National Fuel Gas Company (NFG) Q3 2008 Earnings Report, Transcript and Summary

Good day ladies and gentlemen. And welcome to the Third Quarter 2008 National Fuel Gas Company Conference Call. My name is Carmen. And I'll be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. [Operator Instructions]. As a reminder, ladies and gentlemen, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to our 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 evening's earnings release. With us on the call 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'll open the discussion to questions. We would like to remind you that today's teleconference 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 evening's earnings release for a listing of certain specific risk factors. With that, we'll 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 were over 70% higher than they were in 2007, the increase being driven primarily by the E&P segments. 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. Net increases in production coupled with higher realized commodity prices while 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 the 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 our recent developments. In the utility segment, we promoted Anna Marie Cellino to President of the Distribution Corporation. Anna Marie is a lawyer in a CTA, who, over the course of more than 25 years with company as a one time or another, overseen most every aspect of distribution's business. Anna Marie 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 our utility service territory and given our desire to avoid rate increase request, our ability to control cost will be critical to our future and I have every confidence in Anne's ability to get the job done. We also promoted Ron Cramer to President of the Empire. Ron, who is 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 his complete on about 70% of line and both of the turbo compressor units have been set at the Oakfield Compressor Station. To the end of the 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 a $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 1st, 2008. But obviously the actually flow of gas is contingent upon the completion of the Millennium project. As I've said in the past, when Millennium is ready, we'll be ready. We've also had some good news which regards to the existing Empire line. Last month, two of our Empire anchor shippers executed five year extensions of their firm transportation contracts. In total, the two contracts represent about 190,000 decatherms per day at 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. These division has done everything we've asked of it, increased drilling, increased production, increased reserves, increase EURs and perhaps most importantly, they put in place the fundamental building blocks to ensure steady annual growth. We're also pleased with our California operations and with the exploration successes we've had in the Gulf of Mexico, largely as a result of our new, more focused approached. 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 Fuel's history. Earnings are at record levels. Our balance sheet is as strong as it has ever been and we 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 footprint. The E&P segment will continue to be a principal area of focus. Seneca's initial capital budget for fiscal 2009 is in the range of $195 billion to $270 billion 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 I million acres of mineral rigs. Our aggressive drilling program and the Upper Devonian will continue to grow. As we 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 10 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 in storage and mid-stream businesses. Active producers in the region, including Seneca, are quick to point out the indeed for new gathering and new pipeline infrastructure to get anticipated Marcellus production to market. National Fuel is well positioned to help to solve that problem. Last month after numerous discussions with Appalachian producers, we announced the formation of National Fuel Gas Midstream Corporation headed by Duane Wassum, who is a season veteran of both National Fuel and the pipeline construction industry. This new company has focused on developing, gathering system 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 with West or East project, which as you'll recall, would expand from the terminus of Rex, the Rockies Express, their clinic in Ohio to Overbeck, which is in Central Pennsylvania, and ultimately onto Cornell, New York, with interconnect with the Millennium 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 and open season earlier this week. Starting at Waynesburg, Pennsylvania which is south Pittsburg, the Appalachian Lateral would extend to 135 miles directly through the Marcellus fairway to Overbeck where we'd connect with the northern portion of west to east project which as I indicated ultimately reaches Cornell. While the project is in its early stages, there has been a great deal of interest, particularly from Marcellus' producer and we are very optimistic. Regarding storage development, we continue to make progress on the expansion of our east branch Gilbreth and Tuscarawas storage facility. 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, final application for approval with FERC. Before turning the call over to Matt, let me take a few moments to update you on our smaller businesses. First, we continue make progress on the proposed sale of landfill gas pipeline operations, which is carried out by Horizon, LFG and we call it Toro. And our 50% interest in the Energy Systems North East 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's possible that a sale could close by the end of calendar 2008. As to our ESNE power plant we've recently reached an agreement of principle to sell our 50% interest. We're still hammering out some of the final 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 Horizon LFG and ESNE transactions will result in P&L gains. I'd also like to brief a comment on the Timber segment. As you can see from last night's release, earnings in that business are down from the prior year simply put market conditions are terrible, the down turn in the housing market and the weak economic outlook have combined to create a lack of demand from the high end furniture, cabinetry in foreign markets, into which we sale our product. As a result, we scaled back our operations rather than sale into a depressed market. We will resume normal operations once the demand returns and in the mean time our timber assets not only continue to provide access to our underlying mineral rates, particularly in the Marcellus Shale, and literally continue to grow in value. With that, I will turn the call over to Matt.

Thanks Dave. Good morning everyone. We'd another great quarter at Seneca with production, prices and earnings all up significantly. U.S. 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 full year fiscal 2008 production will exceed 41 Bcfe. In the Gulf of Mexico, we drilled another successful exploration well. The Eugene Island 383 well, found 70 feet of pay and will be sub-sea completed and ties back to a near by 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're 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 Maverick Sand adding another 230,000 barrels of proved reserves. While Southwest Hills field, we're continuing to develop our Monterey Shale play, drilling four wells this quarter. As a result of this program, we should boost our production at Southwest Hills by about 250 barrel equivalent per day. We don't often say a lot about California, because not much change is there, it simply continues to run smoothly providing consistent production and cash flow. But with current prices, the profitability and overall value of West division have increased substantially. That's at the PV-10 and 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 a 110 million cubic feet equivalent. However, we have fallen behind a bit on our drilling schedule. Let's 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 add through the third quarter are over 20 Bcfe more than three times production. In the Marcellus with our partner EOG, we've completed and tested another horizontal well. 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 per day. This well is currently shut in for pressure build up test. We now have two horizontal on ells completed and tested. One of which we believe is not effectively fracked and another which has a very short lateral. Well neither these wells float at a high rate, we do not believe that they are representative, of what we should expect from the development program. With the new rig that EOG is brought in for future horizontals, we plan to drill 3000 to 4000 feet laterally and consequently we expect to have much higher production rates. We are currently drilling the first horizontal well this new rig, we had a plan to lateral of 4000 feet more than three times the lateral of last well. We planned 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 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 in high grade rate new areas for future horizontal drilling. Now for 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 ahead of schedule, we'll be near the high end of our guidance. If we had 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 in 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 Appalachia; 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 09 gas hedged at an average price of $9.49 per Mcf and we have approximately 40% of our fiscal 09 oil hedged and 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 a range of $195 to $270 million. With more than half dedicated to Appalachia including approximately $50 million from 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 the earnings drivers are covered in yesterday's earnings release. We're 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 $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 shut ends of our Gulf of Mexico production due to the hurricanes. Looking forward to fiscal 2009, our preliminary estimates for consolidated earning is in the range of $3.20 and $3.40 per diluted share. The increase in the earrings, results primarily from increased commodity pricing at Seneca. While we were preparing our forecast NYMEX features prices were so volatile that we chose to utilize flat pricing in the base forecast. The pricing assumption built in to our 2009 forecast is a NYMEX Henry Hub gas price of $9.50 per per MMBTU, and then 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 sensitivity table on page 27 of yesterday's release. We've also set our preliminary capital budgets for each of our segments for fiscal 2009. Those preliminary budgets include $195 million 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 were in overall total in the range of $328 million to $403 million. In the pipeline in 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 to reviewing the responses of shippers, mostly producers who have interest in taking capacity from our Midstream Corporation or gathering their production and tying it into other pipelines. And over the next six months, we'll 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 that 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 line for questions, I'll mention the couple of items regarding our utility. In the Pennsylvania division of our utility, we require to make quarterly filings to adjust our rates, to reflect our expected cost of purchase gas. New rates that went into effect on August 1st were based on market data through June and 33% higher then the prior year. During July, we saw such a drastic decline in NYMEX future prices but this week we filed a request with the Pennsylvania Public Utility Commission to decrease our rates in later then more recent market data. Since the utility simply passes along the cost of gas without marking it up the interim adjustment should have no earnings and pack to the company, but heading into the fault, the decrease should make the bills for our Pennsylvania customers less stressful than the 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 and with the projected increase and winner heading bills, we expect thousands more to benefit from rebates under the Conservation Incentive Program and continued savings in their fuel bills. I'll now ask the operator to open the line for questions. Question And Answer

[Operator Instructions]. And the first question comes from the line of Carl Kirst from BMO Capital. Please proceed.

Hey, good morning everybody. Matt, just a quick question with respect to the EOG joint venture, the first is in... certainly understanding the first three wells here horizontal are representative. But can you tell us what the costs were on each of those three wells?

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

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

We are actually drilling the horizontal section now. We expect to crack it in September. Complete it in September.

Okay. And then just lastly, my understanding was there is also going to be a fit well, sort of second year with the new rig, regardless of the results of the fourth, is there a sense of timing of when that would happen and where it happen, kind of immediately after the fourth well is completed or is that something where its more I guess the specific surround that fit well will just be evaluated once we know the results of 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.

In the calendar year, okay. Thanks for the clarifications.

And the next question comes from the line of Shneur Gershuni from UBS. Please proceed.

Hi guys. It's actually Chris. Just had a couple questions this morning, first could you speak to production guidance in 2009 why your E&P CapEx is up considerably production guidance spot year-over-year. I know you spoke little bit about TOM [ph] and Appalachia, so if could you give a little bit more detail there?

Okay, beyond what I said in the comments?

Yes. I mean the focus seems to be more on Appalachia, but it's a pretty sizeable increase in drilling CapEx and I was just curious what the plant EUR in terms of timing or what not?

I think the main thing to understand here, well there is probably two things to understand. One is again, Gulf of Mexico will naturally be down just because we are not spending spent enough money to expect to maintain that 15 Bcf per year production rate. The other thing to understand is 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 till at least about mid year because they require new platforms. So that the timing of new production is going to have a big impact on what our overall production looks like for the year. Meanwhile in we expect to have at least a 20% increase in our production there.

Okay. Also on production guidance on the cost side, the guidance for production cost illustrates substantial year-over-year growth, so I wonder if you can get some color on that.

Sure. The biggest component to that increase is the cost of steam fuel, for California. We'll be increasing our steam in California by something on the order of 15% to 20% so that adds substantially to our costs. Additionally, the cost of gas is going up. We purchase gas from the Rockies and that cost of that gas has going up substantially. And really another thing to look at is, even though it's only 15% to 20% total increase in steaming, the incremental cost of that gas goes up substantially because that's all purchased gas, whereas, normally an order of 30% to 50% of our current tin fuel comes from waste gas that is very inexpensive, incremental increase is all purchased gas.

Okay. Okay, great. One final question with respect to ongoing exploration and Marcellus EOG recently had expressed some concern about their findings EURs and other. Just wondering what you guys are seeing outside... I know I understand your initial comments on the horizontals but given these comments and I guess the seeming decline and interest in Marcellus from EUG, would you guys consider potentially dissolving the JV happening?

Well, first of all let's be clear about what EOG said. I don't think any thing they said would say they are out of decline in the interest. What they said is that the idea of 3 to 4 Bcf wells like some of our competitors may have suggested seemed a bit rich a based on the data and I don't know but I would disagree with that, but 1.5 to 2.0 Bcf wells are highly economic in this way. I think EOG is still very much on board, they are still very good partner and they're proceeding with a new program this year and are expected to pick up a good in next year. Now the way the agreement is written, if they don't need certain drilling requirements, well the deal dissolves on itself.

Okay.

Now, that's not to say that we might not renegotiate certain portions of the agreement, but that's all depended on negotiation and there is nothing been done today.

Right.

Yes, I think, the other thing is remember that I mean EOG payment said you won't see meaningful production from their perspective, meaningful to EOG is different to international field than it is to EOG so just keep that in perspective.

Okay. Well thanks guys and compliments on the quarter.

Welcome.

Your next question comes from the line of Rebecca Followill from Tudor, Pickering, Holt. Please proceed. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Good morning. Several question for you. On the 50 million CapEx in 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. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Okay.

Okay, and includes some additional vertical drilling that we would likely operate beyond those six wells, that has seen and that's less certain in terms of where those wells will go yet but we are planning some additions, and I think include some leasing as well. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Okay. Can you tell us where you plan drill that six vertical wells?

No, I guess I just assume leave that confidential for now Becca. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: 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. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Okay, that's fair. And may be on the California the moderate, area how much acreage do you have that prospective for the Monterey Shale?

Well, lets be clear here, Southwest Hills that's basically already produced from Monterey Shale and we have been for years. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Okay.

The Monterey formation changes across California, classes same [ph] from being, primarily a shale when you are down there Southwest Hills to be an inter rolls kind of inner bedded sands in shale as you go further north, so up in Midway Sunset the Maverick inner rolls actually primitive Monterey but it's the sand there not a shale, I don't know the answer you. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Yes,I got just the four wells that you were talking about during the Monterey and there is a lot of data may be I just missed, apart you guys talked about drilling four Monterey wells?

We did. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Okay. And that's the just the same formation you've been drilling, it's not anything new?

Right, it's the same Monterey Shale in the Southwest Hills [inaudible] Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: And then on Gulf of Mexico, Highland Block 123-L, is that full on target for October?

It's on target for October and probably the biggest variable there is going to be the Hurricane season that's to other than 23-L. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: And your net production is would be what?

From23-L? Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Yes.

Let me think about that for a second. Let me... Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: I think I can get... but right now, does I have to have it right now, just trying to get a feel for what could swing things one way or the other and?

Let me it this way Becca, just a single well that I'd say I think 20 million a day and 3,000 barrels of condensate and we have a 55% working interest. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Okay, so it's unchanged. Is Eugene Island 383 kind of that same range?

Yes, it's probably in that same general range. Rebecca Followill - Tudor, Pickering, Holt & Co. Securities, Inc: Okay. Perfect, thank you guys.

[Operator Instructions]. And your 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 of production in the wells that you are drilling?

Jim it varies from well to well.

Okay.

But, some of these well that are in relatively small reservoirs could be there entire decline 12 months, while others might last to four years.

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

Well yes, of course there is, but I think a better way to look at it is, we're constantly looking that the opportunities available to us, and given projections of gas prices we determine what drilling program we're 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 are there some infrastructure investments that you are making and may be could you give us an update as to what infrastructure looks like, where you are drilling, what it can support and whether you or not there is infrastructure around in new wells that you are contemplating drilling?

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

Thank you.

And we have no further question at this time I would like to turn call back over to management for closing remark.

We would like to thank everyone for taking the time to be with us today. The replay of this call will be available in about one hour on both of our website and by telephone and will run to the close of the business on Friday August 15th. To access the replay online visit our Investor Relations website at investor.nationalffuelgas.com and to excess by telephone call 1888-286-8010 and enter pass code 237696429. This concludes the 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.