National Fuel Gas Company — FY2012 Form 10-K
Reporting period: Fiscal year ended September 30, 2012. The filing also reports the quarter ended September 30, 2012; this is an annual report, not a standalone quarterly filing. Amounts below are U.S. dollars unless noted.
Business context and reporting period
National Fuel is a diversified energy holding company with four reported segments: regulated gas utility distribution, interstate pipeline and storage, oil and gas exploration and production, and energy marketing. Its utility serves approximately 732,600 customers in western New York and northwestern Pennsylvania. Management’s strategy centers on Marcellus Shale development and related gathering and pipeline infrastructure.
Exploration and Production generated 43.9% of 2012 net income available for common stock; Pipeline and Storage 27.5%; Utility 26.6%; Energy Marketing 1.9%; and All Other and Corporate 0.1%.
Financial performance and condition
| Metric | FY2012 | FY2011 | Change / context |
|---|---|---|---|
| Operating revenue | $1.627 billion | $1.779 billion | Down 8.5% |
| Operating income | $448.0 million | $441.2 million | Up 1.6% |
| Operating margin | 27.5% | 24.8% | Operating income divided by revenue |
| Net income available for common stock | $220.1 million | $258.4 million | Down 14.8% |
| Diluted EPS | $2.63 | $3.09 | Down 14.9% |
| Cash from operating activities | $660.8 million | $660.5 million | Essentially unchanged |
| Capital expenditures | $1.037 billion | $820.9 million | Up 26.3% |
| Dividends paid | $118.8 million | $114.6 million | FY2012 declared dividend was $1.44 per share |
Fourth quarter FY2012: Revenue was $313.3 million, operating income $107.3 million, net income $48.8 million and diluted EPS $0.58. The quarter included $12.8 million of after-tax income from the Pipeline and Storage segment’s rate-settlement-related regulatory liability elimination.
Margins and segment trends: Operating income increased despite lower consolidated revenue. Pipeline and Storage earnings rose to $60.5 million from $31.5 million, supported by new Marcellus-related transportation capacity and a rate settlement. Exploration and Production earnings fell to $96.5 million from $124.2 million, primarily from lower gas prices after hedging, higher depletion and operating costs, and the prior-year sale of Gulf of Mexico properties. Utility earnings declined to $58.6 million from $63.2 million, with unusually warm weather a principal factor. Energy Marketing earnings decreased to $4.2 million from $8.8 million.
Cash flow and investment: Operating cash flow was slightly above the prior year, but capital expenditures exceeded it by $376.0 million. Net cash used in investing activities was $1.036 billion. The company funded investment with operating cash, short-term borrowing and a December 2011 debt issue.
Debt and liquidity at September 30, 2012: Long-term debt was $1.399 billion, including $250 million due in March 2013; short-term bank notes and commercial paper totaled $171 million. Cash and temporary investments were $74.5 million. Total current assets were $355.6 million against current liabilities of $734.5 million. The company had a $750 million committed credit facility through January 2017, with no borrowings outstanding under it at year-end, and $335 million of revocable uncommitted bank lines. Its facility-defined debt-to-capitalization ratio was 0.44, below the 0.65 covenant limit. Management stated liquidity was adequate for known demands.
Other key metrics: Total assets were $5.935 billion, shareholders’ equity $1.960 billion, and net property, plant and equipment $4.740 billion. The annual dividend declared increased to $1.44 per share from $1.40.
Material changes versus the prior comparable period
- Net income fell $38.3 million year over year. A $31.4 million after-tax gain on the 2011 sale of Seneca Energy and Model City did not recur in 2012; lower Exploration and Production, Utility and Energy Marketing earnings also contributed.
- Revenue declined largely because warmer weather reduced utility and energy-marketing volumes, and lower natural gas prices reduced Exploration and Production realized prices. Consolidated operating income nevertheless increased.
- Pipeline and Storage revenue increased to $259.3 million from $215.1 million, reflecting new Line N and Tioga County capacity, higher tariff rates and a rate-settlement accounting item.
- Marcellus gas production helped drive total gas production to 66.1 Bcf from 50.5 Bcf. Proved gas reserves increased to 988.4 Bcf from 674.9 Bcf, primarily through Appalachian extensions and discoveries; lower prices also led to negative reserve revisions.
- Capital expenditures rose to $1.037 billion from $820.9 million, and long-term debt increased to $1.399 billion from $1.049 billion. The company issued $500 million of 4.90% notes due 2021 and repaid $150 million of notes.
Outlook, management commentary, risks and unusual items
- FY2013 outlook: Management forecast Appalachian production of 75–85 Bcfe, versus 63 Bcfe in FY2012, despite reducing development spending in response to low gas prices. Estimated total capital expenditures were $689.1 million for FY2013; Exploration and Production spending was estimated at $485.0 million, including $405.3 million in Appalachia. Management also expected to issue long-term debt in FY2013 and refinance or repay the $250 million maturity due March 2013.
- Pipeline projects: Northern Access began initial service November 1, 2012, with full service expected by year-end 2012. Line N 2012 expansion service began in October/November 2012. These projects and Empire’s Tioga County Extension are intended to connect Marcellus production to markets; further proposed expansions depend on shipper commitments and market conditions.
- Reserve and impairment sensitivity: Proved undeveloped reserves were 410 Bcfe, 33% of proved reserves. The company plans to invest approximately $160 million in FY2013 to develop PUD reserves and is committed to developing them within five years. At year-end, the full-cost ceiling exceeded oil and gas property book value by approximately $55.3 million; management estimated a $1/MMBtu reduction in test gas prices alone would have produced an approximately $173.9 million impairment charge.
- Commodity and market exposure: Low gas prices can weaken production economics, reduce reserve values and constrain drilling. The company hedges a portion of expected production, which limits some downside but also limits participation in price increases. Pipeline transportation demand is exposed to changing regional gas-price differentials and contract renewals.
- Regulatory and legal risks: Potential changes to hydraulic-fracturing, pipeline-safety and environmental rules could increase costs or delay development. A Pennsylvania title dispute could create uncertainty over Marcellus gas ownership. Utility and pipeline earnings depend in part on regulatory rates and continued recovery of regulatory assets.
- Environmental matters: Estimated cleanup costs for former manufactured-gas-plant and third-party disposal sites were $15.4–$19.6 million; the $15.4 million minimum was accrued, with recovery expected through rates. A Pennsylvania environmental regulator proposed a civil penalty for alleged erosion-control violations during Trout Run construction; the company disputed many allegations and said the amount was not material to it.
- Other exposures: Pension and post-retirement liabilities, commodity counterparty performance, financing access and interest rates, weather, customer credit and operational or cybersecurity incidents are identified risks. FY2012 pension contributions were $44.0 million, with FY2013 contributions estimated at $30–$45 million; post-retirement contributions were $21.2 million, with FY2013 estimated at $15–$20 million.
- Unusual items: FY2012 Pipeline and Storage results included $12.8 million after-tax benefit from elimination of a post-retirement regulatory liability. Pennsylvania’s natural-gas impact fee increased FY2012 taxes by $9.0 million, including $4.0 million for wells drilled before 2012. No oil and gas impairment was recorded in FY2012.
Important facts for investors to verify
- Whether forecast FY2013 production, capital spending and pipeline project service levels were achieved, and how those outcomes affected cash flow and returns.
- How sustained gas prices and regional price differentials affect reserve economics, future ceiling-test headroom, PUD development and hedging results.
- Renewal and utilization of firm storage and transportation contracts, including the expected changes in affiliate and unaffiliated capacity commitments.
- Funding and refinancing plans for the March 2013 debt maturity, covenant headroom, and the company’s reliance on short-term borrowing as investment exceeds operating cash flow.
- Resolution and financial consequences, if any, of the Pennsylvania environmental allegations, Marcellus title litigation uncertainty, and other regulatory or environmental contingencies.
- Whether the rate-settlement benefit and other nonrecurring items materially affect the comparison of reported earnings with ongoing operating performance.