National Fuel Gas Company

Good day, and thank you for standing by. Welcome to the Q2 2021 National Fuel Gas Company Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Mr. Ken Webster, Director of Investor Relations. Thank you, sir. Please go ahead.

Thank you, Brenda, 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 Dave Bauer, President and Chief Executive Officer of Karen Camiolo, Treasurer and Principal Financial Officer, and Justin Lowitt, President of Seneca Resources. At the end of the prepared remarks, we will open the discussion to questions. The second quarter fiscal 2021 earnings release and May investor presentation have been posted on 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 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 to 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, I'll turn it over to Dave Bauer.

Thank you, Ken. Good morning, everyone. National Fuel had an excellent second quarter with operating results of $1.34 per share, up 38% year-over-year. During the quarter, we saw the benefits of the ongoing expansion of our FERC-regulated interstate pipeline systems, including significant incremental revenues from our Empire North project, which went into service last September. In addition, last summer's Tyler County acquisition continues to exceed our expectations, with gathering throughput and Appalachian production up over 45%. Entry-scale throw cash to $4.05 per share. At the midpoint, an increase of 35% from the prior year. across all our operations we continue to successfully execute on our near-term growth plans our fm 100 expansion and modernization project received its notice to proceed from perc in late february and construction commenced in early march we finished the critical path tree clearing on schedule and construction is underway on both compressor stations we expect to begin construction on the pipeline portion of the project later this month based on our progress to date we're confident the project will be finished on time for a late calendar 21 in service day once complete this project will generate about 50 million dollars of annual revenue for us and along with transco's companion lighting south project will provide seneca with another valuable long-term outlet for its appalachian production with limited additional appalachian takeaway capacity stated to come online in the near term We believe that Seneca's firm transportation portfolio, which accesses diverse and liquid markets, will provide significant value in the years ahead. To maximize the value of this new capacity, Seneca is operating two drilling rigs in Pennsylvania, with first production from its recent rig addition in our eastern development area, scheduled to come online just ahead of the Lighting South in service day. This timing will allow Seneca to capture the premium winter pricing typically seen in the Transco Zone 6 market. This next leg of growth, underpinned by the FM100 project, positions us differently from our Appalachian peers. This project will enhance scale and profitability across our upstream, gathering, and regulated pipeline businesses and is a great example of the value of our integrated business model. Switching gears, the utility also had a good quarter. The warmer than normal weather did have an impact on earnings. That debt expense, which continues to trend a little higher, was also a factor. And Karen will have more to say on that later on in the call. Before moving on, I wanted to take a minute and acknowledge the exceptional performance of our utility and pipeline operations teams during the winter heating season, during which time natural gas service was available to our customers more than 99.9% of the time. This is an impressive achievement that's a testament to the hard work of our dedicated workforce. Across the nation, policymakers are seemingly in a race to transition the nation's energy supply towards intermittent renewable resources. However, the events that transpired during February's superstorm Uri in Texas in the Midwest clearly underscore the need for an all-of-the-above energy strategy. And this is particularly the case in national fuels operating footprint, where the low temperatures that crippled Texas for just a few days are really pretty much the norm for the three coldest months of winter. It becomes readily apparent that there is a long-term need for reliable, weather-hardened infrastructure to serve the energy needs of our region. And I firmly believe that natural gas, with its resilient and safely operated pipeline delivery infrastructure, will remain an important part of the nation's energy solutions. In March, we published our Utilities Pathways to a Low-Carbon Future report, which demonstrates pretty convincingly that natural gas and its associated infrastructure can in fact have a role in a low-carbon world. The report, which was developed using the findings of a study performed by Guidehouse, an independent consulting firm, evaluated scenarios for meeting New York State's aggressive decarbonization targets, focusing on the interplay of energy efficiency, electrification, hybrid heating solutions, and low-carbon fuels to leverage existing utility infrastructure and provide cost-efficient solutions. The study validates that by focusing policy on an all-of-the-above carbon reduction approach, we can achieve significant decarbonization that meets emissions goals while preserving access to low-cost, reliable, and resilient energy for consumers. Also in March, our utility announced greenhouse gas emissions reduction targets for its delivery system of 75% by 2030 and 90% by 2050, both from 1990 levels. The targets rely on our commitment to the continued modernization of our utility infrastructure, which to date has led to a reduction in EPA subpart W emissions of well over 60%. Importantly, our regulators have been supportive of these ongoing modernization efforts, particularly in New York, where our system modernization tracker has allowed us to recover these investments in our system on a timely basis. While we started with the utility, National Fuel is in the process of developing a plan to reduce its overall carbon footprint across the rest of our operations. This plan will include establishing credible emissions reduction targets for our midstream and upstream businesses, as well as enhancing our sustainability disclosures to include additional climate-focused information in line with the TCFC framework. In conclusion, National Fuel is in great shape. Our FM100 project is under construction and on schedule, which positions our pipeline, upstream, and gathering businesses for significant near-term growth. At the same time, our utility business continues to modernize its infrastructure, which will drive meaningful emissions reductions and provide an opportunity for ongoing rate-based growth. Looking to fiscal 22 and beyond, our capital spending requirements will be substantially reduced, particularly in our FERC-regulated pipeline business, which will lead to significant free cash flow and increased financial flexibility. Add to that a half a century of dividend growth and a solid investment-grade balance sheet, and I think you'll find it tough to match National Fuel's long-term value proposition. With that, I'll turn it over to Justin for an update on our upstream operations.

Thanks, Dave, and good morning, everyone. I'd like to start by expressing my excitement to step into the president role at Seneca. Seneca couldn't be in a better place. With a best-in-class group of employees, decades of economic development inventory, an attractive portfolio of takeaway capacity, and the benefits of integration with National Fuels' other subsidiaries, providing a firm foundation. Further, we are aligning Seneca's organization around sustainability and environmental leadership, and are working towards targets for reducing the environmental impact of our operations. In summary, the outlook for Seneca is bright. Moving on to the second quarter, Seneca produced a company record 85.2 bcfe driven by increased highway county volumes from the acquisition completed last summer as well as growth and solid production results from our ongoing appalachian development program during the quarter we brought online 13 new wells in pennsylvania all of which were in our western development area our operations team did a great job turning these recent wells online a few weeks ahead of schedule allowing us to accelerate production during the winter months, capturing premium winter pricing. This increased our second quarter production. However, over the balance of the year and as planned, we expect modestly declining volumes, with only one new pad scheduled to come online in late fiscal 21. During the quarter, we also drilled 14 new wells, 10 in the WDA and 4 in the EDA. As we approach the online date for Light East-South and the winter heating season, We expect to accelerate our completion operations, and we plan to delay turning in line most of these new wells until early fiscal 2022, coinciding with the expected in-service date of our new capacity. With respect to capital, we are forecasting the second half of the year to be heavier due to the increased completion activity that I just mentioned. However, our capital guidance range is unchanged. We also continue to see the benefits of our increased scale, with cash operating expenses dropping to $1.09 per MCFE, a 14% decrease from the prior year. Of note, we have realized a significant decrease in per-unit G&A expense, dropping roughly 25% over the past year, driven by our acquisition and ongoing development in Appalachia. As to service costs, we have experienced limited cost inflation over the past few months, mostly in tubulars. And at this point, we do not anticipate meaningful increases into 2022 based on conversations with our contractors and suppliers. In addition, we continue to make strides in improving our operational efficiencies, particularly inside of the county, where our operations team has cut Utica drilling time by 25% compared to our last track 007 pad. Given our significant inventory of highly economic development locations in Tyree County, and long-term development plans, we expect to realize the benefits of these efficiencies for years to come. On the marketing front, although pricing has been relatively volatile, Seneca is very well hedged for the balance of the fiscal year, with 88% of our East Division gas production locked in physically and financially. We also have firm sales providing basis protection. So all in, about 95% of our forecasted gas production is already sold. That leaves a relatively small amount of production, less than 10 BCF, exposed to invasive spot pricing. I also want to point out a recent project our sister company, NFE Midstream, completed. Tying together the Covington Gathering System with the recently acquired Tyler Gathering System. This has significantly increased Seneca's flexibility to move more gas to premium Dominion and Empire markets versus the weaker TGP 300 Zone 4 market. It's another great example of the significant value we can capture as an integrated business. As we look a bit further out, we've maintained our disciplined approach to hedging and already have 188 BCF of fixed price firm sales, NYMEX swaps, and costless callers in place for fiscal 2022. This provides Seneca with downside protection, but leaves the potential to generate significant additional free cash flow should prices move up. Overall, we remain constructive on long-term natural gas prices, with LNG exports near all-time highs, Mexico exports near all-time highs, and storage levels below both last year and five-year inventories. We expect these factors, together with continued capital discipline by producers, to lead to further strengthening of the natural gas script in 2023 and beyond. As Dave mentioned, F&100 and Lighty South both remain on track for a late calendar 2021 in-service date, And once complete, we'll provide a valuable long-term outlet for Seneca's production from each of its core development areas. This additional capacity sets us up for further production growth throughout fiscal 2022. Thereafter, absent the ability to enter into additional long-term firm sales or firm capacity that would result in strong realized prices, Seneca expects to shift into a maintenance to low-growth production mode. our focus will continue to be on generating significant free cash flow, especially when combined with the cash flows of the company's wholly owned gathering assets. Moving to the regulatory front, while there has been some recent pronouncements in California related to oil production and extraction, I think it's important to note that Seneca's California operations do not utilize fracking. And thus, while we are closely monitoring the regulatory and legislative landscape, We do not expect any significant impact to our operations based on these recent developments. As has long been the case, California can be a challenging regulatory place to conduct business. However, we have been able to successfully navigate a changing regulatory environment while generating strong returns on our oil-producing assets and anticipate that to remain the case. We expect our annual capital levels in California will be in the $10 to $20 million range over the next few years, absent further increases in the longer-term oil strip. Additionally, Senate continues to look for opportunities to invest in solar facilities in California to power our production operations and to reduce our carbon footprint. At present, we have solar facilities already online at our North Midway Sunset Field and our Bakersfield office. And we are constructing another facility in South Midway Sunset, which will provide about 30% of our field electricity use. And with our Appalachian natural gas operations centered on what most would consider to be the lowest emitting shale basin in the U.S., we are well positioned to be an upstream leader in ESG. And with that, I'll turn it over to Carrie.

Thank you, Justin. Good morning, everyone. National Fuel's second quarter gap earnings were $1.23 per share. When you back out items impacting comparability, principally related to the premium paid for the early redemption of our $500 million December 21 maturity, our operating results were $1.34 per share, a significant increase over last year. Dave and Justin already hit on the high-level drivers, so I'll focus on a few other details from the quarter and discuss our outlook for the remainder of the year. First, as I alluded to, we were active in the capital markets a few months ago. In February, we issued $500 million of 2.95% 10-year notes, the proceeds from which were used to fund the early redemption of our $500 million 4.9% coupon December 21 maturity. That transaction was very well received by the market, with our order book reaching more than eight times oversubscribed. That level of demand allowed us to achieve our lowest ever coupon for 10-year notes. Treasuries have moved materially higher since then, so overall this looks like a great transaction for us. With our next maturity not until early 2023, we have a nice window where we don't need to be active in the capital markets. Combining this with our $1 billion in short-term committed credit facilities and our expectation on meaningful future cash flow generation, we're in a great spot from a liquidity position. While this debt issuance will translate into $2.5 million of interest savings per quarter going forward, the fiscal 2021 impact is somewhat muted by the overlapping period during the second quarter where both the redeemed notes and the new issue were on our balance sheet. Before turning to our outlook for the remainder of the year, just a brief update on customer payment trends in the utility. As we stated from the beginning of the pandemic more than a year ago, we expected the biggest headwind on customer payment trends to occur as we got through the winter heating season. Over the past few months, we have seen a modest increase from historic levels of customer nonpayment. As a result, we have continued to accrue incremental bad debt expense and intend to do so for the remainder of the year. At this point, we believe that additional reserve will be adequate to handle potential collection challenges we may face in the coming quarters. As it relates to the rest of the year, based on our strong second quarter results, we've increased our earnings guidance to a range of $3.85 to $4.05 per share, up 15 cents at the midpoint. Given we are now more than halfway through the year, we continue to refine our guidance assumptions. The vast majority of them are spelled out in the earnings release, but I do want to highlight some key operating expense assumptions across each of our businesses. At our regulated companies, consistent with our earlier guidance, we anticipate O&M expense to be up approximately 4% in both our utility and pipeline and storage segments. In the utility, as I mentioned earlier, we are projecting a more conservative expense assumption as it relates to our bad debt reserve. That is being largely offset by ongoing expense savings as we remain focused on keeping our cost structure low. In the pipeline and storage business, the bulk of the year-over-year increase is backloaded in the second half of the fiscal year. For our non-regulated businesses, we now expect Seneca's full-year LOE to range between 82 and 84 cents per MCFE, a penny lower at the midpoint of our revised guidance range. While our LOE rate was lower than this for the first half of the year, as we look to the balance of the fiscal year, we expect to see slightly higher LOE due to increased levels of maintenance over the spring and summer months. On the gathering side of our business, costs are in line with prior expectations and we still anticipate O&M to be in line with our earlier $0.09 per MCF guidance. Lastly, on the expense side of the equation, similar to a couple of our other assumptions, we'd expect Seneca's per unit DB&A to increase over the second half of the year relative to the first two quarters. We had some positive revisions to our reserve bookings in the quarter that had the effect of reducing our DD&A expense. As we look to the back half of the year and beyond, we would expect a DD&A trend closer to the low $0.60 per MCFE area. All of our other key assumptions are fully laid out in the earnings release and investor desk that was published last night. With respect to consolidated capital spending, all of our segment ranges remain the same, and we are still projecting between $720 and $830 million for the fiscal year. There hasn't been any other material changes from a cash flow perspective, and as a result, we expect to live within cash flows this year when you consider the proceeds of our timber sale and our expected dividend payments. We are well hedged for the remainder of the year, so any changes in commodity prices should have a muted impact on earnings and cash flows. In closing, we had a solid first half of the year and are optimistic about the direction we are heading. With that, I'll close and ask the operator to open the line for questions.

And at this time, if you'd like to ask a question, please press star 1 on your telephone keypad. That is star 1. And your first question comes from Holly B. Stewart from Skoda Howard Wells.

Good morning, gentlemen. Good morning, Karen.

Good morning.

Maybe first one for Karen or Dave. It looks like the, I think it's slide seven, the free cash flow guidance from the non-regulated businesses went up modestly versus the prior expectations. curious drivers behind that? I mean, I know we had a better second quarter, but anything else that might be driving some of that better outlook?

Yeah, not really, Holly. I mean, mostly the results for the second quarter and showing up of our marketing market, if you will, our forecast assumptions that you see in the release.

Okay. Okay. And maybe, Justin, one for you, just bigger picture. You had a big M&A deal in your neck of the woods announced yesterday, so I'd be remiss not to to ask you guys kind of what you're seeing out there and maybe how you feel about valuations and sort of the evolution of the M&A market since you did your deal last year with Shell?

Yeah, sure, Holly. You know, I guess first I'd start by just congratulating our friends at Alta on a great result. You know, the The Anadarko assets, when Alta originally bought those, those were ones that we thought were very attractive as well, and they've obviously been very successful with them. And then, you know, note as well, we're looking forward to working with EQT. We've got a number of shared operations in Lycoming County out there, so we'll be partners. You know, overall, I think it's in alignment with continued consolidation in the basin, which we would – anticipate will continue. Certainly highlights the value of the acquisition. You know, we were fortunate in our timing of that, but we picked up, you know, awesome regulated assets, or excuse me, awesome integrated assets with significant, you know, gathering midstream infrastructure, water assets, and, you know, a lot of development inventory. So, you know, we're excited to have that. We're excited to have that done, and we're enjoying the benefits of it today, and we'll continue for a long time.

Okay, great. Maybe, Justin, just one other one for me, and this is more just new, and I can follow up with Ken if you don't have it at your fingertips, but you mentioned most of the tills being sort of done for, for the first half of, or 421. Can you give us those numbers for, I guess, in total for the first half of the year? And then I think you mentioned one more pad that's expected. So curious the number of wells on that pad.

So, Holly, I'll defer to Ken to follow up on the exact number in the first half. The final pad we have remaining this year to bring online, it's six wells in Lycoming County, which will happen late in the fiscal year. But really, you know, in line with what I was suggesting in the remarks there, we really are, we'll be very active in our completions operations throughout the summer and into the fall and even into the next spring. And all that activity is really aligned with the Lighting South end service. But we're really looking to hold back some of that production until we hit those premium winter months and as we look to utilize our new capacity on Lighting South.

Yep, no, that makes sense.

All right, appreciate it. Your next question comes from Zach Parham from JP Morgan.

Thanks. 2Q production was very strong, a bit above our expectations. You talked a little in your prepared remarks about declining in the back half of the year. Can you just give us some detail on kind of the magnitude of the declines you're expecting? And then there's clearly a step up in production in fiscal 22 with FM 100 coming on. So maybe just some detail on how production should trim through 22.

So we haven't guided 22 yet, but, you know, really what we try to do is target our production as best we can in alignment with our operations plan to to have peak production and flow back occurring in the peak winter months when the market's the best. And so we really had engineered and designed our program during fiscal 21 to capture a lot of that. And so we had, and our operations team did a great job accelerating some things to get the tail end of the winter on some pads. So, you know, that just created a little bit of an acceleration in the first half of the year. And then now, you know, we do have that one pad, but we kind of slow down. As we get into Q1, you know, in Q2 of fiscal 22, we'll absolutely be bringing online a number of pads. We haven't guided 22 yet, but I think, you know, big picture, what I would, you know, advise to expect is kind of a gradual increase throughout the year. And so it'll be a year where beginning to end will be more or less continuously growing. So kind of a different you know, a different cadence of production versus what you're seeing here in fiscal 21. Got it.

Thanks, Justin. That's all for me. Sure thing.

Your next question comes from Gordon Loy with J.P. Morgan.

Hey, good morning, all. Thanks for taking the question. So I was looking at a It's 5.33, and I get the kind of the temporary increase in Appalachia, other LOE. And so I guess I was just trying to figure out once the kind of one-time costs to bring kind of the acquired assets in line with Seneca is over, will kind of the other LOE in Appalachia turn back down to like that $0.07 per MCFE range, or will you kind of get a further uplift just from kind of the increased scale?

Sure. So You know, the small incremental increase is really related to some of the work we're doing, particularly on the newly acquired properties. We're really bringing those up to Seneca standards. You know, the other thing that definitely, you know, plays into things a little bit is just as you have more wells, you see you have a little less production per well, and so your fixed costs typically, you know, don't move as much, and so you can have a little bit of creep. But I definitely see that uh see that other loe line or that other loe box you know being in that say seven to nine cent range going forward we're a bit heavy right now largely because of the incremental work we're doing you know bringing those properties up to senate operating standards okay that makes sense my uh my follow-up kind of basically shifting to the other chart is the other loe as a whole for senate that has

basically turn it down pretty consistently since 2018. I'm assuming some of that is down to kind of lower activity in California. But then with kind of activity shifting more and more to Appalachia, is there kind of like a long term run rate that you guys are expecting? Or kind of should we continue to expect your typical kind of small incremental reduction?

Yeah, so the fundamental driver there is really the relative contribution of our Appalachian gas production versus our California oil production. Just on a unit basis, the California oil is higher. It's the nature of the operations out there. So as our production continues to grow in Appalachia relative to California, you should anticipate that gray wedge on the left-hand side of the slide to continue to compress.

Okay, perfect. That makes sense. Congrats on the quarter. Thanks. Thank you.

And if you'd like to ask a question, please press star 1 on your telephone keypad. Your next question comes from Carolyn Shavell with Goldman Sachs and Company.

Hi, good morning. This is Carolyn on for Neil Mehta. Thank you for taking our question. Good morning. I first just wanted to circle back on the production and CapEx trajectory outlook. Given the timing of production for the rest of the year means production will decline as you hold back some of it to bring the wells online when Lydie's valve is complete. It would seem like this implies pretty favorable capital efficiency as the capital has already been ahead of the stronger growth in the winter. I know it's early, but wanted to get your initial thoughts on what that means from a capital spend perspective and to fiscal year 2022?

Sure. So the way to think about it is we added a second rig back in January, and that activity is really the reason to have the increased activity is all about growing into the new capacity. So we've been actively drilling additional wells and that activity will continue. And that activity will continue certainly throughout fiscal 22 with the two rigs running. And then the completion side of it, that gets heavier as we get into the second half of this year, as we start to complete the wells we have that are ducts today. And that activity, though, will continue into fiscal 22. So fiscal 22 will be a... Unlike fiscal 21, We'll have two rigs running the entire year, and we will have a higher level of completions operations ongoing throughout the year as we, as I described earlier, as we kind of go from the beginning of the year to the end of the year, seeing the cadence of production growth being generally consistent, you know, growing each quarter, likely growing each quarter throughout the year as we fully utilize all of our firm sales and firm transport capacity. Big picture, the way to think of it is the activity levels in 22 will actually be a little bit heavier even than fiscal 21. When you get beyond there, that's where you start to see that role happen, and you're at much higher production levels and decreasing capital levels absent an ability to access additional premium markets through firm sales or firm transportation.

Okay, great. That's helpful. Thank you. And then just my follow-up is you have a unique perspective given the integrated business model. And during the prepared remarks, you mentioned you see a favorable outlook for NatGas and for NGLs longer term. But just wanted to get your thoughts more specifically around what you're seeing from a local gas demand and takeaway perspective and how that might inform future growth decisions. And then on the pipeline side, just any latest you can provide on the Northern Access project and how, if at all, that would factor into future growth?

Well, I'll be happy to start on kind of our general views on the gas markets, and then I'll kick it over to Dave to talk about Northern Access. But certainly as it relates to kind of where we see things today, I mean, yeah, we're constructive. You know, we are in a better place certainly than last year. That's an understatement. But, you know, we feel like we've got the Lighting South project coming on, anticipated to come on anyway at the end of this calendar year. That adds additional takeaway capacity, which sets up for some improvement in the in-basin pricing. Overall, generally, at least among the public operators, have been pretty prudent about their overall level of capital spend and seemingly moved towards generating free cash flow and doing what's right by the shareholders. I think that activity probably continues, and we should see basis improve when Light East-South comes on, and then really what happens after that is going to be more about what activity levels look like and overall levels of production, particularly as it relates to our production in generally the northeast and central PA, so lines like the Tennessee 300 line in Transco in Dominion.

And then with respect to the pipeline side, really nothing new to report on the Northern Access front. We did have another victory in court where the appeals court had upheld FERC's position in finding waiver on our 401. water quality certificate. But the state still has the ability to further appeal that, and based on their past history, you know, we fully expect them to do that. So there's a bit of time that's still going to play out on that front. And, you know, once litigation runs out, we'll evaluate the market and update you then.

Great. Thank you. And there are no further questions at this time. I would like to turn the conference over to Mr. Ken Webster for closing remarks.

Thank you, Brenda. We'd like to thank everyone for taking the time to be with us today. A replay of this call will be available this afternoon on both our website and by telephone. and will run through the close of business on Friday, May the 14th. To access the replay online, please visit our investor relations website at investor.nationalfuelgas.com. And to access by telephone, call 1-800-585-8367 and enter conference ID number 2524688. This concludes our conference call for today. Thank you and goodbye.

This concludes today's conference call. Thank you for your participation. You may now disconnect.