National Fuel Gas Company

Good afternoon everyone. I would like to welcome you all to the National Fuel Gas Company Q2 fiscal year 2023 earnings conference call. My name is Rika and I will be your event specialist operating today's call. After the speaker's presentation today we'll conduct a question and answer session. To ask a question at this point please press star then one on your telephone keypad. If you change your mind and would like to withdraw your question, please press star then two. And for operator assistance at any point, it's star zero. Thank you. I would now like to hand the conference over to our host for today, Brandon Hasnett, Director of Investor Relations. So, Brandon, you may begin your conference call.

Thank you, Brika, 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, Tim Silverstein, Treasurer and Principal Financial Officer, and Justin Loweth, President of Seneca Resources and National Fuel Midstream. At the end of the prepared remarks, we will open the discussion to questions. The second quarter fiscal 2023 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'd like to remind you that today's teleconference will contain forward-looking statements. While national fuels expectations, beliefs, and projections are made in good faith and are believed to have a reasonable basis, actual results may differ materially. These statements speak only as of the date on which they are made, and you may refer to last evening's earnings release for a listing of certain specific risk factors. With that, I'll turn it over to Dave Bauer.

Thank you, Brandon, and good morning, everyone. Overall, the second quarter was a good one for national fuel. with strong operational execution across our businesses. Seneca and NFG Midstream had a particularly good quarter. Seneca continues to see excellent results from its development program, which has driven both production and gathering volumes to record levels. Capital spending and per unit operating costs were very much in line with expectations. Pricing was obviously a headwind for the quarter and will likely continue to be challenging in the quarters to come, but we are well hedged for the remainder of this year and for next year. Justin will have a complete update on Seneca's operations later in the call. Seneca was active during the quarter on the land acquisition front. As we announced in our earnings release yesterday, we're acquiring some smaller but highly strategic bolt-on opportunities in our eastern development area. As I've said on past calls, our A&D strategy in Appalachia is focused on assets that are geographically contiguous, that provide an opportunity to leverage our midstream infrastructure, and it can be purchased at a reasonable price. These acquisitions check each of those boxes. Across the three transactions, we're adding approximately 36,000 largely contiguous acres, most all of which are undeveloped. In addition, we're acquiring approximately 20 million cubic feet per day of flowing production and a PDNP well that can be connected to our Lycoming County gathering system at a relatively low cost. These assets add approximately 50 to 70 EDA locations in some of the most highly prolific parts of the basin. In addition, these assets allow us the ability to drill longer laterals off more than 20 of our existing development locations, which should further enhance the capital efficiency and returns of our program. Although these acquisitions will increase our capital outlay for the year, they should be covered entirely by cash from operations. And even considering the transactions, our remaining free cash flow is expected to be sufficient to fund our dividend and to make headway in our goal to reduce absolute levels of debt. Turning to our regulated businesses, operationally our utility and pipeline and storage segments performed well during the quarter, though warmer weather had a negative impact on the utility's financial results. Higher O&M costs across the board were also a headwind, but the higher costs were expected and are the main reason we filed a rate case in Pennsylvania and will likely file in New York and with FERC. Tim will have more to say on this later in the call. In March, we reached a settlement in our Pennsylvania rate case. Under that agreement, the parties agreed to, among other things, a $23 million revenue increase, effective August 1st, and the addition of a weather normalization mechanism. We've had weather norm in New York for many years, but the Pennsylvania Commission has only recently begun to adopt them. This addition is a win-win for both our customers and the company, helping to mitigate the volatility in earnings and cash flows resulting from fluctuations in the weather. The settlement, which was unopposed by the parties to the case, was filed with the Commission a few weeks ago and is expected to be approved at a summer session. All in all, I think this is a good settlement for everyone, and I'd like to thank all of our employees that were involved in this proceeding, which was our first rate case in Pennsylvania in over 15 years. In New York, despite widespread opposition from the public, legislators in Albany continue to pursue natural gas bans. Siena College recently polled individuals throughout New York State, and the results were clear. In our service territory, about 70% of the population is opposed to any type of natural gas ban, whether it be for new construction or in existing homes. And statewide, nearly 90% of the people surveyed are concerned about the costs associated with moving away from natural gas. Nevertheless, despite this clear message, earlier this week the state enacted a budget bill that bans natural gas equipment and building systems in new construction starting in 2026. Governor Hochul, who has advocated for gas bans, signed the legislation and the law. On the surface, this appears to be a significant step towards 100 percent electrification. However, when you dig a little deeper, you find the state tacitly acknowledges the public safety risks of rushing electrification. For one, the new rules contain a litany of exemptions, including for backup natural gas generators, hospitals, medical facilities, commercial kitchens, and industrial and manufacturing uses. Further, the measure includes a provision that exempts natural gas for new construction in areas where the electric grid cannot support the increased load. which at least in the near term may be much of the state. By its own exemptions, it appears the state recognizes that natural gas is critical for both energy reliability and economic prosperity, which is encouraging. In my view, it's not a big leap to see this list of exemptions expanded to include hybrid heating solutions like we've proposed as part of an all of the above approach to decarbonization. Nor is it a stretch to see rules and regulations that consider regional differences in the state. Upstate New York is more than 50% colder than downstate and our housing stock is generally older. Continued use of natural gas in Western New York makes perfect sense. It saves money for consumers and improves energy reliability. And the use of the natural gas system to deliver low and no carbon fuels in the future will build on the significant emissions reductions we've already achieved in our area of the state. So how will this legislation affect national fuel? From a practical standpoint, I don't see any significant impact for the foreseeable future. For one, the bans don't apply to existing buildings, and about 90% of the buildings in our service territory already heat with natural gas. Further, western New York isn't seeing major population growth. In fact, much of our construction growth is the result of repurposing of older commercial and industrial buildings to residential or mixed-use facilities. And lastly, as I stated earlier, industrial uses of natural gas are exempt from the bans. While the threats of more bans and other ill-advised electrification actions will continue to exist so long as the legislature remains in session, it's clear that Albany legislators, and perhaps even the governor herself, are acknowledging the very real fact that imposing gas bans on an increasingly concerned public especially when other more pragmatic solutions are known and achievable? Is it best premature, and at worst, too much of a risk to businesses and residents in New York? In closing, we continue to execute on our development plans across the system and are seeing great results. As we look forward, we remain focused on the efficient allocation of capital towards investments that can deliver strong returns through commodity price cycles and generate significant and sustainable free cash flow that further strengthens our investment-grade balance sheet and improves our financial flexibility. Before turning the call over to Justin, I want to take a moment to recognize Karen Camiolo, who retired last Friday. Karen had a terrific 29-year career with the company, serving as controller and chief accounting officer for nearly 15 years and CFO for the last four. I wish her the very best in retirement. With that, I'll turn the call over to Justin.

Thanks, Dave, and good morning, everyone. Seneca and NFT Midstream had a solid second quarter. Appalachian natural gas production for the quarter came in at 93.2 BCFE, an increase of 3% sequentially and 12% above last year's second quarter production. This increase was driven by solid operational execution and better than expected production from wells turned online in the first half of the year. We also eclipsed the one BCF per day net average for the quarter. a milestone for us. This production growth, combined with our third-party business, drove record throughput at NFG Midstream. This is a trend we'd expect to continue over the near term, particularly with some incremental third-party production that came online at the end of March. The strong production during the quarter offset the headwinds we're facing on the natural gas pricing front. While the long-term outlook remains extremely constructive, with NYMEX futures pricing north of $4 per MMVTU in 2025 and beyond, The near-term supply demand and storage inventory fundamentals will likely pose some challenges through next winter. We expect in-basin pricing will remain challenged over the next couple months until we get into summer, where increased power load demand is expected to provide more support. As we enter the late summer, early fall shoulder season, we expect cash prices to deteriorate again as gas storage levels near capacity. However, we are well insulated from this expected pricing weakness. with over 90% of our remaining production protected by our valuable marketing portfolio, which significantly dampens our exposure. With prices anticipated to improve by next winter, we are modestly adjusting our operation schedule to target higher production volumes in early fiscal 2024. This will primarily be accomplished by pushing out online dates of a pad or two by a couple months, which will bring flush production online in a higher expected winter pricing environment. This is not anticipated to have a material impact on capital or production during the remainder of the fiscal year. As it relates to our overall level of capital for the year, we are maintaining our guidance within the range of 525 to 575 million. As we discussed last quarter, our spot completions crew, top hole rig work, and online activity was front loaded in the first half of the fiscal year. As a result, capital will naturally moderate for the remainder of the year. For reference, during the last six months of the year, we expect to turn in line seven to 13 wells compared to 25 operated and nine non-operated wells in the first two quarters. Despite these adjustments to our operations plan, our production guidance remains unchanged at 370 to 390 BCFE as the aforementioned strong well performance is expected to offset a modest amount of production that we plan to push to the first quarter of fiscal 2024 to take advantage of higher winter pricing. Taking all of this into consideration, I expect our production will increase again in Q3 before declining in Q4 and into early next year, and then ramp up during the peak winter months. As a reminder, our guidance does not incorporate voluntary pricing-related curtailments. Regarding inflation, we are seeing signs of a rollover in service and raw material costs, particularly in tubulars. I believe that the worst of the inflationary headwinds are behind us, and we may see a flat to modest deflationary trend going into fiscal 2024. Looking out longer term, while our existing firm transportation and firm sales portfolio supports our development plans over the next 12 to 18 months, beyond fiscal 2024, we may look to shift our activity to maintenance mode. Absent securing additional firm transportation capacity or the execution of significant new long-term firm sales, we plan to move towards maintenance production levels in fiscal 2025 and beyond. reducing our spending levels. Given the integrated nature of our development plans, this is also expected to result in opportunities to lower long-term capital investment levels at NFG Midstream as we optimize plans and continue to focus on consolidated returns. As communicated previously, Seneca and NFG Midstream plan to increasingly focus our development and capital allocation in our eastern development area, Tioga County in particular, which will allow us to maximize capital efficiency and free cash flow generation in the years to come. On that note, over the last few months, we've had various long-pursued Eastern Development Area bolt-on acquisitions all come together at the same time. As Dave mentioned, we announced three separate transactions that will further deepen our core inventory of Tioga and Lycoming development locations. With our large core operating position in the Eastern Development Area, we believe we can integrate these assets and create differentiated value. First, Seneca has entered into agreement with Southwestern Energy to acquire approximately 30,000 net acres in Tioga and Potter County. That also includes approximately 20 million cubic feet per day of flowing net production. This acreage is contiguous to our existing Tioga position, allowing significant operational efficiencies. We have also executed two smaller contiguous bolt-on acquisitions in Tioga and Lycoming counties, totaling about 6,000 net fee and lease acres with a modest amount of production and one pre-developed non-producing well. We're excited to close these bolt-ons, and we'll be looking at opportunities to integrate these assets with National Fuels' existing midstream infrastructure. Turning to our sustainability initiatives, I would like to highlight a program the Seneca construction team is moving forward with, which we have named our Surface Footprint Neutral Initiative. Through this initiative, we plan to restore, enhance, and protect biodiversity by returning one acre of land to its natural state for every acre of pad and road development disturbance required for our operations through a variety of conservation projects. We also continue to make significant progress on our ongoing emissions reduction efforts. Examples include our aerial facility scale monitoring, pneumatic device conversions at Seneca, and facility modifications at NFT Midstream. And we look forward to sharing more details on our progress when our corporate responsibility report is published later this year. In conclusion, our team continues to successfully execute our plan, and despite the current natural gas pricing headwinds, a robust marketing portfolio and integrated development supports long-term free cash flow generation. Looking beyond fiscal 2023, our integrated operations, deep inventory of high-quality development acreage, and strong culture of safety and sustainability puts us in a great position for continued success throughout all stages of the commodity price cycle. With that, I'll turn the call over to Tim.

Thanks Justin and good morning everyone. Last evening, National Fuel reported second quarter GAAP earnings of $1.53 per share. Excluding items impacting comparability, our adjusted operating results were $1.54 per share, a decrease of 14 cents from last year's second quarter. There were three principal drivers of this decrease, with the largest being related to the sale of our California assets, which closed in June of 2022. Last year, California contributed approximately 13 cents in earnings during the quarter. In addition, we also experienced higher operating costs in our regulated subsidiaries and 11% warmer weather in our utility. Somewhat offsetting these decreases were Seneca's higher production and associated throughput in our gathering business. With respect to weather and regulated operating costs, I'll take a few minutes to address our plans to mitigate their impacts. First, as Dave mentioned, we reached an agreement with parties in our Pennsylvania rate case on a $23 million revenue increase. The settlement agreement was filed in April and we expect a decision from the Commission that would put new rates into effect on August 1st. In addition to the rate increase, the inclusion of a weather normalization mechanism with a dead band of plus or minus 3% will help reduce year-to-year volatility. With this settlement, we expect to continue to have among the lowest, if not the lowest rates in the Commonwealth, which is a great outcome for our customers. This will go a long way to support our ongoing modernization program, further reducing emissions on our system, while mitigating the inflationary pressures we are currently experiencing. In addition to the positive progress in Pennsylvania, in March, the New York Public Service Commission approved a new system improvement tracker. Consistent with our current modernization tracker, this permits us to recover costs associated with new modernization investments. The newly approved tracker allows us to continue recovering costs associated with system modernization investments placed in service from April 1st of this year through September 2024. For all of fiscal 2023, we expect incremental revenues of up to $5 million associated with these two mechanisms, which will go a long way to improving earned ROEs in New York. In conjunction with the new tracker, we also agreed to a short stay out provision with respect to a potential rate case. The earliest we could file is this fall. Given the ongoing inflationary headwinds and the continued growth in rate base from our modernization program, this is the path we are currently proceeding on. This would put new rates into effect at the start of fiscal 25. In our pipeline and storage segment, under our previous rate settlement at Supply Corporation, we can file for a rate increase as early as the end of July. Given our ongoing focus on pipeline modernization and compliance with new regulations, including safety and emission reduction measures, we continue to see rate-based growth and cost increases, pressuring our returns. As a result, we expect to file a rate case in the summer, such that new rates could be in effect as early as next February. Collectively, it is a busy time on the rate case front, but the continued need to focus on system modernization and emission reductions combined with ongoing inflationary headwinds supports rate increases at our regulated subsidiaries. As we look into fiscal 24 and 25, we expect the resolution of these proceedings to contribute to improving earnings and cash flows. Turning to the outlook for the remainder of fiscal 23, we have revised our earnings guidance to a range of $5.10 to $5.40 per share, a decrease of 30 cents or 5% at the midpoint. This is driven by three major factors, the largest of which is the lower expected natural gas price realizations for the remainder of the year. Also contributing to the reduction is the effect of warmer weather on our utility business during the second quarter and higher projected interest expense. The latter is due to a larger near-term financing need that will result from the expected closing of Seneca's bolt-on acquisitions combined with higher interest rates than previously forecasted. Other than these items, the rest of our guidance assumptions for the full year remain unchanged. With respect to natural gas prices, our new guidance reflects a NYMEX price of $2.50 per MMBTU for the remaining six months of the year, which is a 75 cent reduction from our prior guidance. Offsetting some of this impact is the benefit from favorable hedges added during the quarter. For the remainder of the year, we are 77% hedge, This includes 12 BCF of new NYMEX swaps at a price of $3.25. For reference, a 25-cent change in pricing would impact earnings by 9 cents per share. As a reminder, we have 47 BCF of costless collars in place, so this impact is not necessarily linear. On the physical side, we've also been actively locking in near-term sales. At the midpoint of our guidance range, we have approximately 92% of our remaining fiscal year volumes tied to a firm sale. which limits the amount of production exposed to in-basin pricing. We remain committed to our hedging program and will continue to be methodical in adding new hedges. Given the contango in the natural gas forward curve, we see the opportunity to layer in additional hedges in the coming quarters at strong prices, with a particular focus on 2024 and 2025. To that end, with the hedges added during the past few months, we are well positioned for next year. where we already have approximately 265 BCF of hedges in place at good prices. Lastly, I want to discuss our outlook for free cash flow. You will see that we switched the presentation of this metric in our IR deck to focus on cash from operations as opposed to funds from operations. While changes in working capital can drive more volatility under this approach, we believe this gives investors a more complete picture. For the year, we now expect free cash flow, inclusive of working capital, to be $410 million before the impact of our recently announced acquisitions. Accounting for approximately $145 million related to these acquisitions, we are left with $265 million to cover our dividend, with the rest expected to be directed towards debt repayment. From a financing perspective, we redeemed $549 million of long-term debt earlier this year through a combination of short-term debt and cash on hand. As a result, our short-term borrowings increased to approximately $400 million at the end of March. These borrowings were split between commercial paper and a $250 million term loan that matures at the end of June. Given the inverted yield curve and the more challenging bank market over the past two months, we will likely term out a large portion of this short-term debt through long-term debt issuance. This will help reduce near-term interest expense and free up capacity under our $1 billion multi-year revolver. This leaves us with the liquidity to navigate potential macroeconomic challenges and natural gas price volatility in the near term. With long-term NYMEX prices trending above $4, our outlook for free cash flow generation remains strong and is supported by our near-term hedge book and valuable long-term firm sales and firm transportation portfolio. This positions us well to execute on our ongoing deleveraging plans and growing our long-standing dividends. all while retaining the flexibility to strategically invest in further growth opportunities or return additional capital to shareholders. 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 1 on your telephone keypad. If you change your mind, please press star 2. We have our first questioner on the phone lines from Trafford Lamar of Raymond James. Hey, guys. Good morning.

I guess my first question is for Justin, kind of surrounding the 24 capex. I know it's early, but Justin, I know you mentioned some cost plateauing or even decreasing, specifically on the tubular side. What about kind of specifically surrounding service cost deflation? What are you all seeing there on the Reagan track side?

Sure, so, you know, at this point, the, the biggest change that we've seen and so over the last couple of months or so. Is just that there's significantly more availability of services. So specifically with your frack and your rig services. we were very, very tight if you go back six to nine months ago. That's opened up, and that, in our view, is really the first step towards some reductions. Definitely, I think the leading edge is that there may be some modest decreases around that, but we think that's really going to play out over the next three to six months and will significantly relate to the amount of activity in gas basins, but, frankly, also in the oil basin. Our bias on the service side is kind of flat to modestly declining if you look out six to nine months or so.

Okay, perfect. Appreciate the color on that. And then next question is for Dave and Tim. Looking at the balance sheet, You all repaid your 23 maturities and have leverage right around 2x. And you mentioned possibly issuing a longer-term maturity to pay off some shorter-term debt. But with leverage at 2x, you all are investment-grade. How do you all kind of look at kind of a target leverage figure moving forward, especially at this low-price cycle environment?

Yeah, it's a good question. So, I mean, I think the way to think about it is in the high ones low twos is probably the right area for us to be and obviously making sure that we can maintain our metrics comfortably within the bounds that the rating agencies have said through the lower points of the cycle. And if you look at where we're at right now, we've got lots of room within our current guidelines. So I'd say. you know, where we are at today and trending into the high ones over the next year or two is the spot for us.

Okay, perfect. Thank you, guys. Yep. Thank you.

Thank you. As a reminder, it is Star 1 if you'd like to ask a question today. We have had no further questions registered, so I'll hand it back to Brandon Heskett for any final remarks. Oh, I apologize. We do have a follow-up question on the line from Trafford Lamont.

Hey, guys. Thanks for letting me get one more in here. I guess the last thing I have is really on free cash flow, and if you all really considered You know, working in buybacks to shareholder return framework. I mean, obviously y'all have y'all have the base there, but I just want to get y'all's thoughts on potential buybacks moving forward.

Yeah, certainly there'd be the potential for that down the road. Our first goal is to get our absolute levels of leverage down. So not just our metrics like FFO to debt and and debt to EBITDA, but actual total leverage down. Once we hit that, you know, we'll evaluate different opportunities. I mean, our hope is that something would come along that would allow us to grow the company rather than shrink it through a buyback. But absent those opportunities, a buyback is something that we would certainly consider.

That makes sense. Okay. Thanks, y'all.

Thank you. We have no further questions on the line. So we now have a question from Timothy Winter of Garbelli and Company.

Good morning and thanks for taking my question. I was wondering if you could just talk a little bit more about the plan decision to go to a maintenance mode. What's all sort of underlying that plan? And what would maintenance mode look like from, you know, a capital expenditure and production guidance look like?

Sure. Thanks for your question, Tim. You know, what really underpins our development plans and our production growth has remained consistent for a long time now, and it's the ability to reach premium markets. And so we've been fortunate. We've had a really solid firm transportation portfolio, and if you recall, About 16 months ago now, we were able to – our sister company's FM100 and the Lighty South project came online, giving us a significant leg of growth opportunity into strong markets. And we've augmented that, plus our other firm, FT, with firm sales. And so as we look to the future, we don't anticipate any new-build infrastructure is going to get announced and get built by 2025. There's the possibility of capacity turnbacks, and we've been successful at a couple of those over the last year. And there's the potential also of additional long-term firm sales, which has been a practice of ours for a long time. But our view is very much if we don't have a premium market that we'll move the vast majority of our gas to, the right answer is to moderate our capital levels and moderate our production to basically match our long-term takeaway. And then, of course, augmenting all of that with our long-standing policy around methodically entering hedges. As it relates to capital, you know, nothing has really changed much with the prior discussion on that. You know, the general view is that you'd kind of have, excluding any sort of inflation or service cost changes, kind of apple-apple the comment, but generally I would expect Seneca and midstream capital would be $75 to $150 million less per year below current levels. And so there'll be a little bit of a noise in that range, and we may have a large midstream infrastructure project or something like that in a given year that can move you around or an extra pad being completed and so forth. But that would be the general view on the long-term trend, and it's something we'll be talking more about in the coming quarters.

Okay, great. Thank you. That's very helpful.

Thank you. Is Star 1 to ask any further questions today? As we have no questions registered, I'll hand it back to Brandon Hesbitt for any final remarks.

Thank you, Brica. 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 Thursday, May 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, provide access code 313-864. This concludes our conference call for today. Thank you. Goodbye.