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Executives

James C. Welch - Director of IR

David F. Smith - President and CEO

Ronald J. Tanski - Treasurer and Principal Financial Officer

Matthew D. Cabell - President, Seneca Resources Corporation

Analysts

Rebecca Followill - Tudor Pickering Holt & Co. Securities, Inc

Mark Caruso - Millennium Partners

National Fuel Gas Distribution Corporation (NFG) Q2 2008 Earnings Call May 2, 2008 11:00 AM ET

Operator

Good day ladies and gentlemen and welcome to Second Quarter 2008 National Fuel Gas Company Earnings Conference Call. My name is Katrina and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference [Operator Instructions]. As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to our host for today's call Mr. James Welch, Director of Investor Relations, please proceed.

James C. Welch - Director of Investor Relations

Thank you Katrina and good morning everyone. Thank you for 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 Smith, President and Chief Executive Officer and Ron Tanski, Treasurer and Principal Financial Officer. Joining us from Seneca Resources Corporation is Matt Cabell President.

At the end of the prepared remarks, we'll open the discussion to questions. As this call is being publicly broadcast, remind you that today's teleconference discussions will contain forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995. While National Fuel's expectations, beliefs and projections are made in good faith and are believed to have a reasonable basis. Actual results may differ materially. These statements speak only as of the date on which they are made and you may refer to last evening's earnings release for a listing of certain specific risk factors.

With that, we'll begin with Dave Smith.

David F. Smith - President and Chief Executive Officer

Thank you Jim and good morning to everyone. Before giving a brief update on the quarter and our National Fuel's operations, I'd like take a moment to recognize Phil Ackerman who as you know will be retiring at the end of the month. Over the course of his 40 years of service to the company Phil consistently focused on building fuel assets and long term shareholder value.

Along with Bernie Kennedy and Lou Reif, Phil was a principle architect of our integrated diversified corporate model. A model and a strategy that we will carry forward and build upon. In the six and a half years, since October 2001 when Phil was named CEO through the end of last quarter. National Fuel stock delivered an annualized return of about 16% nearly three times that of the S&P 500, by any measuring stick that's a record of which to be proud.

Phil, was and is, also extremely proud of our impressive dividend record including the payment of an increasing dividend for the last 37 consecutive years. We have no intention of breaking that streak anytime soon. The company is in the strong condition it is today and large measure because of Phil, and we owe him a debt of gratitude. On a personal note, I worked for Phil for my entire 30 year career and can say, it's truly been a pleasure I value the friendship and the guidance Phil has provided over the years and will continue to provide. And I wish him and his family the best in retirement.

Now on to the second quarter, which was another excellent quarter for National Fuel. Our consolidated $1.11 per share of net income was yet another record for the company. While higher commodity prices and increased production from continuing operations in our E&P segment were primarily responsible for the 21% increase in net income. It's important to note, that all of our major operating segments reported improved results over the prior year second quarter. As a result, we've increased our earnings guidance for fiscal 2008.

Turning to some of the highlights of the individual segments and our pipeline and storage business, construction of the remaining 60 miles of the Empire Connector project is expected to recommence next week. Site work is on going at the new Oakfield compressor station and we expect to set the two turbo compressor units in early June. Construction and material cost to-date have totaled approximately $65 million and we expect to spend about another $150 million to complete the project.

While that $180 million total is slightly higher than our previous estimate of $177 million, the team has done a wonderful job, in today's pipeline construction environment of controlling cost. Our construction schedule has us, on track for a November 1st, 2008 in service day. But obviously that is contingent, upon the completion of the Millennium project. When Millennium is ready and all indications suggest they will be ready on November the 1st, we will be ready.

Looking beyond the Connector project, Supply Corporation's proposed West to East project continues to evolve. As you will recall, there are multiple sources of supply for that project. Output from the Rex, the Rockies Express, Appalachian Production including that from the Marcellus shale, L&G Deliveries from Cove Point, and on-system storage, initially, we expected that most of the interest for the project will come from wrecked shippers. But lately we are seeing significant interest in the market from other sources as well.

Rex continues to make progress toward Clarington and we are optimistic that our project will ultimately inter-connect with it. But in the mean time, it certainly possible that the West to East project could be built in stage as market demand develops. From Appalachian Production, Cove Point L&G, on-system storage, as these come out, we will put in place our play. We remain optimistic and will continue to update you quarterly on the progress of this project.

Regarding storage development, we continue to make progress on the expansion of our East Branch and Galbraith storages facilities.

During the past quarter, our engineering staff completed the reservoir analysis and concluded that approximately 7Bcf of incremental storage capacity could be provided without the need for any additional base gas. An open season for this capacity is planned for the summer and assuming all goes well, we will file an application for approval with FERC in the first half of 2009.

Supply expects to market the new capacity from both fields as a single offering potentially at market based rates. Turning to exploration and production segment, as Matt will provide a detailed update on all of Seneca's operations, I will briefly address the efforts in our East division. Impressive development of our upper Devonian acreage in Appalachian is continuing according to plan.

Our year-to-date capital spending in that region was nearly double that off a year ago. We are on target to drill 280 wells in 2008. These efforts are clearly paying off, for the first and second quarter production from our shallow wells was up 34% over the same quarters last year. With gas prices where they are and are expected to be, we will continue to aggressively exploit the upper Devonian. We are also excited about the potential of Marcellus Shale play.

Our joint venture with EOG Resources is proceeding at the pace called for, in our agreement. But we are eager to accelerate not only the pace of that program, but the development of our own internal expertise. To that end, a significant portion of the $41 million increase in Seneca's 2008 capital budget will be devoted to the Marcellus. Growing at such a rapid pace is not an easy task. But our Appalachian team has done a terrific job of stepping up to the challenge.

They have been busy hiring the technical staff needed to support this type and this level of activity. By the end of summer, we expect to have doubled the East division's geological staff and tripled its field staff, from last year's level. As we speak, we are in the process of looking for other space, that's twice the size of our existing facility.

In summary, the exploration and development of our extensive Appalachian acreage remains a top priority. We clearly recognize its value and intend to devote the resources that are necessary to maximize its potential.

Before turning the call over Ron, I'd like to address some of our small businesses, including our landfill gas and our timber operations. Two years ago, at one of our analyst conferences, I indicated that we got to grow landfill gas pipeline operations or we sell them. Since, that time, we tried our best to expand Horizon LFG's operations. But we had little luck in doing so.

The methane gas that was once considered a nuisance by landfill operators is now seen as a major source of revenue. As a result landfill operators are now marketing their own methane and that's made it very difficult to expand the business at a price, we find acceptable. Thus we are actively exploring the sale of Horizon LFG and have hired an investment banking advisor to help us with that process.

Assuming an acceptable bid, it's possible that a sale maybe closed by the end of the fiscal year, relatively early in the process. So, too soon to project any details, but it's reasonable to assume that, we'll have at least a modest gain, if we sell the business. Likewise, we are actively exploring the sale of 50% ownership interest in Energy Systems North East LLC, we call it ESNE an 80 megawatt natural gas-fired combined cycle, independent power plant located in North Eastern, Pennsylvania.

This is also early on in the process. So, it's too soon to project any details, but again it's reasonable to assume that we'll have at least modest gains. If we sell our interest in ESNE. The timber business on the other hand is one, we intend to keep at least for the foreseeable future, I understand that at first glance, one might conclude that our timber holdings don't clearly fit and are well head to burner tip model. However a closer look demonstrates numerous synergies with our exploration and production segment, in our pipeline and storage segment.

National Fuel owns the oil and gas mineral rights underlying 90% of our timber acreage including the Marcellus Shale. Our ownership to surface rights facilitates, drilling, gathering, processing and transporting gas on that acreage. Our increased emphasis on Appalachian Production makes our timber acreage, all the more valuable to us. Additionally the timber business, occupies a very small portion of senior management style in a $0.35 of earning to generate is a reasonable return on the relatively modest amount of capital, we committed to that segment.

Consequently, we do not intend to sell our timber assets. With that I will finish and thank you for your attention and I will now turn the call over to Ron.

Ronald J. Tanski - Treasurer and Principal Financial Officer

Thanks Dave and good morning everyone. Last evening's earnings release provides the explanation of the period-to-period variances of earnings in each of the segments. So I won't repeat them here. Recall though that last quarter, I pointed out that a rate design change in the New York division of the utility, would push some margin from the second quarter to the third and fourth quarters.

That did happen as projected and more than $6.5 million of revenue will be spread over the third and fourth quarters. So the differences that you see in the utility segment year-over-year don't reflect any major change in an earnings trend. Instead you need to start a new trend line and establish a new base to compare future earnings in the utility segment again. We also saw a slight uptick in our customer usage per account. We are studying the data and believe that due to economic conditions and high gasoline prices people were not traveling and they were also driving less.

Essentially, they were staying home and they had their heat-on. We actually expect the long term trend of declining use per account to continue. In our New York division, over 6,000 customers have already taken the advantage of rebates totaling $1 million offered under our conservation incentive program. We will step up our advertising program over the coming weeks and we expect many more customers to explore more ways to conserve energy in the face of continued high energy prices.

From a consolidated company viewpoint, in early April, we issued $300 million of new ten year notes at a coupon rate of 6.5%. The proceeds will be used to refund $200 million of notes that will be maturing later this month. And the additional $100 million of funds will be used to fund our pipeline construction program. Regarding the company's buyback of its common shares, during the last quarter the company repurchased 2,392,000 shares, bringing the total repurchases through the end of March to 6,227,553 at a total cost of $241,991 million and that's an average price per share of $38.86.

Dave mentioned the increase in our earnings guidance. As we pointed out, in last night's release that increase is due to the hedging of additional volumes of natural gas in two areas. The first is production and the exploration of production segment. And second volumes of efficiency gas that the pipeline and storage segments plans to sell in the fourth quarter

Our original forecast included selling the efficiency gas volumes at an average LIFO accounting price of approximately $8.14 per dekatherm. We now have some hedges layered in, to sell that gas at an average price of $9.02 a dekatherm. The details for the exploration and production hedging are at page 23 of the earnings release. If you assume annual production to be at the middle of our guidance range. We have... now have approximately 65% of our natural gas production and approximately 55% of our oil production hedged for the remainder of the fiscal year.

Since we have locked in those higher prices, we were able to increase the guidance range. And finally because of the share buyback program, we expect to have a lower weighted average... weighted average number of shares outstanding for the entire year. A lowered number of shares assumed in the revised guidance has the affect of increasing earnings per share by approximately $0.04 per share for the entire year.

Now I will turn the call over to Matt Cabell.

Matthew D. Cabell - President, Seneca Resources Corporation

Thanks Ron. Good morning everyone. Seneca has had another good quarter, with production, revenue and earnings up substantially. Production for the quarter was 10.4 Bcfe, a 4% increase versus the second quarter of last year. This increase came primarily from the East Division, where we produced 2.0 Bcfe versus 1.5 Bcfe last year.

For the six months period our Appalachian Production is up 34%, I expect fiscal year 2008 production for all of Seneca to be closed to the middle of our guidance range of 38 to 44 Bcfe. While production appears to be very much as originally forecast. We are now planning on an increase in fiscal '08 capital spending. We are revising our original budget of $154 million, up to a revised forecast of $195 million.

The upward revisions include acquisitions of approximately $18 million, primarily in California, increased drilling and lease acquisition cost in the Marcellus Shale and Appalachia. And increased development cost in the Gulf of Mexico due to our continued exploration success.

Moving on to some highlights by region, in California, we completed the trade of our interest in the Ohio field plus $14 million. For additional interest in Sesby field [ph]. This allows us to consolidate our position at Sesby and also increases our daily production by 200 barrels of oil equivalent per day, and our reserves by 1.1 million barrels.

In addition, we believe there are some upside potential at Sesby and we may ramp up our activity as soon as next year. In the Gulf of Mexico, we drilled another successful exploration well, extending our streak of successful exploration discoveries to four. This discovery in Highland Block 23L was tested at 20 million cubic feet per day, at 3,000 barrels of condensate per day. Seneca operates and holds 55% working interest. We hope to have it online by October.

Now for an update of our Marcellus Shale activity, first of all, it is important to understand that while EOG is the operator of our joint venture, we are actively working the play internally, over the last several months, we've added five geologists and two engineers to our Appalachian team, including a very experienced engineer who has spend much of his carrier working on horizontal drilling and completions. A geologist who previously consulted on unconventional resources and another geologist who is Ph.D thesis focus on the Appalachian basin.

Our team meets with the EOG regularly to review their program and provide our views of the best locations and operational plans. We have developed a through understanding of the regional geology. Based on our extensive well database which includes numerous Marcellus penetrations. Regional mapping to-date indicates that we have approximately 700,000 net acres that are perspective in the Marcellus. Within that perspective area, we have high graded approximately 425,000 net acres, based on thickness, pressure, organic content and thermal maturity.

Our drilling program will delineate this area, much more precisely as well as defining the resource potential and commerciality. Moving on to current operations our partner EOG has completed the drilling of another horizontal well, which will be fracked later this month. As I have said in the past EOG is an excellent partner, they are very experienced with shell exploration and development. And our teams have an excellent working relationship.

However drilling has preceded more slowly than we had hoped. And although EOG will be bringing in, a new rig this summer, in order to better execute the horizontal program. We are anxious to accelerate the progress of the joint venture. Therefore we plan to propose additional activities, which could include both additional drilling, operated by Seneca and re-completions of existing wells in the Marcellus formation.

The intent of this additional activity, is to evaluate the production potential of vertical wells. High grade areas for future horizontal drilling and build our database of geological and petro-physical properties across our extensive acreage. With the drilling that is planned between both EOG and Seneca, I expect that by December of this year, we will have a much better understanding of the ultimate potential of our Marcellus position.

In summary, this has been another good quarter for Seneca. Production is on track, we've had further exploration success in the Gulf of Mexico. We have consolidated and added to our holdings in California. And we are preparing to ramp-up our activity in the Marcellus Shale.

That concludes our prepared comments, operator I'll turn it over to you now for questions.

Question And Answer

Operator

Thank you. [Operator Instructions] Your first question comes from the line of Rebecca Followill representing Tudor Pickering. Please proceed.

Rebecca Followill - Tudor Pickering Holt & Co. Securities, Inc

Hi on the Marcellus, Matt are you guys going to bring in your own rig for this drilling and...

Matthew D. Cabell - President, Seneca Resources Corporation

Yes.

Rebecca Followill - Tudor Pickering Holt & Co. Securities, Inc

Okay. Just one rig or you going to bring in two rigs or kind of put different timings of that, is it the summer, this fall?

Matthew D. Cabell - President, Seneca Resources Corporation

Just one and the timing is anticipated to be this summer.

Rebecca Followill - Tudor Pickering Holt & Co. Securities, Inc

Okay. Okay thank you.

Operator

Your next question comes from the line of Rick Shulman [ph] representing GLG Partners. Please proceed.

Unidentified Analyst

Hi guys how are you?

Unidentified Company Representative

Good.

Unidentified Analyst

My question is with regard to just the infrastructure in place and infrastructure needs within Appalachia, I mean you have... I don't even know how many companies talking about, not only drilling up current acreage that is proved but also all this Marcellus acreage now being drilled up and proven out. And there is hundreds of thousands, if not millions and even tens of millions of acres of this Marcellus, that needs to get drilled. Is there... how fast does that infrastructure get built? Is there going to be bottleneck and how much more is that going to wind up, costing for you guys and then who eventually, ones that building out, all that the gas gathering and pipeline infrastructure and stuff like that?

David F. Smith - President and Chief Executive Officer

Rick let me take a shot at it, few of those questions anyway. I think there are likely to be bottlenecks, I think you see that with some of the existing producers who are producing a fair amount of gas in Appalachian with regard to who is going to build it, we have set up and we plan on developing a mid stream company. We have all the legal work done. Our President of that company Duane Wassum has been spending a fair amount of time talking to a number of producers.

Obviously those are... that subject to confidentiality agreements. So we see it, as a business opportunity for us to put gathering and to get to the pipeline. So and it will add us, substantial... substantially to the cost of getting the gas out of Appalachian. There is no question that a lot of Marcellus, is in areas where there aren't significant pipelines. But at least from National Fuel's perspective, we are looking at it, as a business opportunity and we are actively pursuing that now.

Unidentified Analyst

I just have one more follow up question and this one, a little bit more theoretical, I guess just on your thoughts. But if more and more of this...of these of gas supplies the one that are coming from these shale plays. And that puts increasing upward pressure on costs for drilling and cost per pipe. And cost for gathering systems, that constantly raises the overall floor price, or break-even price for gas, which means that inevitably drive higher prices, I mean is that guidance thoughts as well. How do you think about it?

David F. Smith - President and Chief Executive Officer

I would look at it, a little differently and say that you are right it raises the floor. But current price environment is well above that floor. So, may be what we are defining is a new floor on gas prices. At least sort of a long term floor with ultimate leasing volatility will drop you down below occasionally.

Ronald J. Tanski - Treasurer and Principal Financial Officer

And Rick just on the other side of that coin, you have to be careful, to the extent that, we talk about all the gas coming into Appalachian, Cove Point and Rex, in Appalachian Production and shale. We need to get the gas out of the area or you could have a real basis issue there. So we are mindful of that too and that has, that would have downward pressure on the price.

Unidentified Analyst

Fair enough. Thank you very much.

Operator

[Operator Instructions]. Your next question comes from the line of Mark Caruso representing Millennium Partners. Please proceed.

Mark Caruso - Millennium Partners

Good morning. I just want... had a quick question, I notice that you didn't raise... you raised the CapEx, didn't raise the production guidance and I understand you said that you are not bringing your rig to develop, further develop the Marcellus. So just curious given the... lag and timing in your fiscal year. When would you expect that, we would begin to see, as your drilling opportunities come to fruition is it sort of a fall event when we start to see those volumes start to kick-in?

Matthew D. Cabell - President, Seneca Resources Corporation

Yes, I would say, that it would be fall. But also keep in mind. We are talking about the additional proposed activities being maybe 6 to 10 vertical wells. It's not necessarily a substantial impact on immediate production. But is very important for us in data gathering and being prepared to drill the horizontal wells or we'll ultimately develop our resources.

Mark Caruso - Millennium Partners

Right but those are in... I think in the release, I read you are going to be adding about 20 wells a month, into Appalachian?

Matthew D. Cabell - President, Seneca Resources Corporation

The 20 wells a month are... that's what we are doing now. And that's all in the plan.

Mark Caruso - Millennium Partners

Right and these will be incremental to that?

Matthew D. Cabell - President, Seneca Resources Corporation

Yes, yes.

Unidentified Analyst

Okay. Got you thanks.

Unidentified Company Representative

The upper Devonian markets.

Matthew D. Cabell - President, Seneca Resources Corporation

Right got you, I appreciate thank you.

Operator

With no further questions in queue, I would now like to turn the call back to Mr. James Welch for closing remark.

James C. Welch - Director of Investor Relations

Thank you Katrina. We'd like to once again thank everyone for taking the time to be with us today. A replay of this call will be available in about 1 hour on both our website and by telephone. And will run to the close of business on Friday May 9th. To access the replay online, visit our Investor Relations website at investor.nationalfuelgas.com. And to access by telephone, call 1-888-286-8010 and enter pass code 39987735.

We would also like to remind everyone, that we'll be making a webcast presentation at the American Gas Association Financial Forum on Monday May 5th at approximately 9:05 AM Eastern Standard Time. To listen to this webcast live or access the replay that will be available for one week following the presentation. Please visit our Investor Relations website. This concludes our conference call for today. Thank you and good bye.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your presentation you may now disconnect. Good day.

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Source: National Fuel Gas Co. F2Q08 (Qtr. End 03/31/08) Earnings Call Transcript
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