National Fuel Gas : Q2 FY 2017 Earnings Transcript

C O R P O R A T E P A R T I C I P A N T S

C O N F E R E N C E C A L L P A R T I C I P A N T S

P R E S E N T A T I O N

Good morning. My name is Virgil I will be your Conference Operator today. At this time, I would like to welcome everyone to the National Fuel Gas Company Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key.

Thank you. Brian Welsch, Director of Investor Relations, you may begin your conference.

Thank you, Virgil, 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 second quarter fiscal 2017 earnings release and May Investor Presentation have been posted to our Investor Relations website. We may refer to these materials during today's call.

We would 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.

National Fuel will be presenting at the American Gas Association's Financial Forum later this month in Orlando. If you plan on attending, please contact me directly to schedule a meeting with Management.

With that, I'll turn it over to Ron Tanski.

Thank you, Brian, and good morning, everyone. As you saw in our earnings release last evening, we had another strong quarter, both financially and operationally. In our upstream exploration and production business, commodity pricing in Appalachia has improved to the point where since October none of our producing wells have been shut in due to pricing. As a result, our produced volumes have been trending at the high end of the range of our production guidance, which has helped drive earnings higher in our Exploration and Production segment and our Gathering segment.

John will give a little more detail on our near-term production marketing plans that we expect will allow us to continue our production trend at the higher end of our guidance range for the rest of the year. The higher earnings in our upstream and gathering businesses offset the slight declines in the earnings of our other business segments, and Dave Bauer will give more detail on the earnings drivers in those segments later in the call.

Overall, our operating folks are doing a great job in all of our business segments. Seneca continues to be a leader in keeping down drilling and completion costs in the Marcellus and our gathering pipeline folks continue to be ready with the pipelines that can take production to market as soon as each well pad is completed.

In the transmission pipeline business, we've been successful in securing new offtake business on our Line N system in Pennsylvania to service a new load for the Shell cracker plant that is now under construction. Last evening, we commenced an open season for yet another 215 MMBtu expansion in Pennsylvania for end use markets on our Line N system. In addition, we were successful in signing up an anchor shipper for the baseload capacity on our Empire North Project and look to get some additional precedent agreements in place for the remaining capacity over the next quarter.

In our utility business, recent audits commissioned by the New York PSC indicate that across many of the metrics studied National Fuel is the most efficient utility in the state and our rates are the lowest of any of the major utilities in the state. Again, operations in all our business segments had been going great for a long time.

That's the old news. The current news is that we're getting lousy regulatory treatment in New York State. Early last month, an executive branch agency stymied our attempt to invest $0.5 billion in a federally approved pipeline project that would help us grow the Company and assure continued strong presence in the state. Contrast that situation with conditions in Pennsylvania where we're continuing to expand our infrastructure for new businesses that are moving in and growing by taking advantage of plentiful domestic energy supplies.

Later last month, another New York executive branch agency issued an order in our utility rate case that awarded our utility a rate of return on equity that is the lowest granted in the state and in the entire

country since at least the 1980s when a consulting firm started keeping track of utility rates of return across the U.S. Given this type of regulatory treatment in the state, we have to take a serious look at our ability to achieve any reasonable growth in New York.

As we pointed out many times, however, our diversified business model provides a number of growth opportunities for us, not necessarily tied to just one state. For the immediate future, we'll focus in areas where we can grow while our lawyers are busy with the DEC in the Second Circuit.

With respect to that lawsuit, unless we're able to negotiate a resolution, we expect our litigation will take a minimum of one full year to resolve but likely longer. Assuming a timely resolution and the need to remobilize all of the engineering and contractor logistics surrounding the Northern Access Project, we'd be looking at an in-service date in either the spring or fall of our 2020 fiscal year.

Keeping with our normal practice, we won't be issuing guidance for our 2018 fiscal year until next quarter, but given the timing changes related to Northern Access we thought it would help to give some preliminary perspective on the forward trajectory of our capital spending, our growth prospects and financing needs.

Until there's greater clarity around Northern Access, Seneca will continue to operate a two-rig program in Appalachia, with one rig dedicated to the Clermont/Rich Valley area and another splitting time between Tioga and Lycoming Counties. A single frac crew will handle completions. At this level of activity Seneca should be able to grow production by at least a 10% CAGR over the next three to five years even without Northern Access. Pricing in the Basin and our success in locking in acceptable returns will dictate our ability to achieve this growth. To that end, we continue to pursue a combination of financial hedges and physical firm sales to create a degree of price certainty for our program.

Recently, we've been particularly focused on adding new firm sales at Clermont/Rich Valley and converting the delivery point of previously executed Dawn-based firm sales to TGP 300. Thus far, John and his team have been successful at both. For example, some recently executed deals for fiscal 2018 have been executed at realized fixed prices that exceed the netback price we would have achieved via deliveries to Dawn.

We've also been focused on adding firm sales tied to our production from Tract 007. We don't hold any firm capacity in the TGP 300 line that runs right through that acreage so our goal is to build a long-term base of firm sales in the neighborhood of 100 to 125 MMBtu per day. To date, we've added 45 MMBtu per day of new firm sales at Tract 007. In the near term, we expect Seneca will live within cash flows under its two rig program. Longer term, as we grow our production base, Seneca has the potential to generate significant free cash flow.

Under Seneca's revised program, Gathering capital should be relatively modest, especially if Seneca transitions to a Utica program in the Western Development Area and can effectively reuse existing infrastructure. Given the expected growth in Seneca's production, the Gathering business should generate significant free cash flow over the next three to five years.

In the Pipeline and Storage business, we expect that the recent New York DEC permit interpretations will not interfere with our normal maintenance and system modernization activities where annual capital requirements should be in the neighborhood of $100 million. And expansion projects like Empire North always cause bumps in that baselinerate. At the Utility, capital spending over the next several years should be consistent with our current $90 million to $100 million a year level.

On a consolidated basis, until we undertake any expansion projects, annual capital spending will likely be in the $500 million to $600 million area. At that level of spending, we should be able to generate consistent growth across our portfolio of assets, deliver long-term free cash flow, maintain our commitment to our dividend and further improve our balance sheet.