National Fuel Gas Company (NFG)

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National Fuel Gas Company is an energy holding company that operates as both a gas utility and a producer and transporter of oil and gas. Its utilities segment serves 725,000 customers in New York and Pennsylvania, while its transportation segment moved 356 Bcfe of petroleum in 2007. Both industries are subject to government regulation, and rates are kept low to enable accessibility for customers while guaranteeing profits for the company. NFG must lobby for rate increases if input costs rise, a process which is long and costly, making the company prone to losing potential profits and creating a lag when input costs rise that squeezes margins. Furthermore, both businesses are prone to seasonality in their revenues, as demand for gas is higher in the colder months of winter.

To supplement the low, steady margins associated with transportation and distribution, National Fuel Gas Co operates an upstream oil and gas exploration and production company through its subsidiary, Seneca. Seneca has reserves in California, on the Gulf Coast, and in the Appalachians. The company is betting on its Appalachian holdings to deliver much of its future growth, despite the relative mystery surrounding the productivity of the region. This is because Californian reserves are beginning to mature, while Gulf coast reserves are prone to slowdowns that come with the hurricane season. With over a million acres in the Appalachians, 800,000 of which are part of the Devonian Shale, the company's growth prospects are rich. Natural Fuel Gas Co doesn't have any real utilities competition thanks to the high cost of infrastructure installation, but the company competes with other pipeline companies like Enbridge and Kinder Morgan, as well as oil and gas producers like Chesapeake Energy and Devon Energy.

[edit] Business and Financials

National Fuel Gas Company had a 2007 operating revenue of just over $2 billion, with operating income of around $396 million. It operates five main business segments and their subsidiaries:

1. Utilities: Through National Fuel Gas Distribution Corporation, NFG delivers gas to 725,000 utilities customers in New York and Pennsylvania. In 2007, it had a total throughput of 135 Bcf, up from 2006's 129 Bcf. This is a price-regulated business.
2. Pipeline and Storage: Through National Fuel Gas Supply Corporation and Empire State Pipeline, NFG uses its installed infrastructure to move gas from production sites to hubs, and from hubs to distribution networks. In 2007, the segment moved 356 Bcf, down from 2006's 375 Bcf. This is a price-regulated business.
3. Exploration and Production: Through Seneca Resources Corporation, NFG explores for oil and gas in California, the Appalachian region, and the Gulf region (including Texas, Louisiana, and Alabama). In 2007, Seneca sold its Canadian holdings to focus on U.S. development, and currently has reserves containing 205,389 MMcf of natural gas and 47,586 Mbbl of oil. The company produced 26,266 MMcf of natural gas and 3,450 MBbl of oil in 2007.
4. Energy Marketing: This segment, operated through National Fuel Resources, Inc., markets natural gas to industrial, commercial, and residential users. In 2007, the company marketed over 50 Bcf, up from 45 Bcf in 2006.
5. Timber: Highland Forest Resources and the Northeast division of Seneca together own over 103 thousand acres of timber property, though this is by far the company's smallest segment. In 2007, timber sold 32.796 million feet of lumber, down from 2006 levels of 36.843 million feet.

[edit] NFG has Increased its Dividends for Thirty Seven Years

NFG has paid out dividends, without fail, for 105 years, and has quietly increased them for the past 37 years; currently, the company pays $0.31 per share.^[1] In the past, utilities paid high dividends because stringent government regulation kept them from having much growth potential. This made them very sensitive to short-term interest rates, as higher interest rates made government bonds more attractive as investments; more people investing in government bonds meant less people buying utilities stock, causing shares to fall. Now, however, the combination of deregulation and the diversification of gas utilities into energy trading, generation, and other businesses mean that the companies have greater growth potential and less exposure to interest rate effects. Now, though utilities still pay dividends, these are lower than in the past - because utilities companies now have a chance for strong share growth, so high dividends are no longer necessary to serve shareholder interests.^[2][3]

[edit] Trends and Forces

[edit] State Regulation of Gas Distribution Guarantees NFG Profits - at the Cost of Low Margins

Utilities and pipelines tend to be highly regulated businesses in the U.S., with the national government setting transmissions rates and state governments setting electric and gas distribution rates. These rules are designed to ensure both profitability for the company and accessibility for the consumer, but often hold back utilities companies, like NFG, from achieving potential revenues and profitability by preventing them from charging delivery rates that the level of demand would really allow. Regulation can also cause the company's margins to be very volatile, as lobbying the government is the only way the company can control its prices. Unfortunately, natural gas costs fluctuate very rapidly, but it takes a long time for utilities lobbyists to convince state and regional regulators to raise the price ceiling. For the most part, regulators will only raise rates if the company can show that something, whether rising costs or inflationary pressure, is causing their margins to shrink to unfair levels.

New York and Pennsylvania have both implemented laws encouraging competition in the gas distribution market; they allow customers to choose between receiving natural gas from utilities companies and natural gas marketers. Though this takes away potential revenue from NFG's utilities segment, the company's marketing segment sold over a third the amount the utility did, and its transportation arm receives revenue for transporting gas for other marketers.

[edit] NFG' Revenues Follow Seasonal Patterns; Unusual Seasons Mean Unusual Sales

Natural gas is used most commonly in home heating systems, making its demand partially dependent on the temperature outside. Since NFG operates on a different fiscal calendar, in which its first quarter ends December 31st, its revenues follow a different quarterly pattern than competitors. For NFG, second-quarter revenue tends to be highest because of New York and Pennsylvania's cold late winters. Both states have rainy first and third quarters which tend to be cooler, causing those months to have higher revenues than summer. The company saw 2007 revenues of $490.7 million (1Q), $798.1 million (2Q), $448.8 million (3Q), and $302 million (4Q)^[4], effectively illustrating how cold temperatures lead to higher gas revenues. This temperature dependence also means that unusual seasonality has a real effect on the company's operations; warmer winters, a predicted outcome of global climate change, will damage the company's revenues by decreasing demand at a key part of the year.

Incidentally, the gas utilities demand cycle is exactly opposite that of electric utilities, who see higher demand in warmer months because air conditioning units are electrically powered.

[edit] National Fuel Gas Company is Gambling on its Upstream Petroleum Operations

With the price of oil at $100/bbl, exploration and production margins have shot through the roof. Because regulation keeps NFG's utilities margins relatively low, the company's upstream oil and gas operations have the potential to make its business really profitable. The segment, in fact, contributed 37.1% of the company's revenue in 2007, but 62.4% of its operating income, while the utilities segment contributed 25.2% of the company's income and 15.1% if its operating income. Historically, petroleum prices have been volatile because of the cyclical nature of commodities prices; E&P businesses see their margins move up and down with the price of oil. Growing demand from emerging markets and slowing production (possibly due to peak oil), however, have lead many to believe that petroleum has nowhere to go but up. If this is the case, NFG's margins will move with it.

[edit] With its California and Gulf Production Dwindling, NFG is Looking to its Appalachian Holdings

In the past, Seneca, NFG's E&P subsidiary, relied on its West Coast and Gulf Coast holdings for much of its oil and gas production. Gulf operations are historically subject to shutdowns and damages from the hurricanes that sweep the coast late every summer; California's fields are starting to mature, with production steadily decreasing. In an effort to increase production and take advantage of $100 oil, Seneca has ramped up drilling in its one million acres of Appalachian holdings.

In 2007, the company drilled 50% more wells than in 2006 in its Appalachian holdings, focusing on the 800,000 acres of Devonian Shale nestled within; the outcome is predicted to be a production increase of 20% in 2008. Appalachian natural gas has another advantage: its proximity to New England. Winters in the area are much harsher than winters on the West Coast or near the Gulf, causing seasonal demand for natural gas to be much greater. Since the Appalachian mineral basins that Seneca owns are much closer to New England than many of the nation's other reserves they are ideal for use in the region, giving them a significant price premium of nearly a dollar per Mcf.

The catch about relying on Appalachia to supply future growth is that very little is known about the region's yield potential. Though it is known that there are 800,000 acres of Devonian Shale within Seneca's holdings, it's unclear as to how much oil and gas the shale could really yield, or at what cost. Furthermore, developing an oil shale can cost up to $60 per barrel.^[5] In the event of a precipitous drop in petroleum price, the shale could become too expensive to profitably develop, and Seneca would be left high and dry.

[edit] Competition

NFG is a diversified natural gas company that does exploration, production, transportation, marketing, and distribution of gas. It competes in the upstream oil and gas business with industry powerhouses like BP, Chevron, Exxon Mobil, ConocoPhillips, and Royal Dutch Shell - the oil majors. It also competes with a number of independent oil & gas companies like Chesapeake Energy, Devon Energy, and EnCana.

The company's pipelines segment competes with natural gas transporters like Energen and Equitable Resources, as well as major pipeline companies like Enbridge, Kinder Morgan, and Chevron.

NFG's utilities segment operates in New York and Pennsylvania. It has little real competition thanks to the high cost of infrastructure installation; government regulation, however, keeps the company from charging the rates and turning the profits that would otherwise be expected of a monopolist that sells products with inelastic demand. On a larger scale, NFG competes with other gas utilities like:

• AGL Resources - AGL Resources operates gas delivery services in Florida, Georgia, Maryland, New Jersey, Tennessee, and Virginia, and has close relationships with twelve different gas marketing companies.
• Atmos Energy - Atmos operates in Texas, Kentucky, Louisiana, Mississippi, Colorado, Kansas, Tennessee, Georgia, Illinois, Iowa, Missouri, and Virginia. It is not only a gas utility but also a natural gas marketing, pipeline, and storage company.
• Energen - Energen is an energy holding company that operates in a variety of businesses, from oil exploration and production to natural gas marketing and distribution. Its utilities business is the largest gas distributor i
• Equitable Resources - Equitable Resources is a vertically integrated natural gas company that operates from the upstream to natural gas distribution. Its gas utilities operate in Pennsylvania, West Virginia, and Kentucky.
• ONEOK - ONEOK is a transport and distribution company that acts as a utility in Oklahoma, Kansas, and Texas.
• Sempra Energy - Sempra is a gas and electric utilities company in California.
• Southern Union Company - Southern Union is engaged in the storage, transport, production, and refining of natural gas; its utilities business operates in Missouri and Massachusetts.
• National Grid Transco - National Grid is a gas and utilities company that operates in the United Kingdom and the United State; in the U.S., it operates in Rhode Island and New York.

[edit] References

1. ↑ Business Week: National Fuel Gas Co
2. ↑ Business Week: "Utility Stocks With Plenty of Spark"
3. ↑ USA Today: "Utilities funds turn into power players"
4. ↑ NFG 2007 10-K, Page 108
5. ↑ Oil Shale and Tar Sands Programmatic EIS: About Oil Shale
6. ↑ ATG 2007 10-K
7. ↑ ATO 2007 10-K
8. ↑ EGN 2007 1-K
9. ↑ EQT 2007 10-K
10. ↑ NFG 2007 10-K
11. ↑ OKE 2007 10-K
12. ↑ SUG 2007 10-K
13. ↑ SRE 2007 10-K
14. ↑ Equitable Resources: Equitable Utilities: Equitable Gas
15. ↑ Reuters Full Description: National Fuel Gas Co
16. ↑ Reuters: Full Description: National Grid Transco