NATIONAL FUEL GAS CO quarterly report, Q2 FY2016

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National Fuel Gas Company — Q2 FY2016 Form 10-Q

Reporting period: Quarter and six months ended March 31, 2016; unaudited. The filing compares results with the corresponding 2015 periods. Amounts below are in U.S. dollars.

Business context and financial performance

The company operates natural gas production, gathering, pipeline and storage, utility distribution, and energy marketing businesses, primarily in western New York and Pennsylvania, with oil production also in California. The fiscal second quarter was significantly affected by low oil and gas prices, warmer weather, and large non-cash oil and gas property impairments.

  • Revenue: Q2 revenue was $449.1 million, down 24.7% from $596.1 million. Six-month revenue was $824.3 million, down 26.4% from $1.120 billion.
  • Profit/(loss): Q2 net loss available to common stock was $147.7 million, or $1.74 per diluted share, versus net income of $16.7 million, or $0.20 per share, a year earlier. Six-month net loss was $336.8 million, or $3.97 per diluted share, versus net income of $101.4 million, or $1.19 per diluted share.
  • Impairments: Oil and gas property impairment charges were $397.4 million pre-tax ($230.5 million after tax) in Q2 and $832.9 million pre-tax ($483.1 million after tax) for six months. The corresponding 2015 six-month period included a $120.3 million pre-tax impairment.
  • Cash flow: Six-month operating cash flow was $312.8 million, down from $507.5 million. Capital expenditures were $359.0 million; investing cash outflow was $272.3 million, including $104.9 million of proceeds from the IOG joint development arrangement. Cash declined by $19.9 million to $93.7 million.
  • Debt and liquidity: Long-term debt was $2.085 billion, compared with $2.084 billion at September 30, 2015; no debt matured within the next 12 months. No short-term debt was outstanding at March 31, and the $750 million multi-year revolving facility was undrawn. The company reported a 0.56 debt-to-capitalization ratio under its credit agreement. Current assets were $376.5 million and current liabilities $352.6 million.
  • Equity and dividends: Shareholders’ equity declined to $1.622 billion from $2.025 billion at September 30, 2015. Dividends declared were $0.395 per share for Q2 and $0.790 per share for six months.
  • Margins: The filing does not provide a single consolidated margin measure.

Material changes and segment results

  • Exploration and Production: Six-month segment loss was $450.4 million versus a $26.8 million loss, primarily reflecting larger ceiling-test impairments, lower commodity prices, and lower gas production. Production revenue after hedging fell $74.4 million. Weighted average realized gas price after hedging was $1.94/Mcf for six months versus $2.79; oil was $31.65/Bbl versus $55.80.
  • Utility: Six-month earnings fell to $50.6 million from $60.8 million. Warmer weather reduced earnings, partly offset by the New York weather normalization clause and lower operating costs. Revenue fell mainly with lower gas costs and throughput.
  • Pipeline and Storage: Six-month earnings declined to $42.5 million from $44.2 million, despite higher revenue, as expenses, depreciation, and interest costs increased.
  • Gathering: Six-month earnings declined to $12.5 million from $18.0 million; lower throughput and higher interest and depreciation costs weighed on results. Q2 earnings, however, increased to $7.6 million from $6.4 million.
  • Energy Marketing: Six-month earnings were $4.7 million versus $6.2 million, mainly due to lower margins and customer volumes.
  • Consolidated interest expense on long-term debt increased $14.7 million for six months, principally following issuance of $450 million of 5.20% notes in June 2015.

Outlook, commentary, and risks

  • Management expects significant additional ceiling-test impairments in each remaining quarter of FY2016; an impairment in Q1 FY2017 is also possible. The company cited low commodity prices and the impact of lower prices entering the rolling 12-month average. Its sensitivity analysis estimated additional after-tax impairment of $123.5 million for a $0.25/MMBtu gas-price decline, $39.9 million for a $5/Bbl oil-price decline, or $163.2 million for both declines, holding other assumptions constant.
  • Marcellus development was slowed; in March 2016 the company reduced its drilling program to one rig from three at the start of FY2016. FY2016 expected capital expenditures were approximately $175 million for Exploration and Production (net of the $115.2 million IOG reimbursement), $145 million for Pipeline and Storage, and $80 million for Gathering. The company said lower commodity prices and production could affect cash generation and funding needs.
  • Because of indenture covenants and recorded impairments, management expected to be restricted from issuing incremental long-term unsecured debt until at least Q3 FY2017, potentially through much of FY2017 if further impairments occur. Management did not anticipate needing incremental long-term debt in FY2016 or FY2017, and expected to use operating cash and, if needed, short-term borrowings. The revolving credit facility was undrawn; long-term debt maturities begin in FY2018.
  • The Northern Access 2016 pipeline project’s target in-service date was delayed to November 2017 from late 2016; estimated cost was $455 million. Northern Access 2015 and other projects were placed in service during the period.
  • After the quarter, on April 28, 2016, the New York utility filed for an annual revenue increase of approximately $41.7 million. If approved, new rates could take effect around April 1, 2017; the outcome is uncertain. FERC also initiated a Section 5 rate review of Empire’s rates.
  • Environmental cleanup liabilities were estimated at $4.7 million, expected to be recovered through rates over approximately 12 years. Other ordinary-course litigation and regulatory matters could affect earnings and cash flows, but the company could not estimate potential losses.
  • Other risks include commodity-price and reserve uncertainty, access to capital and covenant restrictions, project permitting and delays, weather, environmental regulation, and counterparty credit exposure. The filing says management expects liquidity to be adequate to meet known demands.

Most important facts for investors to verify

  • Whether further ceiling-test impairments materialize and how commodity prices affect the full-cost ceiling.
  • Cash generation, capital spending, and funding needs if commodity prices or production remain weak, including the scope of any short-term borrowing.
  • The duration and practical effect of the indenture restriction on incremental long-term debt issuance.
  • Regulatory outcomes and timing for the New York utility rate case and Empire’s FERC rate review.
  • Progress, cost, and revised schedule for Northern Access 2016 and the company’s other expansion projects.
  • Whether the IOG joint-development arrangement proceeds as planned, including the option for participation in the remaining wells and collection of amounts due.