National Fuel Gas Company (NFG) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Q4, 2016 National Fuel Gas Company Earnings Conference Call. At this time, all participants are in a listen-only-mode. Later we will conduct a question-and-answer session and instruction will follow at that time. [Operator Instructions]. As a reminder today's conference is being recorded. I’d now like to introduce your host for today’s conference Brian Welsch, Director of Investor Relations. Sir, you may begin.

Thank you, Kevin and good morning. We appreciate you 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 Ron Tanski, President and Chief Executive Officer; Dave Bauer, Treasurer and Principal Financial Officer; and John McGinnis, President of Seneca Resources Corporation. At the end of the prepared remarks, we will open the discussion to questions. The fourth quarter fiscal 2016 earnings release and the November Investor Presentation have been posted on our Investor Relations website. We may refer to these materials during today’s call. We would also like to remind you that today’s teleconference 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. I would also like to point out that the company will be participating in the Jefferies' Energy Conference in Huston at the end of this month. If you plan on attending, please contact the conference planners or me directly to schedule a meeting with management. With that I'll turn it over to Ron Tanski.

Thanks, Brian and good morning everyone. We reported our 2016 fiscal year results last evening and overall our strong hedge book helped us achieve solid results in the face of the low commodity prices as the whole industry has been facing during 2016. Commodity pricing is now settled into a pattern where we think the impairment for our oil and gas properties that we recorded in the fourth quarter should be our last. If you recall, the company took a number of actions this past year in response to those low prices. Early in the year, we entered into a joint development agreement with the partner to participate in the drilling of 75 of our Marcellus well. We also reduced our drilling activities by dropping to a one rig drilling program and we extended the target in service date for our northern access pipeline project to our 2018 fiscal year. All of those actions have put us in the strong financial position at the end of 2016. Looking forward to fiscal 2017 our team at Seneca continues to focus on drillings and operational efficiencies so we expect that our reserve additions from our ongoing drilling program will continue to be economic even if the forward strip prices that we're seeing today. John McGinnis will have a lot more details regarding our exploration and production operations in just a few minutes. In our utility operations, we're ready for the winter. Our natural gas storage capacity is in quite fall but our operations team always plans to be ready to handle the winter that could be up to 10% colder than normal. We'll do that through the combination of natural gas that is in the storage and our interstate pipeline supply contracts that will be transporting gas into our service territory from the supply basins where the gas is produced. Also in the utility, we're in the midst of an 11-month litigation schedule for our rate case in our New York jurisdiction. We recently requested a one month extension of this schedule to explore settlement options with the parties in the case, but we're not sure that those discussions will lead anywhere. If we don't settle the case and continued through the full litigation, we'd expect to resolution of the case in the spring after the end of our heating season. As a result, there will be no major impact on our earnings for the 2017 fiscal year. Switching to our interstate pipeline segment, we recently received formal approved of our rate case settlement for our Empire Pipeline. We settled for a rate reduction, there was some other accounting adjustments, the impact to Empire's earnings for the next year are expected to be minimal. Looking at our consolidated earnings for fiscal 2017, we laid out our earnings guidance and the assumptions behind our forecast in the release and we expect earnings to be steady for next year. Now, this is exactly what you should expect given the steady business in our rate regulated segments, our strong hedge book for our production to relatively flat pricing that we see in the futures market for our unhedged oil and natural gas production and our one rig drilling program for most of the year and our exploration production segment. Remember also that the portion of the production from our newer joint development wells coming online will be split with our joint development partner. As we’ve talked about for some time, we won't substantially increase our natural gas production until fiscal 2018, that’s when we expect to have additional take away capacity for our production areas via or northern access pipeline and Transco’s Atlantic Sunrise project. Transco recently announced the delay in the in-service state for their project to the middle of 2018. That’s a bit disappointing for us, but it will only have a minor effect and our development plan on our Eastern Development Area. And our own Northern Access project which is the pipeline for increased takeaway capacity from our Western Development Area we’re expecting to receive our FERC certificate soon. We also have an application on filed with the U.S. Army Corp. of Engineers and the New York State Department of Environmental Conservation for federal water quality permits. We’ve had meetings with the New York DEC and we've provided a lot of additional information and studies to them in response to their question. We’re currently in the process of comparing additional information as a result of the meeting we had with them just two weeks ago. Suffice it to say that the regulatory process these days for all major pipeline infrastructures has become more involved. We expect that the DEC will take the full year to review our application which we keep us on track to receive a water quality certificate in March of 2017. We’ll keep you posted if we find that there is any change in that schedule. Now, the discussions with the analysts, we get asked a lot of questions about our alternate plans, if our Northern Access pipeline gets delayed or permit is denied. First, let me reiterate that as recently as our meeting with the New York DEC two weeks ago, we’ve got no indications from them, but things are headed in the wrong direction or the things are off schedule. But, we realize that no infrastructure project is a slam dunk these days. Yes, we were delayed or denied in the very near-term, we'd obviously adjust Seneca’s drilling schedule to adjust production to the firm capacity that we do have. We’d also look to layer in firm sales with marketers and purchasers that do have additional capacity in our current interconnection to the Tennessee system. We’ve also export alternative routes to move Seneca’s production, but those routes don’t get us to a point that as liquid as Dawn [ph] or they involve additional pipes or they would be successive rate or tariff charges that don’t make those routes less economic. For example, we've looked at a route that would move the gas west to an interconnection with Tennessee at station 219. And we’ve also had preliminary discussions with Nexus to add a lateral that could connect their system to our production. We think the Northern Access project is the best on the table so far compared to those alternatives. If, however, New York is intent on shutting down expansion and economic growth in the state, there are alternatives that we could pursue, but we don’t think we are at that stage yet. Now, I’ll turn the call over to John McGinnis, President of Seneca Resources.

Thanks, Ron and good morning, everyone. Seneca produced 39.8 Bcfe during the fourth quarter compared to 37.6 Bcf in the last year’s fourth quarter. Total annual net production was a 161 Bcfe versus a 158-last year, a 2% increase year-over-year. In Pennsylvania, we produced 34.8 Bcf of gas during the fourth quarter, a decrease of 4 Bcf from our third quarter. This decrease in production was largely due to the lack of significant spot sales as a result of lower pricing. For the year, result a total of 7.5 Bcf and to the spot market. With respect to oil and gas reserves, we have completed our audit for this fiscal year approved reserves decreased by 496 Bcfe to a total of around 1.85 Bcfe. This reduction was due to a number of factors including negative revisions due to pricing the sale of reserves as a result of entering into the joint development agreement and removing a few spuds due to pricing and revisions in our drilling schedule. We continue to drive down our Marcellus well cost and operating expenses. Our well costs are now at $663 per foot which we believe is the lowest of our peers and the basin. As a result, our breakeven price is now less than $2 across our broad swap of our WDA acreage. In the EDA, our breakeven prices ranged between the $1.50 and a $1.60. We have now drilled 63 of the 75 Marcellus well commitment in our IOG joint development, 50 of these wells are online and producing. As I stated last quarter the combination of the IOG joint development program moderately reduced activity levels and improved operational efficiencies have led to the substantial decrease in our fiscal year 2016 spending. In addition, our completion operations commenced a little earlier than anticipated on one of our joint development pads triggering a $20 million drilling CapEx contribution by our partner IOG. As a result, Seneca’s total capital expenditure for 2016 came in at $99 million an 82% decrease from $557 million capital outlay in fiscal 2005 and $28 million below the midpoint of our guidance. But as I’ll discuss a bit later, this means our 2017 capital expenditure forecast will be higher by about $28 million as most of this capital just shifted between years. Moving to our Utica Point Pleasant appraisal program, our first Claremont area, Utica horizontal well has now been online for over a 120 day. This well continues to outperform our initial estimates and we are now increasing the EUR per thousand foot to 1.8 Bcf versus the 1.6 we announced last quarter. Our second CRB Utica well would be brought online this quarter and we have just completed drilling two additional Utica wells. Since the Utica Point Pleasant zone is well over 300 foot dig in this area we drilled one of these new wells in a deeper zone, the Upper Point Pleasant to compare productivity to our initial well which was drilled in the lower Utica. Our current appraisal plan is to have 8 Utica wells drilled by the end of this fiscal year with five online. In California, we produced 712,000 barrels of oil during the fourth quarter down slightly from the prior quarter. Annual net production in California was down about a 120,000 BOE year-over-year to 3.4 million BOE. This decrease in production was mainly due to the disruption of the available steam volumes that began during the first quarter in our North Midway Sunset field. We have now elevated this issue and steam volumes have returned to creed disruption levels. On a side note, Seneca is always looking for ways to improve our operations. As an example, this past July we brought online at our North Midway Sunset field the energy industry’s largest solar photovoltaic facility in California. This 3.1 megawatt system is estimated to generate around 5.4 million kilowatt hours of electricity annually all of which will be consumed onsite by Seneca’s crude oil production equipment. This facility would supply around 20% of electricity needs at North Midway Sunset on an annual basis. For fiscal 2017, we are now forecasting capital expenditures to range between $180 million to $220 million. California remains the same ranging $35 million and $45 million but we’re raising our Pennsylvania spend by $20 million, as mentioned before. We forecast our Pennsylvania CapEx to now range between a $145 million and a $175 million and this continues to assume only a one rig drill program during most of the year and daylight only frac operations. In addition, even though our forecasted total gross production volumes will continue to increase we’re lowering the midpoint of our expected net production for the year by 2.5 Bcfe now ranging between a 145 Bcfe to a 170 Bcfe. Our small decrease in forecasted net production is a result of operational schedule changes. First, while we are still targeting the same number of IOG joint development Marcellus wells this year. Some of these wells have been brought forward in the schedule while 100% working interest Seneca wells will be brought online slightly later in the year. And second as I discussed a few minutes ago, as a result of our first Claremont WDA Utica well showing promising early results, we have prioritized additional Utica appraisal drilling in our operation schedule. Given that Utica wells take about twice as long to drill down our Marcellus wells this will also slightly delay bringing on some new Marcellus pads. And with that, I'll turn it over to Dave.

Thanks, John and good morning, everyone. As you read in last night's release, our GAAP earnings for the quarter were $0.44 a share. Excluding the ceiling test impairment charge, operating results were $0.66 per share or 61% increase versus last year's fourth quarter. For the full fiscal year earnings excluding ceiling test charges were $3.04 above the high end of the range of our guidance. Several factors contributed to our performance for the quarter. First, at Seneca DD&A and lease operating expenses were both towards the low end of the range of our guidance. In addition, Seneca was able to claim $1.7 million or $0.02 a share income tax benefit related to the solar facility, John just mentioned. These faculties are a terrific investment. In addition to the tax credit they'll reduce our annual electric cost by about $800,000. At the pipeline and storage segment, revenues of $76 million for the quarter and $306 million for the fiscal year were towards the high end of our guidance and the continued strength of producer volumes. Fiscal '16 was another terrific year for our midstream businesses. On a combined basis, EBITDA from our pipeline and storage and gathering businesses was up 8% over the last year. Lastly, O&M expenses at the pipeline and storage segment were lower than we'd expected really due to a number of smaller items that all happen to go in the right direction. Our team has done a terrific job controlling operating expenses across the system. The pipeline and storage segment is a great example. Over the past five years, we've increased revenues in this segment by more than 40% with no meaningful change in O&M expense. Looking to next year, we're keeping earnings guidance at $2.85 to $3.15 per share. This guidance reflects the new production range, John described earlier as well as the slight revision to our pricing assumptions. All of our remaining major assumptions for next year both with respect to Seneca and the rest of the businesses are unchanged. You can refer to page 7 of last night's release for a summary of our guidance. Seneca has a great hedge book for 2017 particularly on the gas side, where we're more than 80% hedged. Our recent focus has been adding natural gas positions for 2018 and beyond. When despite in October we executed 16.5 Bcf of gas trades for fiscal '18 at about $3.20 per Mcf, which brings our total for 2018 to 77 Bcf. We also added a total of1.1 million barrels of new oil hedge positions for 2017 to 2019 at prices in the low $50 area. Considering these new trades our fiscal 2017 oil production is nearly 45% hedged with an average price of $64 a barrel. Turning to capital spending, we made some small tweaks to the budgets of the individual segments, but our overall consolidated capital budget is still $725 million to $835 million. The $20 million increase in Seneca's budget is purely timing. As John mentioned earlier, Seneca collected $20 million of joint interest billings about a month sooner than originally forecasted which has the effect of shifting $20 million of capital from fiscal '16 to fiscal '17. The budgets at the midstream companies were refined to reflect our updated construction plans. However, our budget for the Northern Access project is unchanged at $455 million. Based on our updated forecast, we still project and out spend in fiscal '17 in the area of $300 million all of which is driven by Northern Access. The remaining segments including E&T are expected to generate free cash flow in 2017. We had a $130 million in cash on hand at year end which will cover a large portion of the outspend. Initially, the difference will be finance using short term debt. This past September we've renewed our $500 million 364 day committed credit facility, and in total we have access to $1.25 billion of short-term credit, all of which is currently undrawn. With respect to long-term debt, as we previously discussed as a result of our recently ceiling test charges and a covenant in an old bond indenture has prohibited us from issuing incremental long-term debt. As you can see in last night’s release, our ceiling test charge for the quarter was pretty modest compared with quarters about $19 million after-tax. While ceiling test charges are always possible, we don't expect any in fiscal '17 assuming prices stay at their current levels. Consequently, we don't expect this covenant will be an issue after the March quarter. As we go through the fiscal year, we will evaluate a longer-term financing options for the Northern Access with the goal of obtaining the lowest cost capital, while at the same time maintaining our credit rating. With that, I'll close and ask the operator to open the line for questions.

[Operator Instructions] Our first question comes from Chris Sighinolfi with Jefferies.

Hey, good morning guys.

Good morning, Chris.

Ron, thanks for the additional color this morning, particularly in regard to contingency plans for Seneca and the pipeline, the regulatory process proves more or longer dated than what you think, I mean obviously, you realize that's not the formal plans, but it’s super helpful. So, I appreciate the color on the alternatives. I guess I have two questions, first for John. Can you just remind me or remind us the WDA development plans as they stand today, I know the rig that you have running now presumably remains in the CVR to complete the IOG JV work and perform the Utica test that you talked about. But just curious, as you get ahead of the firm transport capacity coming, I guess two questions, when shall we see rig additions and sort of where would they naturally build first?

Yeah, good question. Actually, yeah, we’ll remain at a one rig case in the WDA at least into summer - this summer of '17. We’re looking at June-July of potentially adding a second rig and currently it’s scheduled to go to our gamble and drill a couple pads there, but just to satisfy some lease extensions, but we can get those extended with them we’ll bring the rig into the WDA to prepare for Northern Access. So, we’re looking at sometime in June, July, August to bringing that second rig.

Okay, perfect. And in terms of the East, I mean I know you’ve done some Genesio well tests and obviously, we’re waiting on the Atlantic Sunrise capacity there in mid-2018, but at point I guess with the remaining locations you have on the Marcellus front, at what point do you, should we expect maybe some more delineation of the Genesio potential on the East side?

Well probably over the next two years to three years will to the three more Genesio wells, but moving into a full Genesio development program probably won't happen until 2022, 2023, and that's if we’re not successful and continuing to add additional Marcellus acreage. The economics are good but not as good as the Marcellus.

Right, understood. Okay. And then Dave just had one question. I saw there is a dip in fourth-quarter interests on a relatively flat debt balance. Just curious with an elevated amount of capital of capitalized interest in the quarter, if so what sort of things are driving that or if it's something else, is something else?

Yeah, I think it’s a lot of little things, Chris. Capitalized interest certainly can make a difference and I think we had a small adjustment to some interest accruals on some regulatory in the pipeline business that have the effect of lower interest expense by the quarter or for the quarter.

Okay. I think that's it for me. Ron, just I guess on real quick question, you mentioned in this meeting with the New York DEC two weeks ago, I assume that was in response to the letter from the 19th?

Actually, that it had nothing to do with what that letter. It was more set up to kind of review the status and to spot any issues that the DEC might be having. So, they were there with our environmental consultant and our folks and as I mentioned in my prepared remarks that resulted in some more questions that they want us to answer and we’re preparing responses to those. The letter on the 19th that really the that the regulatory folks or lawyers just making sure that all basically all arguments are preserved for everyone’s litigation position if we ever reach that down the road and it was a matter of fact that we fully expected that letter and that had no impact on the discussions with the environmental folks.

Okay understood. I think we’re all aware of you guys progressing in the wake of constitution so it’s pretty I think it’s evidence for some of us that certain things that are transpiring in your process are likely in direct response to some of the things that have the sell the constitution projects is that wrong in thinking that way?

No, that’s absolutely correct.

Okay.

Yeah, and I think I mentioned a couple of calls ago that we actually delayed the filing of our application with the DEC and Army Corp. to make sure we covered some of the things that we were aware that popped up in the constitution application situation.

Okay. Well, thanks again for all the added color. I’ll get back in the queue.

Thanks, Chris.

[Operator Instructions] And I'm not showing any further questions at this time.

Okay. Thank you, Kevin. We’d like to thank everyone for taking the time to be with us today. A replay of this call will be available at approximately 3:00 PM Eastern Time on both our website and by telephone. And we’ll run through the close of business on Friday, November 11, 2016. To access the replay online, please visit our Investor Relations website at investor.nationalfuelgas.com and to access by telephone call 1855-859-2056 and enter conference ID number 976-035-63. This concludes our conference call for today. Thank you and goodbye.

Ladies and gentlemen, you may all disconnect and have a wonderful day.