National Fuel Gas Company

Hello all and welcome. My name is Brika and I will be your conference operator for today. At this time, I would like to welcome everyone to the Q4 2022 National Fuel Gas Company Earnings Conference Call. All lines have been placed on mute today to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your touch phone keypad. If you would like to withdraw your question, please press star two. And for operator assistance at any time, please press star zero. Thank you. Brandon Haskett, Director of Investor Relations, you may begin your conference.

Thank you, Barica, 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, Karen Camiolo, Treasurer and Principal Financial Officer, and Justin Loeth, President of Seneca Resources and National Fuel Midstream. At the end of the prepared remarks, we will open the discussion to questions. The fourth quarter fiscal 2022 earnings release and November 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'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 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, I'll turn it over to Dave Bauer.

Thanks, Brandon. Good morning, everyone. National Fuel ended fiscal 22 with a great fourth quarter. Adjusted operating results were right in line with our expectations at $1.19 per share, a 25% increase over last year. Looking back, fiscal 22 was another exceptional year for National Fuel. Operationally, we had multiple successes, including completing the FM 100 project on time and under budget, growing Seneca's net production by 8%, and replacing more than 150 miles of pipe as part of the utility's modernization program. Strategically, we tightened the focus of our company, selling our California assets at the top of the market. And we also made significant progress on sustainability initiatives. All of these great accomplishments position the company extremely well for the future. While the outlook for the business is strong, we aren't immune to the challenges facing the broader economy. During the year, inflationary pressures and an extremely tight labor market impacted us across our business segments. And as we discussed last quarter, we'll likely have a continuing impact in 2023. Seneca's fourth quarter capital came in a little higher than expected. While some of this was timing between fiscal years, the largest factor was related to increased costs associated with the spot frack crew that is completing two pads in Tioga County ahead of the winter heating season. We've taken several steps to mitigate future inflationary pressures on our upstream capital program, and Justin will have more to say on this later in the call. Regarding the labor market, like most other companies, it's a challenge to attract and retain key talent. In response to these conditions, we've adjusted our compensation practices to bring them more in line with the current market. As a result, we've seen an increase in O&M expense, particularly in our regulated businesses where we have the largest number of employees. These inflationary challenges, along with increased rate base from our modernization program, are expected to lead to rate cases in both divisions of our utility in the coming years. To that end, last week, the Pennsylvania Division of our utility filed its first rate case since 2006. A summary of the filing is included on page 41 of our updated slide deck. In short, we're asking for a $28 million annual rate increase commencing August 1st, 2023. We're also looking to implement a distribution system improvement charge mechanism, or DISC, and a weather normalization clause in our tariff. The DISC is a long-standing modernization tracking mechanism that is commonly used by utilities in Pennsylvania. Like the system modernization tracking mechanism in New York, the DISC would allow us to recover the cost of our Pennsylvania modernization program in a more real-time fashion. The rate proceeding will play out over the next few quarters, and it should be relatively straightforward. We already have the lowest delivery rates in the state by a wide margin. And even after a full $28 million increase, our delivery rates will still be the lowest in the state. We also expect rate cases in our FERC regulated pipeline subsidiaries over the next few years. Under the terms of the settlement agreements governing their rates, Supply and Empire are both required to come in for new rates in 2024 and 2025, respectively, though they can both file earlier than that if they need to. Switching to the outlook for our fiscal 23, the recent drop in the natural gas forward curve has led us to revised guidance to a new range of $6.40 to $6.90 per share. At the midpoint, this is an $0.85 per share reduction, almost all of which is driven by our revised natural gas price assumptions. Despite the reduction, our $6.65 midpoint represents a 13 percent increase in expected earnings year over year. Our longstanding hedging program mitigated a large portion of the drop in expected pricing. Our fiscal 23 production is roughly two-thirds hedged, which is right in line with our stated policy. As a reminder, that policy gives us a lot of latitude, allowing us to hedge between 40 and 80 percent of our production in the current fiscal year. Over the past few years, we've trended closer to the high end of that range. And this was the result of the natural gas pricing outlook that was in place at the time we did the hedges, as well as a desire to have greater certainty around cash flows to help support our investment grade credit rating. Looking forward, we still believe hedging is an important tool to provide downside protection, and I expect Seneca will continue to be active with its program. However, with the improved outlook for natural gas, it's very possible our hedge percentages in fiscal 24 and beyond will trend a bit lower within our policy range. In addition, we've been focused on using more costless collars, which allow us to participate in the upside if commodity prices increase. On the capital spending side of our forecast, the outlook is unchanged. Considering our revised earnings guidance, we now expect funds from operations will exceed capital spending by $325 million for fiscal 23. Karen will have more details on our earnings and cash flow expectations later in the call. Looking beyond 23, the significant investments we've made across our four lines of business should lead to a sustained period of significant free cash flow generation. This puts us in the enviable position where we can simultaneously deleverage our balance sheet, return capital to shareholders through our longstanding dividend, and pursue additional future growth opportunities. National Fuels Outlook is further strengthened by what I see as a growing appreciation of the importance of natural gas. We all know the affordability, resilience, and reliability of natural gas are unmatched by any other form of energy today. At a time when energy security and affordability have never been more important, it's obvious that natural gas and its resilient delivery system needs to be a central component in an all of the above approach to energy policy. One need only look to the challenges facing Europe and California to see the perils of going all in on intermittent resources. Nevertheless, we continue to see policymakers in New York and elsewhere pushing the narrative that growth in wind and solar alone can meet the needs of a fully electric world, including for winter heating and cold climates like Buffalo, without sacrificing affordability and reliability. They fully believe the electric grid can nearly triple in size without impacting costs, and they have complete faith that massive amounts of dispatchable emissions-free generation solutions will be developed when no such technologies exist today at scale. The gap between aspirations and reality is truly remarkable. National Fuel will continue to advocate on behalf of our customers for a more reasonable approach, one that continues to leverage our existing natural gas infrastructure, saving customers money without sacrificing energy reliability. Lastly, before closing, a few words on ESG. In September, we published our third annual corporate responsibility report, which highlights our substantial environmental, social, and governance efforts. In it, you can see that we had another great year with our ESG initiatives. I'm particularly proud of the progress we've made towards our 2030 methane intensity reduction targets, as well as Seneca's responsibly sourced gas certifications. In addition, system-wide, the team did a great job advancing our safety culture. Without a doubt, we're focused on adhering to the guiding principles that are at the core of what makes national fuels successful. In conclusion, fiscal 22 was a great year for National Fuel, and I'm excited about our future. We're in a great position to generate significant and durable free cash flow across our businesses. And combine this with the strength of our investing-grade balance sheet and our significant footprint of assets in one of the lowest emissions intensity basins in the world, and I firmly believe the outlook for National Fuel is as strong as it's ever been. With that, I'll turn the call over to Justin.

Thanks, Dave, and good morning, everyone. Seneca and NFG Midstream wrapped up the fourth quarter of our fiscal year with strong operational and financial performance, continuing the trend of solid execution across our Appalachian Development Program. For the year, net production increased by 8%, reaching a record 353 BCFE, while adjusted EBITDA for our non-regulated businesses increased by 34%. This strong performance continues to be driven by our expansive, high-quality acreage position, the ability to deliver gas to premium markets through our valuable marketing portfolio and gathering infrastructure connectivity, and our unique integrated approach to developing our acreage. From a reserves perspective, we also had a great year. Despite the sale of 175 BCFE-approved reserves, we replaced 240% of our fiscal 2022 production and increased our total reserve base by 319 BCFE. We now sit with approximately 4.2 TCFE approved reserves, of which 79% are approved developed, one of the highest among our Appalachian peers. Looking back, fiscal 22 was a significant year for Seneca. We brought online multiple paths on our acquired acreage in Tioga County, with results from both the Utica and Marcellus exceeding our expectations. And we closed on the sale of our California operations, transitioning to a pure play Appalachian natural gas producer. We also made major strides in our sustainability initiatives, including certifying our natural gas production under MIQ, Equivalent Origin, and Project Canary, further and independently validating our culture of environmental stewardship and operational excellence. On the heels of Seneca's strong results, our gathering business also had a fantastic year, registering record throughput, significantly growing third-party volumes on our system, and commencing the build-out of centralized facilities in Tioga County that will serve our growing production in the years to come. Looking forward, we remain focused on execution, with no change to our long-term plans. We continue to expect our two-rig drilling program to deliver mid to high single-digit production growth over the next few years. In the near term, we expect to accelerate production, with 17 new wells coming online during the first quarter. which will take advantage of the higher natural gas prices expected during the winter months. Ten of these wells are in the WDA and the other seven are in Tioga County. Based on the anticipated timing of these pads, our production this quarter is expected to be flat with Q4 fiscal 22. However, our production will increase towards the end of Q1 as these new pads come online. From there, production should continue to ramp steadily throughout the winter spring and early summer before flattening out or modestly declining into the end of the fiscal year. Given that our operational plans are largely unchanged and we've taken steps to mitigate inflationary pressures where possible, we are maintaining our capital spending guidance range of fiscal 23 of $525 to $575 million. As a reminder, this incorporates the impact of the 15% inflation we experienced in fiscal and an additional expected 10% increase in fiscal 23. At the midpoint of our fiscal 23 guidance range, we'd expect CapEx to be down slightly year over year. As Dave alluded to earlier, fiscal 22 capital came in at $565 million, a bit over guidance, with a portion related to pulling capital forward from fiscal 23 and the remainder related to higher than expected completion costs on a Tioga County pad we plan to bring online later this month. As a result, we had a spot frack crew in place for this pad, and spot activity continues on a second pad over the near term. But by Q2 of fiscal 23, we will be solely utilizing our full-time electric frack fleet under a new long-term contract. We expect that utilizing a dedicated frack crew will allow us to avoid cost challenges we saw with periodically contracting for a spot crew in a tight service environment. And our move to electric equipment will meaningfully reduce our exposure to elevated and volatile diesel prices. Switching to our marketing portfolio, we continue to look for ways to add to or supplement our portfolio of firm transport and firm sales that reach premium markets and support our growth trajectory. During the fourth quarter, we successfully secured about 43,000 decatherms of long-term TransCanada pipeline capacity. This new capacity will complement our existing capacity on Empire Pipelines. providing a path to DON markets in Ontario, Canada. Having direct access to DON hub markets, which is both highly liquid and trades at a premium, is expected to provide significant incremental value for our Tioga production. We also remain focused on accelerating our sustainability and safety initiatives. To that end, in August, Seneca achieved an A certification grade, the highest available certification for 100% of our natural gas production under the MIQ standard for methane emission performance. On the gathering side, we also made significant progress on projects to reduce overall emissions and lower the methane intensity of our operations. For example, at the Claremont West compressor station, the largest owned and operated by NFG Midstream, we are working to convert our current gas-driven pneumatics to an air system, which we expect will be completed by the end of the calendar year. The improvements at this station, alongside our existing emissions-related efforts, are an important step in reaching our long-term methane intensity reduction goals. We also had a great year on safety, reporting a second straight year of zero dart injuries at Seneca and Midstream, while also maintaining and improving our contractor oversight to ensure adherence and performance in alignment with our high safety standards. Given the increased activity levels and, in certain areas, an influx of new workers, This is an outstanding accomplishment and clearly validates our culture of safety first. I want to thank our entire Seneca and midstream teams as well as our contractors for their tireless efforts in achieving these results. In conclusion, our upstream and gathering business are working together hand in glove, continuously finding ways to optimize our operations plan and drive differentiated value from our significant development inventory. Looking forward, we see continued opportunities across our integrated model to enhance margins and investment returns. Our integrated model, paired with our safety and sustainability-focused culture, position us extremely well in fiscal 2023 and beyond. With that, I'll turn the call over to Karen.

Thanks, Justin, and good morning, everyone. National Fuel closed out its fiscal year on a strong note, with gap earnings coming in at $1.71 per share. Several items impacted comparability to our prior year results, that are described in last night's release, so I won't cover them here. Excluding these items, adjusted operating results for the quarter were $1.19 per share, an increase of 25%. Higher natural gas prices, the increase in Seneca's production, and its corresponding impact on gathering throughput, along with the benefits of our FM100 pipeline project, were all key drivers during the quarter. This was partially offset by higher costs in our regulated businesses. As Dave mentioned, the tight labor market has driven increases in employee compensation, which is putting upward pressure on O&M expense. Compared to the prior year, O&M expense was up 13%. We saw the combined impacts of wage increases for both our collectively bargained and salaried employees that went into effect earlier in the year. Additionally, we accrued an expense related to a short-term incentive program for our supervisory workforce that is tied to strong corporate performance for the year across a number of metrics. While operating costs are rising alongside the broader inflationary headwinds, the top line of our regulated businesses is performing really well. Utility margin was up 3% year over year, while revenues in our pipeline and storage segment were up $13 million or 15% over last year. The increase in pipeline revenues was largely attributable to our FM 100 project, along with some good results in our short-term business, which helped push us over the high end of our guidance range. Our commercial team has found ways to optimize our facilities to maximize revenues through short-term contracts, leading to some uplift during the quarter. While modest, these contracts continue to highlight the value of our pipeline infrastructure. Turning to next year, We've reduced our earnings guidance to a range $6.40 to $6.90 per share or $6.65 at the midpoint. This $0.85 decrease is almost entirely due to lower NYMEX natural gas forward prices. We've reduced our natural gas price assumptions from $7.50 in the winter and $5 in the summer to $6 this winter and $4.75 in the summer. As we mentioned last quarter, every 50 cent change in NYMEX natural gas prices impacts earnings by approximately 45 cents. Given that our hedge position remained relatively constant, this pricing sensitivity still holds. Other than a few other minor adjustments, our guidance assumptions are largely unchanged and can be found in our earnings release and investor presentation. One other item of note relates to a recent order in our New York utility that has no impact on earnings or cash flows, but does reduce EBITDA going forward. Due to our pension plans becoming fully funded and significantly de-risked, we made a voluntary filing to stop recovering revenue from our customers that was used to fund these plans. This allows us to reduce utility rates heading into the winter without any impact to our financial results. EBITDA will be reduced by $18 million with an offsetting benefit in non-service pension costs, which falls below operating income on our income statement. This is a bit complicated, so please reach out to Brandon to walk through the finer details. Moving to capital, our consolidated spending was in line with our prior guidance for fiscal 22 And our plans for fiscal 23 remain unchanged. From an overall cash flow perspective, fiscal 22 was a great year. Between cash from operations, our capital spending, and proceeds from the sale of our California properties, we were able to reduce our outstanding debt by $100 million during the year. And but for the $90 million in hedging collateral deposits would have ended the year with no short-term debt outstanding. Looking to fiscal 23, we now expect funds from operations to exceed capital spending by approximately $325 million. This is down $50 million from our prior guidance and is driven primarily by our revised natural gas price assumptions, partly offset by a lower expected cash tax rate, which we now forecast to be in the high single digits as compared to the mid-teens in our prior guidance. This puts us in a great spot to continue growing our long-standing dividend and to fully redeem the $549 million of long-term debt that is maturing next March, which we expect to accomplish with a combination of cash flow and short-term debt as necessary. As we've said for a while now, this focus on near-term debt reduction will leave us with a significant amount of financial flexibility moving forward. We anticipate that it will further reduce our leverage profile with debt to EBITDA trending from roughly 2.2 times at the end of fiscal 22 to below two times next year. This is consistent with the mid triple B metrics the rating agencies have guided us towards, which is where we'd like our rating to be moving forward. With our strong balance sheet and outlook for continued free cash flow generation, We are in a great financial position going forward. With that, I'll ask the operator to open the line for questions.

Thank you. If you would like to ask a question, please press star then one on your touch screen keypad. If you change your mind at any time, please press star two. The first question we have from the phone line comes from John Abba of Bank of America. John, your line is open.

Good morning, and thank you for taking our questions. My first question is, you know, just given where inflation has been going and stuff, is just how do you think about maintenance capex across your various businesses sort of long term?

Well, we've had an ongoing capital program that we're going to stick with. I think what it does is, you know, to the extent that there are inflationary pressures over time, I think it just influences the timing at the edges of when we would be filing for a rate case. But we're certainly going to do what we need to do to keep the system safe and reliable.

Yeah, I was actually sort of thinking about, you know, what do you think of long-term maintenance capex for the E&P business, gathering business? pipeline and segment and utility business. I mean, I understand what you're saying about the utilities to keep it reliable, but where do you think long-term maintenance capex is for the E&T business?

Yeah. So, John, I'd say the general view is where we are now to go down to a maintenance, you would look for that number to come down by 50 to 150 million per year. You know, it'd be a little bit different because unlike today where we're continuously operating a couple rigs, utilizing top hole rig and we'll have active completions and we're growing our production as I've spoken about and plan to continue to grow in that mid to high single digits. Moving to kind of a flat mode, we wouldn't have the same cadence of completions and that would cause a little variability year to year at Seneca. It would also cause a little variability at midstream as we think about expansions. But big picture, you know, you can think broadly about a $50 to $150 million reduction.

That's – I appreciate it. And then the follow-up question I have is to Karen here. So, Karen, if I understand, so cash taxes – the fiscal 2023 will now be in the high single digits versus the mid-teens prior. How do you think of cash taxes looking at STRIP beyond fiscal 2023, and when do you expect to be full cash taxes, just based off the change in cash tax guidance?

Yeah, so, I mean, I think we'll be, over the next few years, definitely moving into the mid-teens and As far as when we'd be a full taxpayer, we're looking at probably 2024.

That is very helpful. Thank you very much for taking our questions.

You bet.

Thanks.

Thank you. We now have Yimeng Chowdhury of Goldman Sachs. Yimeng, your line is now open.

Hi, good morning, and thank you for taking my question. For the first question, we'd love to get your thoughts on New York's coping rules. How does it change your long term plans on ENP business for growing their business? And if that creates additional opportunities for NSG to participate in other business plans like RNG, for example, or carbon sequestration, for example?

You broke up just a little on the first part for EMP. Could you say that one more time, please?

Sure. So we'd love your thoughts around the New York scoping rules. And then how does that change your plans for EMP business for it to grow? And if it creates any additional opportunities for NSG to participate in, like businesses like RNG, for example, which you had indicated before.

Yeah, well, I'll start with the scoping plan. The Climate Action Council's busy finalizing the plan that they would vote on and publish it at the end of the year. You know, our hope is that they take a more reasonable approach than what was put forth in the initial scoping plan. It seemed to me that they pretty much ignored costs and reliability, and it's our hope that they take a more reasoned, all of the above, or hybrid approach, however you want to describe it, approach to energy policy going forward. I think regardless of the scoping plan, when you just look at the overall trends towards decarbonization, um you know independent of what happens there or or at seneca uh we have the ability to um to participate in rng hydrogen and the like and it's an area that we've uh that we have teams in place that are uh are looking at that and you know it's it's my hope and expectation that over time we will come to a point where we are able to uh to make investments there um With respect to both then the scoping plan and RNG, I'm not so sure that has much of an impact on our E&P business. For the near term, we're going to be operating a two-rig program, generating considerable free cash flow. And we're going to do that regardless of what happens in New York. And the level of capital that we're talking about on the RNG and hydrogen side isn't so big that it would put a two-rig program you know, or make it difficult to fund a two-week program.

Gotcha. That's great, Kala. Thank you. And then maybe if I should guess, if we look at the eastern development area, can you remind us how much inventory do you have in that area? And then if there are any bolt-on opportunities which you would look towards to add to inventory?

Yeah, so across the EDA, I mean, we have well over a decade of inventory within that area across Tioga and Lycoming counties. So we're sitting in a great spot. We do continue to evaluate opportunities to bolt on. We'll continue to do so. And we'll continue to be, you know, basically adhering to the principles we put out before, which is focusing on assets where We see them as either continuous or very contiguous or very proximate to our existing acreage, ideally having an opportunity to leverage our integrated model, whether that's at the gathering side or at supply and empire. We'll continue to focus on those, and as those opportunities come up, we'll certainly evaluate them and look to complete the ones that make sense.

That makes sense. Thank you.

Thank you. As a reminder, if you would like to ask any further questions, please press star then one on your telephone keypads. We now have the next question on the line from Trafford Lamar of Raymond James. Please go ahead when you're ready, Trafford.

Guys, thanks for taking my question. My first one is kind of an item that's been pretty topical this quarter. It revolves around widening the basis differentials. And you all have a good chunk of firm sales already baked in. But looking at the revised guide, I saw kind of basis dips widening, especially in the second half of 23. Can you all kind of talk about what you all have seen recently and kind of your thoughts on maybe second half of 23 and beyond?

Yeah, sure. Happy to, Trevor. You know, generally, to say it's been an interesting and volatile market is probably a huge understatement. You know, we're very well positioned. I would encourage you to, as you have time, to look at slide 29 of our investor deck. That gives you a really good visibility into our overall level of what I'll call takeaway protection. So the combination of our firm sales and takeaway capacity. Overall for the year, we've got 88% of our forecasted production flowing through either from transport and or from sales. So that significantly mitigates our exposure to any sort of in-basin, you know, low cash prices right out of the gates. And then on slide 29, what you can really see is we've developed our portfolio to kind of meet our expected growing production throughout the year. And so where we are today versus the growth that we expect through the year, particularly into Q3, you can see that following the quarterly disclosure on our firm sales. And so we think we've positioned the portfolio really well. We have seen the forward marks widen, and so we thought it made sense to kind of true those up to literally what we're seeing as of a couple days ago in the forwards. But again, that is not a very big exposure for us. It's a relatively minor exposure for us given our positioning on firm sales. And then you combine that with our kind of hedge and fixed price position, which is roughly two-thirds. We think we're in a pretty good spot to participate in upside and to have some protection to any sort of downside.

Great. Thanks for that, Justin. And then one more on Seneca. You mentioned the long-term contract with an electric frack crew coming on in 2Q. A diesel over $5 a gallon, what are the cost savings versus a diesel crew at this time?

It's very significant. So on an annualized basis, it's well over $2. The net difference between the gas versus the diesel is well over $10 million. So it's a pretty big move to go from one input fuel to the other from a cost perspective. And obviously, there's some great intangibles there from an emissions and our long-term sustainability goals as well. But that'll meaningfully mitigate some of the pricing around our completion operations.

Great. Thanks for the color, and congrats on a really good year, guys. Thank you.

Thank you. I'd like to turn the call back over to Brandon Husband for any final remarks.

Thank you, Brika. 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. It will run through the close of business on Friday, November 11th. To access the replay online, please visit our investor relations website at investor.nationalfuelgas.com. And to access by telephone, call 1-866-813-9403 and enter conference ID number 533110. This concludes our conference call for today. Thank you and goodbye.

Thank you all for joining. That does conclude today's call. You may now disconnect your line.