fiscal year end. Looking to 2012, we expect capital spending will be in the range of $845 million to $1.01 billion.

As Dave said earlier, Seneca will be adding two rigs to its Marcellus program by the end of calendar 2011, and it's the increased drilling as a result of those rigs that will drive our increased spending in 2012. As Seneca ramps up its drilling program, I expect capital spending will outpace cash flows in 2012 by about $275 million. Now, that assumes $4.00 gas and $80.00 oil, should prices stay at their current levels, it's likely our shortfall will be lower than that. Perhaps as much as $50 million to $60 million lower. I should also emphasize, that this is our no JV scenario. Should we do a JV, our short-term capital needs would likely decrease. Our next long-term debt maturity is for $150 million this November.

At this point, I expect we'll do a long-term debt issuance in the summer or early fall to refinance that maturity. Interest rates are attractive, so we'll likely pre-fund a large chunk of our capital program as well. In total, you can plan on the issuance in the $400 million area. Again, the amount and timing of any issuance are dependent on the outcome of the JV process.

Our balance sheet is in great shape and can handle the additional leverage. Our equity-to-cap ratio was 63% at March 31st, and should be in that vicinity come the end of the fiscal year. Assuming $300 million to $350 million of incremental borrowings over the next 18 months, I expect our equity-to-cap ratio at September 30, 2012 will be in the very high 50s, maybe even the low 60s if current NYMEX pricing holds.

In summary, National Fuel is in great shape. Earnings are up, and our strong balance sheet makes us well positioned for future growth. With that, I'll ask the operator to open the line for questions.

(Operator Instructions). And your first question comes from the line of Kevin Smith with Raymond James. Please proceed.

Good morning, gentlemen. And nice quarter.

Thanks, Kevin.

Just a few questions on your E&P operations. Matt, I know you talked a little about Owl's Nest. Do you think the rock quality differs? Is there a different pressure from Northeast? And also do you think you'll need 3D seismic for this area, it seems that there's some faulting in your presentation or a little bit, not smooth formation.

Good question, Kevin. We're in the process of permitting our 3D seismic program in Owl's Nest. It's a 50 square mile program. Your other question was rock quality and pressure, and I think, I guess two parts to that.

One, the Marcellus is thinner as you move to the West. It is not dramatically thinner, but it is thinner, but and it's a little shallower so the shallow nature means you're going to be under a little less pressure. Other than that, it's good quality rock.

Okay. And then one other question. You mention the Geneseo formation, I hope I pronounced that correctly. I don't know much about that. I haven't heard a lot of talk. Is there other industry participants been drilling into that, and what got you interested in it?

Well, there has been a few other tests in the Geneseo, and it's an Upper Devonian Shale. It's a shale that may go by other names as you go to Southwestern Pennsylvania. And we identified it some time ago as a potential candidate, even before there were any other well tests in it.

Okay. Any talk about how far it spreads? Is it something that you think will be several counties?

I guess I'm not prepared to discuss that yet, Kevin. There's obviously still potential competitive leasing, and there is still a lot for us to learn.

Should we expect more tests this is year?

Probably not in this fiscal year.

Okay. Thank you very much.

(technical difficulties)

Our next question will come from the line of Carl Kirst with BMO Capital Markets. Please proceed.

Thanks, good morning, everybody. I appreciate you guys hanging on the line here.

Thanks, Carl.

Actually I just emailed my questions into Tim.

Thanks for your patience.

Hey, just a couple quick and I wasn't scribbling down fast enough. Matt, you had mentioned a $2.1 million IP well, I believe in the Western Marcellus. I didn't catch where that was.

That was actually in Tioga County, Carl. In Western Tioga. On the track 007 which is the Western part of Tioga County.

Okay. Was there anything different that you did on that well as far as, you know, you're still kind of testing out completion techniques?

No, there wasn't actually. It was a well that had a little bit different rock quality. We recognized after drilling it, even before we had fracked it, that it was likely to be more difficult to frac than some of the other wells.

What we haven't figured out is, how much of that variation is local, and how much is more regional. So there's a lot more work for us to do on the track before we have any complete conclusions. It's only the first well.

Perfect, thank you. And then the second question and again understanding where we are in the very nascent stage, was there always two Utica pilot wells planned, or should we in any way take, the idea that we're doing a second well as at all indicative of perhaps a very positive first read on the first Utica test?

No, the second one was already in the plan.

Okay. And then last question if I could, and understanding the sensitivities around this I'm not sure if you can answer. But with respect to the JV conversations which remain ongoing, do you find that there are wide variations in what people are looking for? Or is it actually fairly narrow and it's just quite frankly, kind of coming down to price? Like I didn't know if you had people out there at 100% cash or 100% carry, looking for half the acreage, some looking for 10% of the acreage, so you're going through a lot of these almost kind of normalizing factors to figure out which is the best opportunity? Or is everyone kind of looking for the same thing?

Yeah, Carl, I can't say much about it but your instincts are pretty good. Clearly there is a variety of interest and it's not necessarily everybody out there looking for exactly the same asset, exactly the same percentage. You have different players of different sizes, different interests, different expertise. So your instincts there are pretty good. That's one of the reasons why it's a little more complicated than I think we initially thought it would be. But overall, I mean I think it's fair to say people are pretty impressed with the assets, and the acreage, and it's fair to say that we are drawing to a conclusion.

No, that's great color, so I very much appreciate that. Thanks, guys.

Your next question comes from the line of Andrea Sharkey with Gabelli & Company, please proceed.

Hi, good morning, guys.

Good morning, Andrea.

Good morning.

I know again with the JV you probably can't talk much about it, but I was just curious if you had any industry perspective thoughts on the recent deal where Chevron bought acreage from Chief, was that close to any of your acreage? Any thoughts on maybe why Chevron would have chosen to do a deal with them versus you? Obviously you can't say about whether they looked at your acreage, or whatever, but just high level maybe why go that direction than a potential JV?

Sure, Andrea, I think the acreage that Chevron acquired from Chief was largely South of our acreage and probably in reasonably close proximity to where their acreage was that they acquired from Atlas. Now, I'm not absolutely certain of that, but I think that's the case and I would expect that that's what drew them to the Chief deal.

Okay. That makes sense. And then I guess just, you know, we've seen cost pressures on the drilling and completion side. Have you seen that stabilizing? Is that still increasing? And then how are you doing in terms of availability of getting those additional rigs, and then the frac crews that you need? Do you have long term contracts in place, and what's your thoughts on that?

First I would separate the drilling from all of the completion services. Drilling, new rigs are a little bit more expensive day rate than the first rigs we got. But frankly, we're drilling the wells faster and longer laterals in a shorter period of time. Actually if anything our drilling costs are really coming down, especially on a per foot basis.

Completion costs have been going up over the course of the last, say, 18 months. I guess we're hopeful that they'll stabilize here and, we're doing things like arranging long term contracts for a frac crew that will be with us all the time, so that we don't have to kind of take frac crews when they're available. That helps some with the availability question. But honestly, the market is still pretty tight, and if you wanted three frac crews tomorrow, you wouldn't be able to get that.

Great. And then I guess just one last question and then I'll turn it back. I sort of tried to back into you that you completed 14 wells this quarter. I guess first, is that correct? And then maybe just broadly, what were the sort of average IP rates on those?

I think that 14 sounds reasonably accurate. I don't know that I've got a count by quarter, and the average IP is probably somewhere in the oh, let's say $4 million to $5 million a day range.

Great. Those are great results. Thanks.

At this time, there are no further questions in the queue. I would like to turn the call over to Management for any closing remarks.

Thank you, Latasha. We would like to thank everyone for taking the time to be with us today.

A replay of this call will be available at approximately 2 PM ET on both our website and by telephone, and will run through the close of business on Friday, May 13, 2011. To access the replay online, visit our Investor Relations website at investor.nationalfuelgas.com. And to access by telephone call 1-888-286-8010 and enter passcode 37028042.

This concludes our conference call for today. Thank you and goodbye.

Thank you for your participation, this conclude today's conference. You may all now disconnect. Good day.