NATIONAL FUEL GAS CO - Quarter Report: 2018 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from____ to_____
Commission File Number 1-3880
NATIONAL FUEL GAS COMPANY
(Exact name of registrant as specified in its charter)
New Jersey | 13-1086010 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
6363 Main Street | |
Williamsville, New York | 14221 |
(Address of principal executive offices) | (Zip Code) |
(716) 857-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. YES þ NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer | þ | Accelerated Filer | ¨ |
Non-Accelerated Filer | ¨ (Do not check if a smaller reporting company) | Smaller Reporting Company | ¨ |
Emerging Growth Company | ¨ | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO þ
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common stock, par value $1.00 per share, outstanding at April 30, 2018: 85,927,173 shares.
GLOSSARY OF TERMS
Frequently used abbreviations, acronyms, or terms used in this report:
National Fuel Gas Companies | |
Company | The Registrant, the Registrant and its subsidiaries or the Registrant’s subsidiaries as appropriate in the context of the disclosure |
Distribution Corporation | National Fuel Gas Distribution Corporation |
Empire | Empire Pipeline, Inc. |
Midstream Corporation | National Fuel Gas Midstream Corporation |
National Fuel | National Fuel Gas Company |
NFR | National Fuel Resources, Inc. |
Registrant | National Fuel Gas Company |
Seneca | Seneca Resources Corporation |
Supply Corporation | National Fuel Gas Supply Corporation |
Regulatory Agencies | |
CFTC | Commodity Futures Trading Commission |
EPA | United States Environmental Protection Agency |
FASB | Financial Accounting Standards Board |
FERC | Federal Energy Regulatory Commission |
NYDEC | New York State Department of Environmental Conservation |
NYPSC | State of New York Public Service Commission |
PaDEP | Pennsylvania Department of Environmental Protection |
PaPUC | Pennsylvania Public Utility Commission |
SEC | Securities and Exchange Commission |
Other | |
2017 Form 10-K | The Company’s Annual Report on Form 10-K for the year ended September 30, 2017 |
2017 Tax Reform Act | Tax legislation referred to as the "Tax Cuts and Jobs Act," enacted December 22, 2017. |
Bbl | Barrel (of oil) |
Bcf | Billion cubic feet (of natural gas) |
Bcfe (or Mcfe) – represents Bcf (or Mcf) Equivalent | The total heat value (Btu) of natural gas and oil expressed as a volume of natural gas. The Company uses a conversion formula of 1 barrel of oil = 6 Mcf of natural gas. |
Btu | British thermal unit; the amount of heat needed to raise the temperature of one pound of water one degree Fahrenheit |
Capital expenditure | Represents additions to property, plant, and equipment, or the amount of money a company spends to buy capital assets or upgrade its existing capital assets. |
Cashout revenues | A cash resolution of a gas imbalance whereby a customer (e.g. a marketer) pays for gas the customer receives in excess of amounts delivered into pipeline/storage or distribution systems by the customer’s shipper. |
Degree day | A measure of the coldness of the weather experienced, based on the extent to which the daily average temperature falls below a reference temperature, usually 65 degrees Fahrenheit. |
Derivative | A financial instrument or other contract, the terms of which include an underlying variable (a price, interest rate, index rate, exchange rate, or other variable) and a notional amount (number of units, barrels, cubic feet, etc.). The terms also permit for the instrument or contract to be settled net and no initial net investment is required to enter into the financial instrument or contract. Examples include futures contracts, forward contracts, options, no cost collars and swaps. |
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Development costs | Costs incurred to obtain access to proved oil and gas reserves and to provide facilities for extracting, treating, gathering and storing the oil and gas |
Dodd-Frank Act | Dodd-Frank Wall Street Reform and Consumer Protection Act. |
Dth | Decatherm; one Dth of natural gas has a heating value of 1,000,000 British thermal units, approximately equal to the heating value of 1 Mcf of natural gas. |
Exchange Act | Securities Exchange Act of 1934, as amended |
Expenditures for long-lived assets | Includes capital expenditures, stock acquisitions and/or investments in partnerships. |
Exploration costs | Costs incurred in identifying areas that may warrant examination, as well as costs incurred in examining specific areas, including drilling exploratory wells. |
Exploratory well | A well drilled in unproven or semi-proven territory for the purpose of ascertaining the presence underground of a commercial hydrocarbon deposit. |
FERC 7(c) application | An application to the FERC under Section 7(c) of the federal Natural Gas Act for authority to construct, operate (and provide services through) facilities to transport or store natural gas in interstate commerce. |
Firm transportation and/or storage | The transportation and/or storage service that a supplier of such service is obligated by contract to provide and for which the customer is obligated to pay whether or not the service is utilized. |
GAAP | Accounting principles generally accepted in the United States of America |
Goodwill | An intangible asset representing the difference between the fair value of a company and the price at which a company is purchased. |
Hedging | A method of minimizing the impact of price, interest rate, and/or foreign currency exchange rate changes, often times through the use of derivative financial instruments. |
Hub | Location where pipelines intersect enabling the trading, transportation, storage, exchange, lending and borrowing of natural gas. |
ICE | Intercontinental Exchange. An exchange which maintains a futures market for crude oil and natural gas. |
Interruptible transportation and/or storage | The transportation and/or storage service that, in accordance with contractual arrangements, can be interrupted by the supplier of such service, and for which the customer does not pay unless utilized. |
LDC | Local distribution company |
LIBOR | London Interbank Offered Rate |
LIFO | Last-in, first-out |
Marcellus Shale | A Middle Devonian-age geological shale formation that is present nearly a mile or more below the surface in the Appalachian region of the United States, including much of Pennsylvania and southern New York. |
Mbbl | Thousand barrels (of oil) |
Mcf | Thousand cubic feet (of natural gas) |
MD&A | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
MDth | Thousand decatherms (of natural gas) |
MMBtu | Million British thermal units (heating value of one decatherm of natural gas) |
MMcf | Million cubic feet (of natural gas) |
NEPA | National Environmental Policy Act of 1969, as amended |
NGA | The Natural Gas Act of 1938, as amended; the federal law regulating interstate natural gas pipeline and storage companies, among other things, codified beginning at 15 U.S.C. Section 717. |
NYMEX | New York Mercantile Exchange. An exchange which maintains a futures market for crude oil and natural gas. |
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Open Season | A bidding procedure used by pipelines to allocate firm transportation or storage capacity among prospective shippers, in which all bids submitted during a defined time period are evaluated as if they had been submitted simultaneously. |
Precedent Agreement | An agreement between a pipeline company and a potential customer to sign a service agreement after specified events (called “conditions precedent”) happen, usually within a specified time. |
Proved developed reserves | Reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. |
Proved undeveloped (PUD) reserves | Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required to make these reserves productive. |
Reserves | The unproduced but recoverable oil and/or gas in place in a formation which has been proven by production. |
Revenue decoupling mechanism | A rate mechanism which adjusts customer rates to render a utility financially indifferent to throughput decreases resulting from conservation. |
S&P | Standard & Poor’s Rating Service |
SAR | Stock appreciation right |
Service agreement | The binding agreement by which the pipeline company agrees to provide service and the shipper agrees to pay for the service. |
Stock acquisitions | Investments in corporations |
Utica Shale | A Middle Ordovician-age geological formation lying several thousand feet below the Marcellus Shale in the Appalachian region of the United States, including much of Ohio, Pennsylvania, West Virginia and southern New York. |
VEBA | Voluntary Employees’ Beneficiary Association |
WNC | Weather normalization clause; a clause in utility rates which adjusts customer rates to allow a utility to recover its normal operating costs calculated at normal temperatures. If temperatures during the measured period are warmer than normal, customer rates are adjusted upward in order to recover projected operating costs. If temperatures during the measured period are colder than normal, customer rates are adjusted downward so that only the projected operating costs will be recovered. |
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INDEX | Page | |
Item 3. Defaults Upon Senior Securities | • | |
Item 4. Mine Safety Disclosures | • | |
Item 5. Other Information | • | |
• The Company has nothing to report under this item.
All references to a certain year in this report are to the Company’s fiscal year ended September 30 of that year, unless otherwise noted.
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Part I. Financial Information
Item 1. Financial Statements
National Fuel Gas Company
Consolidated Statements of Income and Earnings
Reinvested in the Business
(Unaudited)
Three Months Ended March 31, | Six Months Ended March 31, | ||||||||||||||
(Thousands of Dollars, Except Per Common Share Amounts) | 2018 | 2017 | 2018 | 2017 | |||||||||||
INCOME | |||||||||||||||
Operating Revenues: | |||||||||||||||
Utility and Energy Marketing Revenues | $ | 339,422 | $ | 308,889 | $ | 565,147 | $ | 516,669 | |||||||
Exploration and Production and Other Revenues | 147,868 | 159,997 | 288,318 | 321,691 | |||||||||||
Pipeline and Storage and Gathering Revenues | 53,615 | 53,189 | 107,096 | 106,216 | |||||||||||
540,905 | 522,075 | 960,561 | 944,576 | ||||||||||||
Operating Expenses: | |||||||||||||||
Purchased Gas | 176,608 | 147,971 | 270,642 | 218,214 | |||||||||||
Operation and Maintenance: | |||||||||||||||
Utility and Energy Marketing | 61,410 | 63,907 | 112,780 | 114,329 | |||||||||||
Exploration and Production and Other | 39,586 | 37,593 | 75,127 | 68,055 | |||||||||||
Pipeline and Storage and Gathering | 22,642 | 23,106 | 42,679 | 45,766 | |||||||||||
Property, Franchise and Other Taxes | 22,802 | 22,542 | 43,650 | 42,921 | |||||||||||
Depreciation, Depletion and Amortization | 61,155 | 56,999 | 116,985 | 113,194 | |||||||||||
384,203 | 352,118 | 661,863 | 602,479 | ||||||||||||
Operating Income | 156,702 | 169,957 | 298,698 | 342,097 | |||||||||||
Other Income (Expense): | |||||||||||||||
Interest Income | 1,025 | 391 | 3,275 | 1,991 | |||||||||||
Other Income | 770 | 1,744 | 2,492 | 3,356 | |||||||||||
Interest Expense on Long-Term Debt | (27,148 | ) | (28,913 | ) | (55,235 | ) | (58,016 | ) | |||||||
Other Interest Expense | (1,233 | ) | (924 | ) | (1,736 | ) | (1,834 | ) | |||||||
Income Before Income Taxes | 130,116 | 142,255 | 247,494 | 287,594 | |||||||||||
Income Tax Expense (Benefit) | 38,269 | 52,971 | (43,007 | ) | 109,403 | ||||||||||
Net Income Available for Common Stock | 91,847 | 89,284 | 290,501 | 178,191 | |||||||||||
EARNINGS REINVESTED IN THE BUSINESS | |||||||||||||||
Balance at Beginning of Period | 1,014,733 | 762,641 | 851,669 | 676,361 | |||||||||||
1,106,580 | 851,925 | 1,142,170 | 854,552 | ||||||||||||
Dividends on Common Stock | (35,641 | ) | (34,577 | ) | (71,231 | ) | (69,120 | ) | |||||||
Cumulative Effect of Adoption of Authoritative Guidance for Stock-Based Compensation | — | — | — | 31,916 | |||||||||||
Balance at March 31 | $ | 1,070,939 | $ | 817,348 | $ | 1,070,939 | $ | 817,348 | |||||||
Earnings Per Common Share: | |||||||||||||||
Basic: | |||||||||||||||
Net Income Available for Common Stock | $ | 1.07 | $ | 1.05 | $ | 3.39 | $ | 2.09 | |||||||
Diluted: | |||||||||||||||
Net Income Available for Common Stock | $ | 1.06 | $ | 1.04 | $ | 3.37 | $ | 2.07 | |||||||
Weighted Average Common Shares Outstanding: | |||||||||||||||
Used in Basic Calculation | 85,809,233 | 85,334,887 | 85,718,779 | 85,261,575 | |||||||||||
Used in Diluted Calculation | 86,323,636 | 86,006,614 | 86,318,892 | 85,897,282 | |||||||||||
Dividends Per Common Share: | |||||||||||||||
Dividends Declared | $ | 0.415 | $ | 0.405 | $ | 0.830 | $ | 0.810 | |||||||
See Notes to Condensed Consolidated Financial Statements
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National Fuel Gas Company
Consolidated Statements of Comprehensive Income
(Unaudited)
Three Months Ended March 31, | Six Months Ended March 31, | ||||||||||||||
(Thousands of Dollars) | 2018 | 2017 | 2018 | 2017 | |||||||||||
Net Income Available for Common Stock | $ | 91,847 | $ | 89,284 | $ | 290,501 | $ | 178,191 | |||||||
Other Comprehensive Income (Loss), Before Tax: | |||||||||||||||
Unrealized Gain (Loss) on Securities Available for Sale Arising During the Period | (678 | ) | 1,726 | (722 | ) | 843 | |||||||||
Unrealized Gain (Loss) on Derivative Financial Instruments Arising During the Period | (12,582 | ) | 44,097 | (18,081 | ) | (8,404 | ) | ||||||||
Reclassification Adjustment for Realized (Gains) Losses on Securities Available for Sale in Net Income | — | — | (430 | ) | (741 | ) | |||||||||
Reclassification Adjustment for Realized (Gains) Losses on Derivative Financial Instruments in Net Income | 3,199 | (10,472 | ) | (9,349 | ) | (41,189 | ) | ||||||||
Other Comprehensive Income (Loss), Before Tax | (10,061 | ) | 35,351 | (28,582 | ) | (49,491 | ) | ||||||||
Income Tax Expense (Benefit) Related to Unrealized Gain (Loss) on Securities Available for Sale Arising During the Period | (252 | ) | 645 | (317 | ) | 300 | |||||||||
Income Tax Expense (Benefit) Related to Unrealized Gain (Loss) on Derivative Financial Instruments Arising During the Period | (3,519 | ) | 18,352 | (5,824 | ) | (3,699 | ) | ||||||||
Reclassification Adjustment for Income Tax Benefit (Expense) on Realized Losses (Gains) from Securities Available for Sale in Net Income | — | — | (158 | ) | (272 | ) | |||||||||
Reclassification Adjustment for Income Tax Benefit (Expense) on Realized Losses (Gains) from Derivative Financial Instruments in Net Income | 551 | (4,414 | ) | (4,646 | ) | (17,369 | ) | ||||||||
Income Taxes – Net | (3,220 | ) | 14,583 | (10,945 | ) | (21,040 | ) | ||||||||
Other Comprehensive Income (Loss) | (6,841 | ) | 20,768 | (17,637 | ) | (28,451 | ) | ||||||||
Comprehensive Income | $ | 85,006 | $ | 110,052 | $ | 272,864 | $ | 149,740 | |||||||
See Notes to Condensed Consolidated Financial Statements
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National Fuel Gas Company
Consolidated Balance Sheets
(Unaudited)
March 31, 2018 | September 30, 2017 | ||||||
(Thousands of Dollars) | |||||||
ASSETS | |||||||
Property, Plant and Equipment | $ | 10,126,931 | $ | 9,945,560 | |||
Less - Accumulated Depreciation, Depletion and Amortization | 5,344,134 | 5,271,486 | |||||
4,782,797 | 4,674,074 | ||||||
Current Assets | |||||||
Cash and Temporary Cash Investments | 227,994 | 555,530 | |||||
Hedging Collateral Deposits | 3,657 | 1,741 | |||||
Receivables – Net of Allowance for Uncollectible Accounts of $28,592 and $22,526, Respectively | 198,922 | 112,383 | |||||
Unbilled Revenue | 60,059 | 22,883 | |||||
Gas Stored Underground | 6,842 | 35,689 | |||||
Materials and Supplies - at average cost | 34,769 | 33,926 | |||||
Unrecovered Purchased Gas Costs | 426 | 4,623 | |||||
Other Current Assets | 60,324 | 51,505 | |||||
592,993 | 818,280 | ||||||
Other Assets | |||||||
Recoverable Future Taxes | 115,514 | 181,363 | |||||
Unamortized Debt Expense | 7,861 | 1,159 | |||||
Other Regulatory Assets | 171,902 | 174,433 | |||||
Deferred Charges | 36,835 | 30,047 | |||||
Other Investments | 123,039 | 125,265 | |||||
Goodwill | 5,476 | 5,476 | |||||
Prepaid Post-Retirement Benefit Costs | 59,586 | 56,370 | |||||
Fair Value of Derivative Financial Instruments | 18,144 | 36,111 | |||||
Other | 426 | 742 | |||||
538,783 | 610,966 | ||||||
Total Assets | $ | 5,914,573 | $ | 6,103,320 | |||
See Notes to Condensed Consolidated Financial Statements
8
National Fuel Gas Company
Consolidated Balance Sheets
(Unaudited)
March 31, 2018 | September 30, 2017 | ||||||
(Thousands of Dollars) | |||||||
CAPITALIZATION AND LIABILITIES | |||||||
Capitalization: | |||||||
Comprehensive Shareholders’ Equity | |||||||
Common Stock, $1 Par Value | |||||||
Authorized - 200,000,000 Shares; Issued And Outstanding – 85,881,897 Shares and 85,543,125 Shares, Respectively | $ | 85,882 | $ | 85,543 | |||
Paid in Capital | 810,126 | 796,646 | |||||
Earnings Reinvested in the Business | 1,070,939 | 851,669 | |||||
Accumulated Other Comprehensive Loss | (47,760 | ) | (30,123 | ) | |||
Total Comprehensive Shareholders’ Equity | 1,919,187 | 1,703,735 | |||||
Long-Term Debt, Net of Current Portion and Unamortized Discount and Debt Issuance Costs | 2,085,012 | 2,083,681 | |||||
Total Capitalization | 4,004,199 | 3,787,416 | |||||
Current and Accrued Liabilities | |||||||
Notes Payable to Banks and Commercial Paper | — | — | |||||
Current Portion of Long-Term Debt | — | 300,000 | |||||
Accounts Payable | 127,585 | 126,443 | |||||
Amounts Payable to Customers | 12,083 | — | |||||
Dividends Payable | 35,641 | 35,500 | |||||
Interest Payable on Long-Term Debt | 26,435 | 35,031 | |||||
Customer Advances | 154 | 15,701 | |||||
Customer Security Deposits | 18,973 | 20,372 | |||||
Other Accruals and Current Liabilities | 147,549 | 111,889 | |||||
Fair Value of Derivative Financial Instruments | 11,475 | 1,103 | |||||
379,895 | 646,039 | ||||||
Deferred Credits | |||||||
Deferred Income Taxes | 482,682 | 891,287 | |||||
Taxes Refundable to Customers | 365,091 | 95,739 | |||||
Cost of Removal Regulatory Liability | 207,711 | 204,630 | |||||
Other Regulatory Liabilities | 124,868 | 113,716 | |||||
Pension and Other Post-Retirement Liabilities | 133,852 | 149,079 | |||||
Asset Retirement Obligations | 106,481 | 106,395 | |||||
Other Deferred Credits | 109,794 | 109,019 | |||||
1,530,479 | 1,669,865 | ||||||
Commitments and Contingencies (Note 6) | — | — | |||||
Total Capitalization and Liabilities | $ | 5,914,573 | $ | 6,103,320 | |||
See Notes to Condensed Consolidated Financial Statements
9
National Fuel Gas Company
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended March 31, | |||||||
(Thousands of Dollars) | 2018 | 2017 | |||||
OPERATING ACTIVITIES | |||||||
Net Income Available for Common Stock | $ | 290,501 | $ | 178,191 | |||
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: | |||||||
Depreciation, Depletion and Amortization | 116,985 | 113,194 | |||||
Deferred Income Taxes | (62,459 | ) | 63,781 | ||||
Stock-Based Compensation | 7,862 | 5,632 | |||||
Other | 8,052 | 7,713 | |||||
Change in: | |||||||
Hedging Collateral Deposits | (1,916 | ) | (287 | ) | |||
Receivables and Unbilled Revenue | (123,954 | ) | (92,155 | ) | |||
Gas Stored Underground and Materials and Supplies | 28,004 | 24,476 | |||||
Unrecovered Purchased Gas Costs | 4,197 | (2,241 | ) | ||||
Other Current Assets | (8,819 | ) | 7,769 | ||||
Accounts Payable | 10,838 | 13,997 | |||||
Amounts Payable to Customers | 12,083 | (71 | ) | ||||
Customer Advances | (15,547 | ) | (14,462 | ) | |||
Customer Security Deposits | (1,399 | ) | 1,493 | ||||
Other Accruals and Current Liabilities | 37,646 | 44,690 | |||||
Other Assets | (9,541 | ) | (32 | ) | |||
Other Liabilities | (5,767 | ) | 202 | ||||
Net Cash Provided by Operating Activities | 286,766 | 351,890 | |||||
INVESTING ACTIVITIES | |||||||
Capital Expenditures | (261,720 | ) | (208,231 | ) | |||
Net Proceeds from Sale of Oil and Gas Producing Properties | 17,310 | 26,554 | |||||
Other | 5,355 | (3,225 | ) | ||||
Net Cash Used in Investing Activities | (239,055 | ) | (184,902 | ) | |||
FINANCING ACTIVITIES | |||||||
Reduction of Long-Term Debt | (307,047 | ) | — | ||||
Dividends Paid on Common Stock | (71,091 | ) | (69,017 | ) | |||
Net Proceeds from Issuance of Common Stock | 2,891 | 3,230 | |||||
Net Cash Used in Financing Activities | (375,247 | ) | (65,787 | ) | |||
Net Increase (Decrease) in Cash and Temporary Cash Investments | (327,536 | ) | 101,201 | ||||
Cash and Temporary Cash Investments at October 1 | 555,530 | 129,972 | |||||
Cash and Temporary Cash Investments at March 31 | $ | 227,994 | $ | 231,173 | |||
Supplemental Disclosure of Cash Flow Information | |||||||
Non-Cash Investing Activities: | |||||||
Non-Cash Capital Expenditures | $ | 51,939 | $ | 36,932 | |||
See Notes to Condensed Consolidated Financial Statements
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National Fuel Gas Company
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation. The Company consolidates all entities in which it has a controlling financial interest. All significant intercompany balances and transactions are eliminated. The Company uses proportionate consolidation when accounting for drilling arrangements related to oil and gas producing properties accounted for under the full cost method of accounting.
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Earnings for Interim Periods. The Company, in its opinion, has included all adjustments (which consist of only normally recurring adjustments, unless otherwise disclosed in this Form 10-Q) that are necessary for a fair statement of the results of operations for the reported periods. The consolidated financial statements and notes thereto, included herein, should be read in conjunction with the financial statements and notes for the years ended September 30, 2017, 2016 and 2015 that are included in the Company's 2017 Form 10-K. The consolidated financial statements for the year ended September 30, 2018 will be audited by the Company's independent registered public accounting firm after the end of the fiscal year.
The earnings for the six months ended March 31, 2018 should not be taken as a prediction of earnings for the entire fiscal year ending September 30, 2018. Most of the business of the Utility and Energy Marketing segments is seasonal in nature and is influenced by weather conditions. Due to the seasonal nature of the heating business in the Utility and Energy Marketing segments, earnings during the winter months normally represent a substantial part of the earnings that those segments are expected to achieve for the entire fiscal year. The Company’s business segments are discussed more fully in Note 7 – Business Segment Information.
Consolidated Statements of Cash Flows. For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of generally three months or less to be cash equivalents.
Hedging Collateral Deposits. This is an account title for cash held in margin accounts funded by the Company to serve as collateral for hedging positions. In accordance with its accounting policy, the Company does not offset hedging collateral deposits paid or received against related derivative financial instruments liability or asset balances.
Gas Stored Underground. In the Utility segment, gas stored underground is carried at lower of cost or net realizable value, on a LIFO method. Gas stored underground normally declines during the first and second quarters of the year and is replenished during the third and fourth quarters. In the Utility segment, the current cost of replacing gas withdrawn from storage is recorded in the Consolidated Statements of Income and a reserve for gas replacement is recorded in the Consolidated Balance Sheets under the caption “Other Accruals and Current Liabilities.” Such reserve, which amounted to $34.3 million at March 31, 2018, is reduced to zero by September 30 of each year as the inventory is replenished.
Property, Plant and Equipment. In the Company’s Exploration and Production segment, oil and gas property acquisition, exploration and development costs are capitalized under the full cost method of accounting. Under this methodology, all costs associated with property acquisition, exploration and development activities are capitalized, including internal costs directly identified with acquisition, exploration and development activities. The internal costs that are capitalized do not include any costs related to production, general corporate overhead, or similar activities. The Company does not recognize any gain or loss on the sale or other disposition of oil and gas properties unless the gain or loss would significantly alter the relationship between capitalized costs and proved reserves of oil and gas attributable to a cost center.
Capitalized costs include costs related to unproved properties, which are excluded from amortization until proved reserves are found or it is determined that the unproved properties are impaired. Such costs amounted to $67.6 million and $80.9 million at March 31, 2018 and September 30, 2017, respectively. All costs related to unproved properties are reviewed quarterly to determine if impairment has occurred. The amount of any impairment is transferred to the pool of capitalized costs being amortized.
Capitalized costs are subject to the SEC full cost ceiling test. The ceiling test, which is performed each quarter, determines a limit, or ceiling, on the amount of property acquisition, exploration and development costs that can be capitalized. The ceiling under this test represents (a) the present value of estimated future net cash flows, excluding future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet, using a discount factor of 10%, which is computed
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by applying prices of oil and gas (as adjusted for hedging) to estimated future production of proved oil and gas reserves as of the date of the latest balance sheet, less estimated future expenditures, plus (b) the cost of unevaluated properties not being depleted, less (c) income tax effects related to the differences between the book and tax basis of the properties. The natural gas and oil prices used to calculate the full cost ceiling are based on an unweighted arithmetic average of the first day of the month oil and gas prices for each month within the twelve-month period prior to the end of the reporting period. If capitalized costs, net of accumulated depreciation, depletion and amortization and related deferred income taxes, exceed the ceiling at the end of any quarter, a permanent impairment is required to be charged to earnings in that quarter. At March 31, 2018, the ceiling exceeded the book value of the oil and gas properties by approximately $502.8 million. In adjusting estimated future cash flows for hedging under the ceiling test at March 31, 2018, estimated future net cash flows were increased by $7.5 million.
On December 1, 2015, Seneca and IOG - CRV Marcellus, LLC (IOG), an affiliate of IOG Capital, LP, and funds managed by affiliates of Fortress Investment Group, LLC, executed a joint development agreement that allows IOG to participate in the development of certain oil and gas interests owned by Seneca in Elk, McKean and Cameron Counties, Pennsylvania. On June 13, 2016, Seneca and IOG executed an extension of the joint development agreement. Under the terms of the extended agreement, Seneca and IOG will jointly participate in a program to develop up to 75 Marcellus wells, with Seneca serving as program operator. IOG will hold an 80% working interest in all of the joint development wells. In total, IOG is expected to fund approximately $305 million for its 80% working interest in the 75 joint development wells. Of this amount, IOG has funded $301.5 million as of March 31, 2018, which includes $181.2 million of cash ($137.3 million in fiscal 2016, $26.6 million in fiscal 2017 and $17.3 million in the six months ended March 31, 2018) shown as Net Proceeds from Sale of Oil and Gas Producing Properties on the Consolidated Statements of Cash Flows for fiscal 2016, fiscal 2017 and for the six months ended March 31, 2018, respectively. Such proceeds from sale represent funding received from IOG for costs previously incurred by Seneca to develop a portion of the 75 joint development wells. As the fee-owner of the property’s mineral rights, Seneca currently retains a 7.5% royalty interest and the remaining 20% working interest (26% net revenue interest) in 56 of the joint development wells. In the remaining 19 wells, Seneca retains a 20% working and net revenue interest. Seneca’s working interest under the agreement will increase to 85% after IOG achieves a 15% internal rate of return.
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Accumulated Other Comprehensive Loss. The components of Accumulated Other Comprehensive Loss and changes for the quarter and six months ended March 31, 2018 and 2017, net of related tax effect, are as follows (amounts in parentheses indicate debits) (in thousands):
Gains and Losses on Derivative Financial Instruments | Gains and Losses on Securities Available for Sale | Funded Status of the Pension and Other Post-Retirement Benefit Plans | Total | |||||||||
Three Months Ended March 31, 2018 | ||||||||||||
Balance at January 1, 2018 | $ | 10,256 | $ | 7,311 | $ | (58,486 | ) | $ | (40,919 | ) | ||
Other Comprehensive Gains and Losses Before Reclassifications | (9,063 | ) | (426 | ) | — | (9,489 | ) | |||||
Amounts Reclassified From Other Comprehensive Income (Loss) | 2,648 | — | — | 2,648 | ||||||||
Balance at March 31, 2018 | $ | 3,841 | $ | 6,885 | $ | (58,486 | ) | $ | (47,760 | ) | ||
Six Months Ended March 31, 2018 | ||||||||||||
Balance at October 1, 2017 | $ | 20,801 | $ | 7,562 | $ | (58,486 | ) | $ | (30,123 | ) | ||
Other Comprehensive Gains and Losses Before Reclassifications | (12,257 | ) | (405 | ) | — | (12,662 | ) | |||||
Amounts Reclassified From Other Comprehensive Income (Loss) | (4,703 | ) | (272 | ) | — | (4,975 | ) | |||||
Balance at March 31, 2018 | $ | 3,841 | $ | 6,885 | $ | (58,486 | ) | $ | (47,760 | ) | ||
Three Months Ended March 31, 2017 | ||||||||||||
Balance at January 1, 2017 | $ | 16,570 | $ | 5,047 | $ | (76,476 | ) | $ | (54,859 | ) | ||
Other Comprehensive Gains and Losses Before Reclassifications | 25,745 | 1,081 | — | 26,826 | ||||||||
Amounts Reclassified From Other Comprehensive Income (Loss) | (6,058 | ) | — | — | (6,058 | ) | ||||||
Balance at March 31, 2017 | $ | 36,257 | $ | 6,128 | $ | (76,476 | ) | $ | (34,091 | ) | ||
Six Months Ended March 31, 2017 | ||||||||||||
Balance at October 1, 2016 | $ | 64,782 | $ | 6,054 | $ | (76,476 | ) | $ | (5,640 | ) | ||
Other Comprehensive Gains and Losses Before Reclassifications | (4,705 | ) | 543 | — | (4,162 | ) | ||||||
Amounts Reclassified From Other Comprehensive Income (Loss) | (23,820 | ) | (469 | ) | — | (24,289 | ) | |||||
Balance at March 31, 2017 | $ | 36,257 | $ | 6,128 | $ | (76,476 | ) | $ | (34,091 | ) | ||
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Reclassifications Out of Accumulated Other Comprehensive Loss. The details about the reclassification adjustments out of accumulated other comprehensive loss for the quarter and six months ended March 31, 2018 and 2017 are as follows (amounts in parentheses indicate debits to the income statement) (in thousands):
Details About Accumulated Other Comprehensive Loss Components | Amount of Gain or (Loss) Reclassified from Accumulated Other Comprehensive Loss | Affected Line Item in the Statement Where Net Income is Presented | |||||||||||
Three Months Ended March 31, | Six Months Ended March 31, | ||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||
Gains (Losses) on Derivative Financial Instrument Cash Flow Hedges: | |||||||||||||
Commodity Contracts | ($3,467 | ) | $12,109 | $9,375 | $43,429 | Operating Revenues | |||||||
Commodity Contracts | 750 | (1,498 | ) | 947 | (1,958 | ) | Purchased Gas | ||||||
Foreign Currency Contracts | (482 | ) | (139 | ) | (973 | ) | (282 | ) | Operation and Maintenance Expense | ||||
Gains (Losses) on Securities Available for Sale | — | — | 430 | 741 | Other Income | ||||||||
(3,199 | ) | 10,472 | 9,779 | 41,930 | Total Before Income Tax | ||||||||
551 | (4,414 | ) | (4,804 | ) | (17,641 | ) | Income Tax Expense | ||||||
($2,648 | ) | $6,058 | $4,975 | $24,289 | Net of Tax | ||||||||
Other Current Assets. The components of the Company’s Other Current Assets are as follows (in thousands):
At March 31, 2018 | At September 30, 2017 | ||||||
Prepayments | $ | 6,208 | $ | 10,927 | |||
Prepaid Property and Other Taxes | 22,482 | 13,974 | |||||
Federal Income Taxes Receivable | 17,282 | — | |||||
State Income Taxes Receivable | 2,371 | 9,689 | |||||
Fair Values of Firm Commitments | 1,608 | 1,031 | |||||
Regulatory Assets | 10,373 | 15,884 | |||||
$ | 60,324 | $ | 51,505 | ||||
Other Accruals and Current Liabilities. The components of the Company’s Other Accruals and Current Liabilities are as follows (in thousands):
At March 31, 2018 | At September 30, 2017 | ||||||
Accrued Capital Expenditures | $ | 26,800 | $ | 37,382 | |||
Regulatory Liabilities | 41,409 | 34,059 | |||||
Reserve for Gas Replacement | 34,332 | — | |||||
Federal Income Taxes Payable | — | 1,775 | |||||
2017 Tax Reform Act Regulatory Refund | 11,336 | — | |||||
Other | 33,672 | 38,673 | |||||
$ | 147,549 | $ | 111,889 | ||||
Earnings Per Common Share. Basic earnings per common share is computed by dividing income or loss by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For purposes of determining earnings per common share, the potentially dilutive securities the Company had outstanding were stock options, SARs, restricted stock units and performance shares. For the quarter and six months ended March 31, 2018, the diluted weighted average shares outstanding shown on the Consolidated Statements of Income reflects the potential dilution as a result of these securities as determined using the Treasury Stock Method. Stock options, SARs, restricted stock units and performance shares that are
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antidilutive are excluded from the calculation of diluted earnings per common share. There were 685,338 securities and 316,159 securities excluded as being antidilutive for the quarter and six months ended March 31, 2018, respectively. There were 157,554 securities and 158,211 securities excluded as being antidilutive for the quarter and six months ended March 31, 2017, respectively.
Stock-Based Compensation. The Company granted 208,588 performance shares during the six months ended March 31, 2018. The weighted average fair value of such performance shares was $50.95 per share for the six months ended March 31, 2018. Performance shares are an award constituting units denominated in common stock of the Company, the number of which may be adjusted over a performance cycle based upon the extent to which performance goals have been satisfied. Earned performance shares may be distributed in the form of shares of common stock of the Company, an equivalent value in cash or a combination of cash and shares of common stock of the Company, as determined by the Company. The performance shares do not entitle the participant to receive dividends during the vesting period.
Half of the performance shares granted during the six months ended March 31, 2018 must meet a performance goal related to relative return on capital over the performance cycle of October 1, 2017 to September 30, 2020. The performance goal over the performance cycle is the Company’s total return on capital relative to the total return on capital of other companies in a group selected by the Compensation Committee (“Report Group”). Total return on capital for a given company means the average of the Report Group companies’ returns on capital for each twelve month period corresponding to each of the Company’s fiscal years during the performance cycle, based on data reported for the Report Group companies in the Bloomberg database. The number of these performance shares that will vest and be paid will depend upon the Company’s performance relative to the Report Group and not upon the absolute level of return achieved by the Company. The fair value of these performance shares is calculated by multiplying the expected number of shares that will be issued by the average market price of Company common stock on the date of grant reduced by the present value of forgone dividends over the vesting term of the award. The fair value is recorded as compensation expense over the vesting term of the award. The other half of the performance shares granted during the six months ended March 31, 2018 must meet a performance goal related to relative total shareholder return over the performance cycle of October 1, 2017 to September 30, 2020. The performance goal over the performance cycle is the Company’s three-year total shareholder return relative to the three-year total shareholder return of the other companies in the Report Group. Three-year shareholder return for a given company will be based on the data reported for that company (with the starting and ending stock prices over the performance cycle calculated as the average closing stock price for the prior calendar month and with dividends reinvested in that company’s securities at each ex-dividend date) in the Bloomberg database. The number of these total shareholder return performance shares ("TSR performance shares") that will vest and be paid will depend upon the Company’s performance relative to the Report Group and not upon the absolute level of return achieved by the Company. The fair value price at the date of grant for the TSR performance shares is determined using a Monte Carlo simulation technique, which includes a reduction in value for the present value of forgone dividends over the vesting term of the award. This price is multiplied by the number of TSR performance shares awarded, the result of which is recorded as compensation expense over the vesting term of the award.
The Company granted 89,672 non-performance based restricted stock units during the six months ended March 31, 2018. The weighted average fair value of such non-performance based restricted stock units was $51.23 per share for the six months ended March 31, 2018. Restricted stock units represent the right to receive shares of common stock of the Company (or the equivalent value in cash or a combination of cash and shares of common stock of the Company, as determined by the Company) at the end of a specified time period. These non-performance based restricted stock units do not entitle the participant to receive dividends during the vesting period. The accounting for non-performance based restricted stock units is the same as the accounting for restricted share awards, except that the fair value at the date of grant of the restricted stock units must be reduced by the present value of forgone dividends over the vesting term of the award.
New Authoritative Accounting and Financial Reporting Guidance. In May 2014, the FASB issued authoritative guidance regarding revenue recognition. The authoritative guidance provides a single, comprehensive revenue recognition model for all contracts with customers to improve comparability. The revenue standard contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The original effective date of this authoritative guidance was as of the Company's first quarter of fiscal 2018. However, the FASB has delayed the effective date of the new revenue standard by one year, and the guidance will now be effective as of the Company's first quarter of fiscal 2019. Working towards this implementation date, the Company is currently evaluating the guidance and the various issues identified by industry based revenue recognition task forces. The Company does not believe that its revenue recognition policies will change materially, although the Company is still assessing the impact. The Company will need to enhance its financial statement disclosures to comply with the new authoritative guidance.
In February 2016, the FASB issued authoritative guidance requiring organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by all leases, regardless of whether they are considered to be capital leases or operating leases. The FASB’s previous authoritative guidance required organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by capital leases while excluding
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operating leases from balance sheet recognition. The new authoritative guidance will be effective as of the Company’s first quarter of fiscal 2020, with early adoption permitted. The Company does not anticipate early adoption and is currently evaluating the provisions of the revised guidance.
In March 2016, the FASB issued authoritative guidance simplifying several aspects of the accounting for stock-based compensation. The Company adopted this guidance effective as of October 1, 2016, recognizing a cumulative effect adjustment that increased retained earnings by $31.9 million. The cumulative effect represents the tax benefit of previously unrecognized tax deductions in excess of stock compensation recorded for financial reporting purposes. On a prospective basis, the tax effect of all future differences between stock compensation recorded for financial reporting purposes and actual tax deductions for stock compensation will be recognized upon vesting or settlement as income tax expense or benefit in the income statement. From a statement of cash flows perspective, the tax benefits relating to differences between stock compensation recorded for financial reporting purposes and actual tax deductions for stock compensation are now included in cash provided by operating activities instead of cash provided by financing activities. The changes to the statement of cash flows were applied prospectively at the time of adoption.
In March 2017, the FASB issued authoritative guidance related to the presentation of net periodic pension cost and net periodic postretirement benefit cost. The new guidance requires segregation of the service cost component from the other components of net periodic pension cost and net periodic postretirement benefit cost for financial reporting purposes. The service cost component is to be presented on the income statement in the same line items as other compensation costs included within Operating Expenses and the other components of net periodic pension cost and net periodic postretirement benefit cost are to be presented on the income statement below the subtotal labeled Operating Income (Loss). Under this guidance, the service cost component shall be the only component eligible to be capitalized as part of the cost of inventory or property, plant and equipment. The new guidance will be effective as of the Company’s first quarter of fiscal 2019, with early adoption permitted. The Company does not anticipate early adoption and is currently evaluating the interaction of this authoritative guidance with the various regulatory provisions concerning pension and postretirement benefit costs in the Company’s Utility and Pipeline and Storage segments.
In February 2018, the FASB issued authoritative guidance that allows an entity to elect a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the 2017 Tax Reform Act and requires certain disclosures about stranded tax effects. The new guidance will be effective as of the Company’s first quarter of fiscal 2020, with early adoption permitted. The Company anticipates early adoption and is currently awaiting regulatory approval of the reclassification to retained earnings from the FERC for the Company’s Pipeline and Storage segment.
Note 2 – Fair Value Measurements
The FASB authoritative guidance regarding fair value measurements establishes a fair-value hierarchy and prioritizes the inputs used in valuation techniques that measure fair value. Those inputs are prioritized into three levels. Level 1 inputs are unadjusted quoted prices in active markets for assets or liabilities that the Company can access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly at the measurement date. Level 3 inputs are unobservable inputs for the asset or liability at the measurement date. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.
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The following table sets forth, by level within the fair value hierarchy, the Company's financial assets and liabilities (as applicable) that were accounted for at fair value on a recurring basis as of March 31, 2018 and September 30, 2017. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The fair value presentation for over the counter swaps combines gas and oil swaps because a significant number of the counterparties enter into both gas and oil swap agreements with the Company.
Recurring Fair Value Measures | At fair value as of March 31, 2018 | ||||||||||||||||||
(Thousands of Dollars) | Level 1 | Level 2 | Level 3 | Netting Adjustments(1) | Total(1) | ||||||||||||||
Assets: | |||||||||||||||||||
Cash Equivalents – Money Market Mutual Funds | $ | 196,448 | $ | — | $ | — | $ | — | $ | 196,448 | |||||||||
Derivative Financial Instruments: | |||||||||||||||||||
Commodity Futures Contracts – Gas | 727 | — | — | (727 | ) | — | |||||||||||||
Over the Counter Swaps – Gas and Oil | — | 32,770 | — | (14,837 | ) | 17,933 | |||||||||||||
Foreign Currency Contracts | — | 608 | — | (397 | ) | 211 | |||||||||||||
Other Investments: | |||||||||||||||||||
Balanced Equity Mutual Fund | 36,910 | — | — | — | 36,910 | ||||||||||||||
Fixed Income Mutual Fund | 44,192 | — | — | — | 44,192 | ||||||||||||||
Common Stock – Financial Services Industry | 2,885 | — | — | — | 2,885 | ||||||||||||||
Hedging Collateral Deposits | 3,657 | — | — | — | 3,657 | ||||||||||||||
Total | $ | 284,819 | $ | 33,378 | $ | — | $ | (15,961 | ) | $ | 302,236 | ||||||||
Liabilities: | |||||||||||||||||||
Derivative Financial Instruments: | |||||||||||||||||||
Commodity Futures Contracts – Gas | $ | 1,479 | $ | — | $ | — | $ | (727 | ) | $ | 752 | ||||||||
Over the Counter Swaps – Gas and Oil | — | 24,911 | — | (14,837 | ) | 10,074 | |||||||||||||
Foreign Currency Contracts | — | 1,046 | — | (397 | ) | 649 | |||||||||||||
Total | $ | 1,479 | $ | 25,957 | $ | — | $ | (15,961 | ) | $ | 11,475 | ||||||||
Total Net Assets/(Liabilities) | $ | 283,340 | $ | 7,421 | $ | — | $ | — | $ | 290,761 | |||||||||
Recurring Fair Value Measures | At fair value as of September 30, 2017 | ||||||||||||||||||
(Thousands of Dollars) | Level 1 | Level 2 | Level 3 | Netting Adjustments(1) | Total(1) | ||||||||||||||
Assets: | |||||||||||||||||||
Cash Equivalents – Money Market Mutual Funds | $ | 527,978 | $ | — | $ | — | $ | — | $ | 527,978 | |||||||||
Derivative Financial Instruments: | |||||||||||||||||||
Commodity Futures Contracts – Gas | 1,483 | — | — | (963 | ) | 520 | |||||||||||||
Over the Counter Swaps – Gas and Oil | — | 38,977 | — | (4,206 | ) | 34,771 | |||||||||||||
Foreign Currency Contracts | — | 1,227 | — | (407 | ) | 820 | |||||||||||||
Other Investments: | |||||||||||||||||||
Balanced Equity Mutual Fund | 37,033 | — | — | — | 37,033 | ||||||||||||||
Fixed Income Mutual Fund | 45,727 | — | — | — | 45,727 | ||||||||||||||
Common Stock – Financial Services Industry | 3,150 | — | — | — | 3,150 | ||||||||||||||
Hedging Collateral Deposits | 1,741 | — | — | — | 1,741 | ||||||||||||||
Total | $ | 617,112 | $ | 40,204 | $ | — | $ | (5,576 | ) | $ | 651,740 | ||||||||
Liabilities: | |||||||||||||||||||
Derivative Financial Instruments: | |||||||||||||||||||
Commodity Futures Contracts – Gas | $ | 963 | $ | — | $ | — | $ | (963 | ) | $ | — | ||||||||
Over the Counter Swaps – Gas and Oil | — | 5,309 | — | (4,206 | ) | 1,103 | |||||||||||||
Foreign Currency Contracts | — | 407 | — | (407 | ) | — | |||||||||||||
Total | $ | 963 | $ | 5,716 | $ | — | $ | (5,576 | ) | $ | 1,103 | ||||||||
Total Net Assets/(Liabilities) | $ | 616,149 | $ | 34,488 | $ | — | $ | — | $ | 650,637 | |||||||||
(1) | Netting Adjustments represent the impact of legally-enforceable master netting arrangements that allow the Company to net gain and loss positions held with the same counterparties. The net asset or net liability for each counterparty is recorded as an asset or liability on the Company’s balance sheet. |
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Derivative Financial Instruments
At March 31, 2018 and September 30, 2017, the derivative financial instruments reported in Level 1 consist of natural gas NYMEX and ICE futures contracts used in the Company’s Energy Marketing segment. Hedging collateral deposits were $3.7 million at March 31, 2018 and $1.7 million at September 30, 2017, which were associated with these futures contracts and have been reported in Level 1 as well. The derivative financial instruments reported in Level 2 at March 31, 2018 and September 30, 2017 consist of natural gas price swap agreements used in the Company’s Exploration and Production and Energy Marketing segments, crude oil price swap agreements used in the Company’s Exploration and Production segment and foreign currency contracts used in the Company's Exploration and Production segment. The derivative financial instruments reported in Level 2 at March 31, 2018 also include basis hedge swap agreements used in the Company's Energy Marketing segment. The fair value of the Level 2 price swap agreements is based on an internal, discounted cash flow model that uses observable inputs (i.e. LIBOR based discount rates and basis differential information, if applicable, at active natural gas and crude oil trading markets). The fair value of the Level 2 foreign currency contracts is determined using the market approach based on observable market transactions of forward Canadian currency rates.
The accounting rules for fair value measurements and disclosures require consideration of the impact of nonperformance risk (including credit risk) from a market participant perspective in the measurement of the fair value of assets and liabilities. At March 31, 2018, the Company determined that nonperformance risk would have no material impact on its financial position or results of operation. To assess nonperformance risk, the Company considered information such as any applicable collateral posted, master netting arrangements, and applied a market-based method by using the counterparty's (assuming the derivative is in a gain position) or the Company’s (assuming the derivative is in a loss position) credit default swaps rates.
For the quarters and six months ended March 31, 2018 and March 31, 2017, there were no assets or liabilities measured at fair value and classified as Level 3. For the quarters and six months ended March 31, 2018 and March 31, 2017, no transfers in or out of Level 1 or Level 2 occurred.
Note 3 – Financial Instruments
Long-Term Debt. The fair market value of the Company’s debt, as presented in the table below, was determined using a discounted cash flow model, which incorporates the Company’s credit ratings and current market conditions in determining the yield, and subsequently, the fair market value of the debt. Based on these criteria, the fair market value of long-term debt, including current portion, was as follows (in thousands):
March 31, 2018 | September 30, 2017 | ||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | ||||||||||||
Long-Term Debt | $ | 2,085,012 | $ | 2,169,067 | $ | 2,383,681 | $ | 2,523,639 | |||||||
The fair value amounts are not intended to reflect principal amounts that the Company will ultimately be required to pay. Carrying amounts for other financial instruments recorded on the Company’s Consolidated Balance Sheets approximate fair value. The fair value of long-term debt was calculated using observable inputs (U.S. Treasuries/LIBOR for the risk free component and company specific credit spread information – generally obtained from recent trade activity in the debt). As such, the Company considers the debt to be Level 2.
Any temporary cash investments, notes payable to banks and commercial paper are stated at cost. Temporary cash investments are considered Level 1, while notes payable to banks and commercial paper are considered to be Level 2. Given the short-term nature of the notes payable to banks and commercial paper, the Company believes cost is a reasonable approximation of fair value.
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Other Investments. The components of the Company's Other Investments are as follows (in thousands):
At March 31, 2018 | At September 30, 2017 | ||||||
Life Insurance Contracts | $ | 39,052 | $ | 39,355 | |||
Equity Mutual Fund | 36,910 | 37,033 | |||||
Fixed Income Mutual Fund | 44,192 | 45,727 | |||||
Marketable Equity Securities | 2,885 | 3,150 | |||||
$ | 123,039 | $ | 125,265 | ||||
Investments in life insurance contracts are stated at their cash surrender values or net present value. Investments in an equity mutual fund, a fixed income mutual fund and the stock of an insurance company (marketable equity securities) are stated at fair value based on quoted market prices. The gross unrealized gain on the equity mutual fund was $9.4 million at March 31, 2018 and $9.9 million at September 30, 2017. A sale of shares in the equity mutual fund during the six months ended March 31, 2018 resulted in $1.5 million of cash proceeds and a realized gain of $0.4 million. The gross unrealized loss on the fixed income mutual fund was $0.5 million at March 31, 2018 and was less than $0.1 million at September 30, 2017. A sale of shares in the fixed income mutual fund during the six months ended March 31, 2018 resulted in $1.5 million of cash proceeds and a realized loss of less than $0.1 million. The gross unrealized gain on the marketable equity securities was $1.9 million at March 31, 2018 and $2.2 million at September 30, 2017. The insurance contracts and marketable equity and fixed income securities are primarily informal funding mechanisms for various benefit obligations the Company has to certain employees.
Derivative Financial Instruments. The Company uses derivative financial instruments to manage commodity price risk in the Exploration and Production segment as well as the Energy Marketing segment. The Company enters into futures contracts and over-the-counter swap agreements for natural gas and crude oil to manage the price risk associated with forecasted sales of gas and oil. In addition, the Company also enters into foreign exchange forward contracts to manage the risk of currency fluctuations associated with transportation costs denominated in Canadian currency in the Exploration and Production segment. These instruments are accounted for as cash flow hedges. The Company also enters into futures contracts and swaps, which are accounted for as cash flow hedges, to manage the price risk associated with forecasted gas purchases. The Company enters into futures contracts and swaps to mitigate risk associated with fixed price sales commitments, fixed price purchase commitments, and the decline in value of natural gas held in storage. These instruments are accounted for as fair value hedges. The duration of the Company’s combined cash flow and fair value commodity hedges does not typically exceed 5 years while the foreign currency forward contracts do not exceed 8 years. The Exploration and Production segment holds the majority of the Company’s derivative financial instruments.
The Company has presented its net derivative assets and liabilities as “Fair Value of Derivative Financial Instruments” on its Consolidated Balance Sheets at March 31, 2018 and September 30, 2017. Substantially all of the derivative financial instruments reported on those line items relate to commodity contracts and a small portion relates to foreign currency forward contracts.
Cash Flow Hedges
For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (loss) and reclassified into earnings in the period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
As of March 31, 2018, the Company had the following commodity derivative contracts (swaps and futures contracts) outstanding:
Commodity | Units | ||
Natural Gas | 106.6 | Bcf (short positions) | |
Natural Gas | 1.7 | Bcf (long positions) | |
Crude Oil | 4,284,000 | Bbls (short positions) | |
As of March 31, 2018, the Company was hedging a total of $91.1 million of forecasted transportation costs denominated in Canadian dollars with foreign currency forward contracts (long positions).
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As of March 31, 2018, the Company had $8.1 million ($3.8 million after tax) of net hedging gains included in the accumulated other comprehensive income (loss) balance. It is expected that $4.1 million ($1.6 million after tax) of unrealized losses will be reclassified into the Consolidated Statement of Income within the next 12 months as the underlying hedged transaction are recorded in earnings. It is expected that $12.2 million ($5.4 million after tax) of unrealized gains will be reclassified into the Consolidated Statement of Income after 12 months as the underlying hedged transaction are recorded in earnings.
The Effect of Derivative Financial Instruments on the Statement of Financial Performance for the | ||||||||||||||||||||
Three Months Ended March 31, 2018 and 2017 (Thousands of Dollars) | ||||||||||||||||||||
Derivatives in Cash Flow Hedging Relationships | Amount of Derivative Gain or (Loss) Recognized in Other Comprehensive Income (Loss) on the Consolidated Statement of Comprehensive Income (Loss) (Effective Portion) for the Three Months Ended March 31, | Location of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion) | Amount of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion) for the Three Months Ended March 31, | Location of Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) | Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) for the Three Months Ended March 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||
Commodity Contracts | $ | (10,514 | ) | $ | 42,484 | Operating Revenue | $ | (3,467 | ) | $ | 12,109 | Operating Revenue | $ | 335 | $ | — | ||||
Commodity Contracts | (344 | ) | 1,044 | Purchased Gas | 750 | (1,498 | ) | Not Applicable | — | — | ||||||||||
Foreign Currency Contracts | (1,724 | ) | 569 | Operation and Maintenance Expense | (482 | ) | (139 | ) | Not Applicable | — | — | |||||||||
Total | $ | (12,582 | ) | $ | 44,097 | $ | (3,199 | ) | $ | 10,472 | $ | 335 | $ | — | ||||||
The Effect of Derivative Financial Instruments on the Statement of Financial Performance for the | ||||||||||||||||||||
Six Months Ended March 31, 2018 and 2017 (Thousands of Dollars) | ||||||||||||||||||||
Derivatives in Cash Flow Hedging Relationships | Amount of Derivative Gain or (Loss) Recognized in Other Comprehensive Income (Loss) on the Consolidated Statement of Comprehensive Income (Loss) (Effective Portion) for the Six Months Ended March 31, | Location of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion) | Amount of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion) for the Six Months Ended March 31, | Location of Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) | Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) for the Six Months Ended March 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||
Commodity Contracts | $ | (16,463 | ) | $ | (7,960 | ) | Operating Revenue | $ | 9,375 | $ | 43,429 | Operating Revenue | $ | (98 | ) | $ | (100 | ) | ||
Commodity Contracts | 613 | (492 | ) | Purchased Gas | 947 | (1,958 | ) | Not Applicable | — | — | ||||||||||
Foreign Currency Contracts | (2,231 | ) | 48 | Operation and Maintenance Expense | (973 | ) | (282 | ) | Not Applicable | — | — | |||||||||
Total | $ | (18,081 | ) | $ | (8,404 | ) | $ | 9,349 | $ | 41,189 | $ | (98 | ) | $ | (100 | ) | ||||
Fair Value Hedges
The Company utilizes fair value hedges to mitigate risk associated with fixed price sales commitments, fixed price purchase commitments, and the decline in the value of certain natural gas held in storage. With respect to fixed price sales commitments, the Company enters into long positions to mitigate the risk of price increases for natural gas supplies that could occur after the Company enters into fixed price sales agreements with its customers. With respect to fixed price purchase commitments, the Company enters into short positions to mitigate the risk of price decreases that could occur after the Company
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locks into fixed price purchase deals with its suppliers. With respect to storage hedges, the Company enters into short positions to mitigate the risk of price decreases that could result in a lower of cost or net realizable value writedown of the value of natural gas in storage that is recorded in the Company’s financial statements. As of March 31, 2018, the Company’s Energy Marketing segment had fair value hedges covering approximately 21.7 Bcf (21.1 Bcf of fixed price sales commitments and 0.6 Bcf of commitments related to the withdrawal of storage gas). For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk completely offset each other in current earnings, as shown below.
Derivatives in Fair Value Hedging Relationships | Location of Gain or (Loss) on Derivative and Hedged Item Recognized in the Consolidated Statement of Income | Amount of Gain or (Loss) on Derivative Recognized in the Consolidated Statement of Income for the Six Months Ended March 31, 2018 (In Thousands) | Amount of Gain or (Loss) on the Hedged Item Recognized in the Consolidated Statement of Income for the Six Months Ended March 31, 2018 (In Thousands) | ||||
Commodity Contracts | Operating Revenues | $ | (838 | ) | $ | 838 | |
Commodity Contracts | Purchased Gas | $ | (196 | ) | $ | 196 | |
$ | (1,034 | ) | $ | 1,034 | |||
Credit Risk
The Company may be exposed to credit risk on any of the derivative financial instruments that are in a gain position. Credit risk relates to the risk of loss that the Company would incur as a result of nonperformance by counterparties pursuant to the terms of their contractual obligations. To mitigate such credit risk, management performs a credit check, and then on a quarterly basis monitors counterparty credit exposure. The majority of the Company’s counterparties are financial institutions and energy traders. The Company has over-the-counter swap positions and applicable foreign currency forward contracts with seventeen counterparties of which eight are in a net gain position. On average, the Company had $2.3 million of credit exposure per counterparty in a gain position at March 31, 2018. The maximum credit exposure per counterparty in a gain position at March 31, 2018 was $8.6 million. As of March 31, 2018, no collateral was received from the counterparties by the Company. The Company's gain position on such derivative financial instruments had not exceeded the established thresholds at which the counterparties would be required to post collateral, nor had the counterparties' credit ratings declined to levels at which the counterparties were required to post collateral.
As of March 31, 2018, fourteen of the seventeen counterparties to the Company’s outstanding derivative instrument contracts (specifically the over-the-counter swaps and applicable foreign currency forward contracts) had a common credit-risk related contingency feature. In the event the Company’s credit rating increases or falls below a certain threshold (applicable debt ratings), the available credit extended to the Company would either increase or decrease. A decline in the Company’s credit rating, in and of itself, would not cause the Company to be required to increase the level of its hedging collateral deposits (in the form of cash deposits, letters of credit or treasury debt instruments). If the Company’s outstanding derivative instrument contracts were in a liability position (or if the liability were larger) and/or the Company’s credit rating declined, then additional hedging collateral deposits may be required. At March 31, 2018, the fair market value of the derivative financial instrument assets with a credit-risk related contingency feature was $16.8 million according to the Company’s internal model (discussed in Note 2 — Fair Value Measurements). At March 31, 2018, the fair market value of the derivative financial instrument liabilities with a credit-risk related contingency feature was $8.5 million according to the Company's internal model (discussed in Note 2 - Fair Value Measurements). For its over-the-counter swap agreements and foreign currency forward contracts, no hedging collateral deposits were required to be posted by the Company at March 31, 2018.
For its exchange traded futures contracts, the Company was required to post $3.7 million in hedging collateral deposits as of March 31, 2018. As these are exchange traded futures contracts, there are no specific credit-risk related contingency features. The Company posts or receives hedging collateral based on open positions and margin requirements it has with its counterparties.
The Company’s requirement to post hedging collateral deposits and the Company's right to receive hedging collateral deposits is based on the fair value determined by the Company’s counterparties, which may differ from the Company’s assessment of fair value. Hedging collateral deposits may also include closed derivative positions in which the broker has not cleared the cash from the account to offset the derivative liability. The Company records liabilities related to closed derivative positions in Other
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Accruals and Current Liabilities on the Consolidated Balance Sheet. These liabilities are relieved when the broker clears the cash from the hedging collateral deposit account. This is discussed in Note 1 under Hedging Collateral Deposits.
Note 4 - Income Taxes
The effective tax rate for the quarters ended March 31, 2018 and March 31, 2017 was 29.4% and 37.2%, respectively. The difference is primarily a result of the lower statutory rate of 24.5% under the 2017 Tax Reform Act (as discussed below). The effective tax rate for the six months ended March 31, 2018 and March 31, 2017 was negative 17.4% and 38.0%, respectively. The difference is a result of the impact of the one-time remeasurement of the deferred income tax liability and a lower statutory rate of 24.5% under the 2017 Tax Reform Act.
On December 22, 2017, federal tax legislation referred to as the “Tax Cuts and Jobs Act” (the 2017 Tax Reform Act) was enacted. The 2017 Tax Reform Act significantly changes the taxation of business entities and includes a reduction in the corporate federal income tax rate from 35% to a blended 24.5% for fiscal 2018 and 21% for fiscal 2019 and beyond. The changes had a material impact on the financial statements in the quarter and six months ended March 31, 2018. The Company’s deferred income taxes were remeasured based upon the new tax rates. For the non-rate regulated activities through the six months ended March 31, 2018, the change in deferred income taxes of $107.0 million was recorded as a reduction to income tax expense. For the Company's rate regulated activities, the reduction in deferred income taxes of $336.7 million was recorded as a decrease to Recoverable Future Taxes of $65.7 million and an increase to Taxes Refundable to Customers of $271.0 million. The 2017 Tax Reform Act includes provisions that stipulate how these excess deferred taxes are to be passed back to customers for certain accelerated tax depreciation benefits. Potential refunds of other deferred income taxes will be determined by the federal and state regulatory agencies. The Company is currently reviewing guidance issued by regulatory agencies in the jurisdictions in which it operates. For further discussion, refer to Note 9 - Regulatory Matters.
The 2017 Tax Reform Act also repealed the corporate alternative minimum tax (AMT) and provides that the Company’s existing AMT credit carryovers are refundable beginning in fiscal 2019. As of March 31, 2018, the Company had $89.6 million of AMT credit carryovers that are expected to be utilized or refunded between fiscal 2019 and fiscal 2022. During the quarter ended March 31, 2018, the Company recorded a $4.0 million estimate of the potential sequestration of the refunds of the AMT credits.
The SEC issued guidance in Staff Accounting Bulletin 118 (SAB 118) which provides for up to a one year period (the measurement period) in which to complete the required analysis and income tax accounting for the 2017 Tax Reform Act. The Company has determined a reasonable estimate for the measurement of the changes in deferred income taxes (noted above), which have been reflected as provisional amounts in the March 31, 2018 financial statements. The final determination of the impact of the income tax effects of these items will require additional analysis and further interpretation of the 2017 Tax Reform Act from yet to be issued U.S. Treasury regulations, state income tax guidance, federal/state regulatory guidance, technical corrections and the filing of the Company's fiscal 2017 federal consolidated tax return. The Company expects to finalize the analysis within SAB 118’s one-year measurement period.
Note 5 - Capitalization
Common Stock. During the six months ended March 31, 2018, the Company issued 64,085 original issue shares of common stock as a result of SARs exercises, 68,534 original issue shares of common stock for restricted stock units that vested and 79,079 original issue shares of common stock for performance shares that vested. In addition, the Company issued 109,535 original issue shares of common stock for the Direct Stock Purchase and Dividend Reinvestment Plan and 55,280 original issue shares of common stock for the Company’s 401(k) plans. The Company also issued 13,833 original issue shares of common stock to the non-employee directors of the Company who receive compensation under the Company’s 2009 Non-Employee Director Equity Compensation Plan, as partial consideration for the directors’ services during the six months ended March 31, 2018. Holders of stock-based compensation awards will often tender shares of common stock to the Company for payment of applicable withholding taxes. During the six months ended March 31, 2018, 51,574 shares of common stock were tendered to the Company for such purposes. The Company considers all shares tendered as cancelled shares restored to the status of authorized but unissued shares, in accordance with New Jersey law.
Current Portion of Long-Term Debt. None of the Company's long-term debt at March 31, 2018 will mature within the following twelve-month period. Current Portion of Long-Term Debt at September 30, 2017 consisted of $300.0 million of 6.50% notes scheduled to mature in April 2018. The Company redeemed these notes on October 18, 2017 for $307.0 million, plus accrued interest. The call premium was recorded to Unamortized Debt Expense on the Consolidated Balance Sheet in October 2017.
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Note 6 - Commitments and Contingencies
Environmental Matters. The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and to comply with regulatory requirements. It is the Company’s policy to accrue estimated environmental clean-up costs (investigation and remediation) when such amounts can reasonably be estimated and it is probable that the Company will be required to incur such costs.
At March 31, 2018, the Company has estimated its remaining clean-up costs related to former manufactured gas plant sites will be approximately $7.1 million, which includes a $4.2 million estimated minimum liability to remediate a former manufactured gas plant site located in New York. In March 2018, the NYDEC issued a Record of Decision for this New York site and the minimum liability reflects the remedy selected in the Record of Decision. The Company's liability for such clean-up costs has been recorded in Other Deferred Credits on the Consolidated Balance Sheet at March 31, 2018. The Company expects to recover its environmental clean-up costs through rate recovery over a period of approximately 4 years and is currently not aware of any material additional exposure to environmental liabilities. However, changes in environmental laws and regulations, new information or other factors could have an adverse financial impact on the Company.
Northern Access 2016 Project. On February 3, 2017, Supply Corporation and Empire received FERC approval of the Northern Access 2016 project described herein. On April 7, 2017, the NYDEC issued a Notice of Denial of the federal Clean Water Act Section 401 Water Quality Certification and other state stream and wetland permits for the New York portion of the project (the Water Quality Certification for the Pennsylvania portion of the project was received on January 27, 2017). On April 21, 2017, Supply Corporation and Empire filed a Petition for Review in the United States Court of Appeals for the Second Circuit of the NYDEC's Notice of Denial with respect to National Fuel's application for the Water Quality Certification, and on May 11, 2017, the Company commenced legal action in New York State Supreme Court challenging the NYDEC's actions with regard to various state permits. The Company also has pending with FERC a proceeding asserting, among other things, that the NYDEC exceeded the reasonable and statutory time frames to take action under the Clean Water Act and, therefore, waived its opportunity to approve or deny the Water Quality Certification. In light of these pending legal actions, the Company has not yet determined a target in-service date. As a result of the decision of the NYDEC, Supply Corporation and Empire evaluated the capitalized project costs for impairment as of March 31, 2018 and determined that an impairment charge was not required. The evaluation considered probability weighted scenarios of undiscounted future net cash flows, including a scenario assuming successful resolution with the NYDEC and construction of the pipeline, as well as a scenario where the project does not proceed. Further developments or indicators of an unfavorable resolution could result in the impairment of a significant portion of the project costs, which totaled $75.1 million at March 31, 2018. The project costs are included within Property, Plant and Equipment and Deferred Charges on the Consolidated Balance Sheet.
Other. The Company is involved in other litigation and regulatory matters arising in the normal course of business. These other matters may include, for example, negligence claims and tax, regulatory or other governmental audits, inspections, investigations and other proceedings. These matters may involve state and federal taxes, safety, compliance with regulations, rate base, cost of service and purchased gas cost issues, among other things. While these other matters arising in the normal course of business could have a material effect on earnings and cash flows in the period in which they are resolved, an estimate of the possible loss or range of loss, if any, cannot be made at this time.
Note 7 – Business Segment Information
The Company reports financial results for five segments: Exploration and Production, Pipeline and Storage, Gathering, Utility and Energy Marketing. The division of the Company’s operations into reportable segments is based upon a combination of factors including differences in products and services, regulatory environment and geographic factors.
The data presented in the tables below reflect financial information for the segments and reconciliations to consolidated amounts. As stated in the 2017 Form 10-K, the Company evaluates segment performance based on income before discontinued operations, extraordinary items and cumulative effects of changes in accounting (when applicable). When these items are not applicable, the Company evaluates performance based on net income. There have not been any changes in the basis of segmentation nor in the basis of measuring segment profit or loss from those used in the Company’s 2017 Form 10-K. A listing of segment assets at March 31, 2018 and September 30, 2017 is shown in the tables below.
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Quarter Ended March 31, 2018 (Thousands) | |||||||||
Exploration and Production | Pipeline and Storage | Gathering | Utility | Energy Marketing | Total Reportable Segments | All Other | Corporate and Intersegment Eliminations | Total Consolidated | |
Revenue from External Customers | $146,411 | $53,714 | $(99) | $283,778 | $55,644 | $539,448 | $1,232 | $225 | $540,905 |
Intersegment Revenues | $— | $23,044 | $27,832 | $5,700 | $(51) | $56,525 | $— | $(56,525) | $— |
Segment Profit: Net Income (Loss) | $26,537 | $22,724 | $11,770 | $33,360 | $578 | $94,969 | $207 | $(3,329) | $91,847 |
Six Months Ended March 31, 2018 (Thousands) | |||||||||
Exploration and Production | Pipeline and Storage | Gathering | Utility | Energy Marketing | Total Reportable Segments | All Other | Corporate and Intersegment Eliminations | Total Consolidated | |
Revenue from External Customers | $285,552 | $107,025 | $71 | $470,867 | $94,280 | $957,795 | $2,328 | $438 | $960,561 |
Intersegment Revenues | $— | $45,028 | $51,497 | $7,882 | $76 | $104,483 | $— | $(104,483) | $— |
Segment Profit: Net Income (Loss) | $133,235 | $61,186 | $57,169 | $54,353 | $1,624 | $307,567 | $(511) | $(16,555) | $290,501 |
(Thousands) | Exploration and Production | Pipeline and Storage | Gathering | Utility | Energy Marketing | Total Reportable Segments | All Other | Corporate and Intersegment Eliminations | Total Consolidated |
Segment Assets: | |||||||||
At March 31, 2018 | $1,540,251 | $1,764,554 | $517,335 | $1,963,421 | $61,166 | $5,846,727 | $77,252 | $(9,406) | $5,914,573 |
At September 30, 2017 | $1,407,152 | $1,929,788 | $580,051 | $2,013,123 | $60,937 | $5,991,051 | $76,861 | $35,408 | $6,103,320 |
Quarter Ended March 31, 2017 (Thousands) | |||||||||
Exploration and Production | Pipeline and Storage | Gathering | Utility | Energy Marketing | Total Reportable Segments | All Other | Corporate and Intersegment Eliminations | Total Consolidated | |
Revenue from External Customers | $159,553 | $53,163 | $26 | $257,949 | $50,940 | $521,631 | $218 | $226 | $522,075 |
Intersegment Revenues | $— | $22,592 | $27,936 | $6,096 | $16 | $56,640 | $— | $(56,640) | $— |
Segment Profit: Net Income (Loss) | $33,769 | $19,256 | $10,285 | $25,581 | $905 | $89,796 | $(221) | $(291) | $89,284 |
Six Months Ended March 31, 2017 (Thousands) | |||||||||
Exploration and Production | Pipeline and Storage | Gathering | Utility | Energy Marketing | Total Reportable Segments | All Other | Corporate and Intersegment Eliminations | Total Consolidated | |
Revenue from External Customers | $320,485 | $106,164 | $52 | $428,919 | $87,750 | $943,370 | $772 | $434 | $944,576 |
Intersegment Revenues | $— | $44,746 | $55,776 | $7,922 | $35 | $108,479 | $— | $(108,479) | $— |
Segment Profit: Net Income (Loss) | $68,849 | $38,624 | $21,266 | $46,755 | $2,687 | $178,181 | $(400) | $410 | $178,191 |
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Note 8 – Retirement Plan and Other Post-Retirement Benefits
Components of Net Periodic Benefit Cost (in thousands):
Retirement Plan | Other Post-Retirement Benefits | ||||||||||||
Three Months Ended March 31, | 2018 | 2017 | 2018 | 2017 | |||||||||
Service Cost | $ | 2,480 | $ | 2,992 | $ | 458 | $ | 612 | |||||
Interest Cost | 8,252 | 9,596 | 3,700 | 4,752 | |||||||||
Expected Return on Plan Assets | (15,429 | ) | (14,929 | ) | (7,871 | ) | (7,865 | ) | |||||
Amortization of Prior Service Cost (Credit) | 235 | 264 | (107 | ) | (107 | ) | |||||||
Amortization of Losses | 9,301 | 10,672 | 2,639 | 4,604 | |||||||||
Net Amortization and Deferral for Regulatory Purposes (Including Volumetric Adjustments) (1) | 6,492 | 6,234 | 6,250 | 3,790 | |||||||||
Net Periodic Benefit Cost | $ | 11,331 | $ | 14,829 | $ | 5,069 | $ | 5,786 | |||||
Retirement Plan | Other Post-Retirement Benefits | ||||||||||||
Six Months Ended March 31, | 2018 | 2017 | 2018 | 2017 | |||||||||
Service Cost | $ | 4,960 | $ | 5,984 | $ | 915 | $ | 1,224 | |||||
Interest Cost | 16,503 | 19,192 | 7,400 | 9,504 | |||||||||
Expected Return on Plan Assets | (30,857 | ) | (29,859 | ) | (15,741 | ) | (15,729 | ) | |||||
Amortization of Prior Service Cost (Credit) | 469 | 529 | (214 | ) | (214 | ) | |||||||
Amortization of Losses | 18,602 | 21,343 | 5,279 | 9,207 | |||||||||
Net Amortization and Deferral for Regulatory Purposes (Including Volumetric Adjustments) (1) | 8,214 | 6,770 | 9,858 | 5,102 | |||||||||
Net Periodic Benefit Cost | $ | 17,891 | $ | 23,959 | $ | 7,497 | $ | 9,094 | |||||
(1) | The Company’s policy is to record retirement plan and other post-retirement benefit costs in the Utility segment on a volumetric basis to reflect the fact that the Utility segment experiences higher throughput of natural gas in the winter months and lower throughput of natural gas in the summer months. |
Employer Contributions. During the six months ended March 31, 2018, the Company contributed $27.6 million to its tax-qualified, noncontributory defined-benefit retirement plan (Retirement Plan) and $2.1 million to its VEBA trusts for its other post-retirement benefits. In the remainder of 2018, the Company may contribute up to $5.0 million to the Retirement Plan. In the remainder of 2018, the Company expects its contributions to the VEBA trusts to be in the range of $0.5 million to $1.0 million.
Note 9 – Regulatory Matters
New York Jurisdiction
Distribution Corporation's current delivery rates in its New York jurisdiction were approved by the NYPSC in an order issued on April 20, 2017 with rates becoming effective May 1, 2017. On July 28, 2017, Distribution Corporation filed an appeal with New York State Supreme Court, Albany County, seeking review of the Order. The appeal contends that portions of the Order should be invalidated because they fail to meet the applicable legal standard for agency decisions. On December 11, 2017, the appeal was transferred to the Supreme Court, Appellate Division, Third Department. The Company cannot predict the outcome of the appeal at this time.
On December 29, 2017, the NYPSC issued an order instituting a proceeding to study the potential effects of the enactment of the 2017 Tax Reform Act on the tax expenses and liabilities of New York utilities, and the “regulatory treatment of any windfalls resulting from same in order to preserve the benefits for ratepayers.” In its order, the NYPSC stated that the effect of the 2017 Tax Reform Act on utilities’ taxation is likely to be material and complex and that the proceeding was needed to begin the process of addressing the impact on the State’s utilities and ratepayers. The order also declares that utilities are “put on notice that it is
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the [NYPSC]’s intent to ensure that net benefits accruing from the Tax Act are preserved for ratepayers, either through deferral accounting or another method, from the first day the Tax Act is put into effect. Utilities acting contrary to this intent do so at their own risk.” Pursuant to the order, a technical conference was held with the utilities in February 2018, and on March 29, 2018, the New York Department of Public Service Staff (Staff) issued a proposal for accounting and ratemaking treatment of the tax changes. Interested parties have been invited to comment on the Staff proposal, including whether and how to incorporate into utility rates any modifications necessary to reflect changes in federal tax law affecting utilities. Refer to Note 4 - Income Taxes for further discussion of the 2017 Tax Reform Act.
Pennsylvania Jurisdiction
Distribution Corporation’s Pennsylvania jurisdiction delivery rates are being charged to customers in accordance with a rate settlement approved by the PaPUC. The rate settlement does not specify any requirement to file a future rate case.
By Secretarial Letter issued February 12, 2018, the PaPUC initiated a proceeding to determine the effects of the 2017 Tax Reform Act on the tax liabilities of PaPUC-regulated public utilities for 2018 and future years and the feasibility of reflecting such impacts on the rates charged to utility ratepayers. In connection with such letter, the PaPUC issued certain data requests to utilities regarding the 2017 Tax Reform Act, and Distribution Corporation filed responses in March 2018. On March 15, 2018, the PaPUC issued a Temporary Rates Order making Distribution Corporation’s rates (along with the rates of other Pennsylvania public utilities not presently in a general rate increase proceeding) temporary for a period of six months, which may be extended by the PaPUC for an additional six months. The order states that due to the decrease in federal tax rates associated with the 2017 Tax Reform Act, it appears that existing utility rates may be excessive and, therefore, no longer just and reasonable. The order states that the PaPUC is making rates temporary to maximize its authority to establish any negative surcharge, refund or other rate adjustment deemed to be necessary, just and reasonable to account for the tax rate reductions associated with the 2017 Tax Reform Act, and is consistent with the approach that the PaPUC took following federal tax reform in 1986. The order further states that the PaPUC anticipates that after further review and analysis of the responses to data requests, financial information and public comments, it will direct utilities to file appropriate tariffs to account for the tax reductions associated with the 2017 Tax Reform Act that became effective January 1, 2018. Refer to Note 4 - Income Taxes for further discussion of the 2017 Tax Reform Act.
FERC Jurisdiction
Supply Corporation currently has no active rate case on file. Supply Corporation's current rate settlement requires a rate case filing no later than December 31, 2019.
Empire currently has no active rate case on file. Empire’s current rate settlement requires a rate case filing no later than July 1, 2021.
On March 15, 2018, the FERC issued three documents regarding its plans to undertake review of the 2017 Tax Reform Act and its impact on pipelines: a Notice of Proposed Rulemaking which proposes to require pipelines to file a new form isolating the tax impact to each pipeline and also to make an election regarding the action the pipelines will take to address the lower tax rates, one of which is filing a Section 4 rate proceeding; a Policy Statement regarding the treatment of taxes by MLP entities; and a Notice of Inquiry regarding treatment of accumulated deferred income taxes and other tax issues associated with the 2017 Tax Reform Act. The Company cannot predict the outcome of any of these proceedings at this time. Refer to Note 4 - Income Taxes for further discussion of the 2017 Tax Reform Act.
Note 10 – Subsequent Event
The Company entered into a purchase and sale agreement to sell its oil and gas properties in the Sespe Field area of Ventura County, California in October 2017 for $43 million. The Company completed the sale on May 1, 2018, effective as of October 1, 2017, receiving net proceeds of $38.3 million. For the period of October 1, 2017 through April 30, 2018, the Company retained all production revenue less production expenses, resulting in lower proceeds from sale at the closing date. The divestiture of the Company’s oil and gas properties in the Sespe Field reflects continuing efforts to focus West Coast development activities in the San Joaquin basin, particularly at the Midway Sunset field in Kern County, California. Under the full cost method of accounting for oil and natural gas properties, the sale proceeds were accounted for as a reduction of capitalized costs. Since the disposition did not significantly alter the relationship between capitalized costs and proved reserves of oil and gas attributable to the cost center, the Company did not record any gain or loss from this sale.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
Please note that this overview is a high-level summary of items that are discussed in greater detail in subsequent sections of this report.
The Company is a diversified energy company engaged principally in the production, gathering, transportation, distribution and marketing of natural gas. The Company operates an integrated business, with assets centered in western New York and Pennsylvania, being utilized for, and benefiting from, the production and transportation of natural gas from the Appalachian basin. Current development activities are focused primarily in the Marcellus and Utica Shale. The common geographic footprint of the Company’s subsidiaries enables them to share management, labor, facilities and support services across various businesses and pursue coordinated projects designed to produce and transport natural gas from the Appalachian basin to markets in Canada and the eastern United States. The Company's efforts in this regard are not limited to affiliated projects. The Company has also been designing and building pipeline projects for the transportation of natural gas for non-affiliated natural gas producers in the Appalachian basin. The Company also develops and produces oil reserves, primarily in California. The Company reports financial results for five business segments.
For the quarter and six months ended March 31, 2018 compared to the quarter and six months ended March 31, 2017, the Company experienced an increase in earnings of $2.5 million and $112.3 million, respectively. As a result of the 2017 Tax Reform Act, the effective tax rates for the quarter and six months ended March 31, 2018 of 29.4% and negative 17.4%, respectively, reflect a lower statutory rate of 24.5%. The effective tax rate for the six months ended March 31, 2018 also reflects the impact of a remeasurement of the Company's accumulated deferred income tax liability based upon the new tax rates, recorded as a $107.0 million reduction to income tax expense. This remeasurement amount reflects a $4.0 million reduction of income tax benefit recorded during the quarter ended March 31, 2018 to reflect an estimate of the potential sequestration of the refunds of alternative minimum tax credits. The Company's non-regulated operations are benefiting from the 2017 Tax Reform Act while the regulated operations anticipate future rate reductions. For further discussion of the impact of the 2017 Tax Reform Act to the Company, refer to Item 1 at Note 4 — Income Taxes. For further discussion of the Company’s earnings, refer to the Results of Operations section below.
On February 3, 2017, the Company, in its Pipeline and Storage segment, received FERC approval of a project to move significant prospective Marcellus production from Seneca’s Western Development Area at Clermont to an Empire interconnection with TransCanada Pipeline at Chippawa and an interconnection with Tennessee Gas Pipeline’s 200 Line in East Aurora, New York (“Northern Access 2016”). On April 7, 2017, the NYDEC issued a Notice of Denial of the federal Clean Water Act Section 401 Water Quality Certification and other state stream and wetland permits for the New York portion of the project (the Water Quality Certification for the Pennsylvania portion of the project was received on January 27, 2017). On April 21, 2017, the Company appealed the NYDEC's decision with regard to the Water Quality Certification to the United States Court of Appeals for the Second Circuit, and on May 11, 2017, the Company commenced legal action in New York State Supreme Court challenging the NYDEC's actions with regard to various state permits. The Company also has pending with FERC a proceeding asserting, among other things, that the NYDEC exceeded the reasonable and statutory time frames to take action under the Clean Water Act and, therefore, waived its opportunity to approve or deny the Water Quality Certification. The Company remains committed to the project. Approximately $75.1 million in costs have been incurred on this project through March 31, 2018, with the costs residing either in Construction Work in Progress, a component of Property, Plant and Equipment on the Consolidated Balance Sheet, or Deferred Charges.
From a financing perspective, in September 2017, the Company issued $300.0 million of 3.95% notes due in September 2027. The proceeds of the debt issuance were used for the October 2017 redemption of $300.0 million of the Company's 6.50% notes that were scheduled to mature in April 2018. The Company expects to use cash on hand and cash from operations to meet its capital expenditure needs for the remainder of fiscal 2018 and may issue short-term and/or long-term debt during fiscal 2018 as needed.
CRITICAL ACCOUNTING ESTIMATES
For a complete discussion of critical accounting estimates, refer to "Critical Accounting Estimates" in Item 7 of the Company's 2017 Form 10-K. There have been no material changes to that disclosure other than as set forth below. The information presented below updates and should be read in conjunction with the critical accounting estimates in that Form 10-K.
Oil and Gas Exploration and Development Costs. The Company, in its Exploration and Production segment, follows the full cost method of accounting for determining the book value of its oil and natural gas properties. In accordance with this methodology, the Company is required to perform a quarterly ceiling test. Under the ceiling test, the present value of future revenues from the
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Company's oil and gas reserves based on an unweighted arithmetic average of the first day of the month oil and gas prices for each month within the twelve-month period prior to the end of the reporting period (the “ceiling”) is compared with the book value of the Company’s oil and gas properties at the balance sheet date. If the book value of the oil and gas properties exceeds the ceiling, a non-cash impairment charge must be recorded to reduce the book value of the oil and gas properties to the calculated ceiling. At March 31, 2018, the ceiling exceeded the book value of the oil and gas properties by approximately $502.8 million. The 12-month average of the first day of the month price for crude oil for each month during the twelve months ended March 31, 2018, based on posted Midway Sunset prices, was $52.01 per Bbl. The 12-month average of the first day of the month price for natural gas for each month during the twelve months ended March 31, 2018, based on the quoted Henry Hub spot price for natural gas, was $3.00 per MMBtu. (Note – because actual pricing of the Company’s various producing properties varies depending on their location and hedging, the prices used to calculate the ceiling may differ from the Midway Sunset and Henry Hub prices, which are only indicative of the 12-month average prices for the twelve months ended March 31, 2018. Pricing differences would include adjustments for regional market differentials, transportation fees and contractual arrangements.) The following table illustrates the sensitivity of the ceiling test calculation to commodity price changes, specifically showing the amounts the ceiling would have exceeded the book value of the Company's oil and gas properties at March 31, 2018 (which would not have resulted in an impairment charge) if natural gas prices were $0.25 per MMBtu lower than the average prices used at March 31, 2018, if crude oil prices were $5 per Bbl lower than the average prices used at March 31, 2018, and if both natural gas prices and crude oil prices were $0.25 per MMBtu and $5 per Bbl lower than the average prices used at March 31, 2018 (all amounts are presented after-tax). These calculated amounts are based solely on price changes and do not take into account any other changes to the ceiling test calculation, including, among others, changes in reserve quantities and future cost estimates.
Ceiling Testing Sensitivity to Commodity Price Changes | |||||||||||
(Millions) | $0.25/MMBtu Decrease in Natural Gas Prices | $5.00/Bbl Decrease in Crude Oil Prices | $0.25/MMBtu Decrease in Natural Gas Prices and $5.00/Bbl Decrease in Crude Oil Prices | ||||||||
Excess of Ceiling over Book Value under Sensitivity Analysis | $ | 348.2 | $ | 465.9 | $ | 311.3 | |||||
It is difficult to predict what factors could lead to future impairments under the SEC's full cost ceiling test. Fluctuations in or subtractions from proved reserves, increases in development costs for undeveloped reserves and significant fluctuations in oil and gas prices have an impact on the amount of the ceiling at any point in time. For a more complete discussion of the full cost method of accounting, refer to "Oil and Gas Exploration and Development Costs" under "Critical Accounting Estimates" in Item 7 of the Company's 2017 Form 10-K.
2017 Tax Reform Act. On December 22, 2017, the tax legislation referred to as the “Tax Cuts and Jobs Act” (the 2017 Tax Reform Act) was enacted. The 2017 Tax Reform Act significantly changes the taxation of business entities and includes a reduction in the corporate federal income tax rate from 35% to a blended 24.5% for fiscal 2018 and 21% for fiscal 2019 and beyond. As a fiscal year taxpayer, the Company is required to use a blended tax rate for fiscal 2018.
The Company has determined a reasonable estimate under SAB 118 for the measurement of the changes in deferred income taxes in the March 31, 2018 financial statements. The final determination of the impact of the income tax effects of these items will require additional analysis and further interpretation of the 2017 Tax Reform Act from yet to be issued U.S. Treasury regulations, state income tax guidance, federal and state regulatory guidance, technical corrections and the filing of the Company's fiscal 2017 federal consolidated tax return. The Company expects to finalize the analysis within SAB 118's one-year measurement period. For further discussion of the impact of the 2017 Tax Reform Act to the Company, refer to Item 1 at Note 4 — Income Taxes.
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RESULTS OF OPERATIONS
Earnings
The Company's earnings were $91.8 million for the quarter ended March 31, 2018 compared to earnings of $89.3 million for the quarter ended March 31, 2017. The increase in earnings of $2.5 million is primarily a result of higher earnings in the Utility segment, Pipeline and Storage segment, Gathering segment and All Other category. Lower earnings in the Exploration and Production segment and Energy Marketing segment, as well as a loss in the Corporate category, partially offset these increases.
The Company's earnings were $290.5 million for the six months ended March 31, 2018 compared to earnings of $178.2 million for the six months ended March 31, 2017. The increase in earnings of $112.3 million is primarily a result of higher earnings in the Exploration and Production segment, Gathering segment, Pipeline and Storage segment and Utility segment. Lower earnings in the Energy Marketing segment, as well as losses in the Corporate and All Other categories, partially offset these increases.
The Company's earnings for the six months ended March 31, 2018 include a $107.0 million remeasurement of accumulated deferred income taxes and a lower statutory rate of 24.5% as a result of the 2017 Tax Reform Act, as discussed above. This remeasurement amount reflects a $4.0 million reduction of income tax benefit recorded during the quarter ended March 31, 2018 to reflect an estimate of the potential sequestration of the refunds of alternative minimum tax credits. Additional discussion of earnings in each of the business segments can be found in the business segment information that follows. Note that all amounts used in the earnings discussions are after-tax amounts, unless otherwise noted.
Earnings (Loss) by Segment
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||||||||
(Thousands) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||||||||
Exploration and Production | $ | 26,537 | $ | 33,769 | $ | (7,232 | ) | $ | 133,235 | $ | 68,849 | $ | 64,386 | |||||
Pipeline and Storage | 22,724 | 19,256 | 3,468 | 61,186 | 38,624 | 22,562 | ||||||||||||
Gathering | 11,770 | 10,285 | 1,485 | 57,169 | 21,266 | 35,903 | ||||||||||||
Utility | 33,360 | 25,581 | 7,779 | 54,353 | 46,755 | 7,598 | ||||||||||||
Energy Marketing | 578 | 905 | (327 | ) | 1,624 | 2,687 | (1,063 | ) | ||||||||||
Total Reportable Segments | 94,969 | 89,796 | 5,173 | 307,567 | 178,181 | 129,386 | ||||||||||||
All Other | 207 | (221 | ) | 428 | (511 | ) | (400 | ) | (111 | ) | ||||||||
Corporate | (3,329 | ) | (291 | ) | (3,038 | ) | (16,555 | ) | 410 | (16,965 | ) | |||||||
Total Consolidated | $ | 91,847 | $ | 89,284 | $ | 2,563 | $ | 290,501 | $ | 178,191 | $ | 112,310 | ||||||
Exploration and Production
Exploration and Production Operating Revenues
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||||||||
(Thousands) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||||||||
Gas (after Hedging) | $ | 105,996 | $ | 122,818 | $ | (16,822 | ) | $ | 204,111 | $ | 243,383 | $ | (39,272 | ) | ||||
Oil (after Hedging) | 38,663 | 35,659 | 3,004 | 78,877 | 75,115 | 3,762 | ||||||||||||
Gas Processing Plant | 1,073 | 928 | 145 | 2,138 | 1,689 | 449 | ||||||||||||
Other | 679 | 148 | 531 | 426 | 298 | 128 | ||||||||||||
$ | 146,411 | $ | 159,553 | $ | (13,142 | ) | $ | 285,552 | $ | 320,485 | $ | (34,933 | ) | |||||
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Production Volumes
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||
2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | |||||||
Gas Production (MMcf) | ||||||||||||
Appalachia | 41,403 | 40,805 | 598 | 76,817 | 80,612 | (3,795 | ) | |||||
West Coast | 675 | 737 | (62 | ) | 1,370 | 1,513 | (143 | ) | ||||
Total Production | 42,078 | 41,542 | 536 | 78,187 | 82,125 | (3,938 | ) | |||||
Oil Production (Mbbl) | ||||||||||||
Appalachia | 1 | 2 | (1 | ) | 2 | 2 | — | |||||
West Coast | 662 | 672 | (10 | ) | 1,334 | 1,393 | (59 | ) | ||||
Total Production | 663 | 674 | (11 | ) | 1,336 | 1,395 | (59 | ) | ||||
Average Prices
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||||||||
2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | |||||||||||||
Average Gas Price/Mcf | ||||||||||||||||||
Appalachia | $ | 2.46 | $ | 2.71 | $ | (0.25 | ) | $ | 2.41 | $ | 2.54 | $ | (0.13 | ) | ||||
West Coast | $ | 4.40 | $ | 4.57 | $ | (0.17 | ) | $ | 4.70 | $ | 4.40 | $ | 0.30 | |||||
Weighted Average | $ | 2.49 | $ | 2.75 | $ | (0.26 | ) | $ | 2.45 | $ | 2.57 | $ | (0.12 | ) | ||||
Weighted Average After Hedging | $ | 2.52 | $ | 2.96 | $ | (0.44 | ) | $ | 2.61 | $ | 2.96 | $ | (0.35 | ) | ||||
Average Oil Price/Bbl | ||||||||||||||||||
Appalachia | $ | 58.54 | $ | 49.87 | $ | 8.67 | $ | 49.82 | $ | 49.04 | $ | 0.78 | ||||||
West Coast | $ | 65.39 | $ | 47.96 | $ | 17.43 | $ | 61.61 | $ | 45.75 | $ | 15.86 | ||||||
Weighted Average | $ | 65.39 | $ | 47.96 | $ | 17.43 | $ | 61.60 | $ | 45.82 | $ | 15.78 | ||||||
Weighted Average After Hedging | $ | 58.31 | $ | 52.92 | $ | 5.39 | $ | 59.05 | $ | 53.85 | $ | 5.20 | ||||||
2018 Compared with 2017
Operating revenues for the Exploration and Production segment decreased $13.1 million for the quarter ended March 31, 2018 as compared with the quarter ended March 31, 2017. Gas production revenue after hedging decreased $16.8 million due to a $0.44 per Mcf decrease in the weighted average price of gas after hedging. This decrease to operating revenues was partially offset by an increase in oil production revenue after hedging of $3.0 million. The increase in oil production revenue was largely due to a $5.39 per Bbl increase in the weighted average price of oil after hedging.
Operating revenues for the Exploration and Production segment decreased $34.9 million for the six months ended March 31, 2018 as compared with the six months ended March 31, 2017. Gas production revenue after hedging decreased $39.3 million primarily due to a $0.35 per Mcf decrease in the weighted average price of gas after hedging coupled with a decrease in gas production. The decrease in production was primarily due to natural declines from Marcellus wells in the Eastern Development Area. This was partially offset by production increases in the Western Development Area from new Marcellus and Utica wells coupled with a decrease in price-related curtailments during the six months ended March 31, 2018 compared to the six months ended March 31, 2017. This decrease to operating revenues was partially offset by an increase in oil production revenue after hedging of $3.8 million. The increase in oil production revenue was due to a $5.20 per Bbl increase in the weighted average price of oil after hedging, which was partially offset by a decrease in crude oil production. The decrease in crude oil production in the West Coast region was largely due to the lagging current year impact of decreased steam operations and well workover activity at its North Midway Sunset field in prior years (due to lower crude oil prices) coupled with oil production losses due to temporary
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shut-in production in Ventura County, California in response to the wildfires occurring in fiscal 2018. During the six months ended March 31, 2018, there was an increase in steam operations and well workover activity versus the six months ended March 31, 2017, which will stimulate future crude oil production.
The Exploration and Production segment's earnings for the quarter ended March 31, 2018 were $26.5 million, a decrease of $7.3 million when compared with earnings of $33.8 million for the quarter ended March 31, 2017. This decrease in earnings was primarily due to lower natural gas prices after hedging ($12.0 million), lower crude oil production ($0.4 million), higher production expenses ($0.8 million), higher depletion expense ($2.0 million) and higher other operating expenses ($0.4 million). The decrease in earnings also reflects an additional remeasurement of accumulated deferred income taxes ($0.8 million) to reflect an estimate of the potential sequestration of the refunds of alternative minimum tax credits resulting from the 2017 Tax Reform Act. The increase in production expenses is primarily due to increased well repairs and workovers, coupled with increased steam fuel costs, increased repairs and maintenance, and increased transportation expenses. The increase in depletion expense was due to an increase in capitalized costs and a slight increase in production, partially offset by an increase in reserves (an increase in reserves lowers the per Mcf/barrel depletion rate). The increase in other operating expenses was primarily due to an increase in computer expenses and an increase in personnel costs. These factors, which decreased earnings during the quarter ended March 31, 2018 compared to the quarter ended March 31, 2017, were partially offset by an increase in earnings due to the current period earnings impact of the change in federal tax rate from 35% to a blended rate of 24.5% for fiscal 2018 on current income taxes ($3.5 million), which was the result of the 2017 Tax Reform Act. It also reflects higher crude oil prices after hedging ($2.3 million), higher natural gas production ($1.0 million), and lower income tax expense, excluding the impact of the 2017 Tax Reform Act ($1.9 million). The decrease in income tax expense, excluding the impact of the 2017 Tax Reform Act, was largely due to the impact of temporary differences reversing after fiscal 2018 at a 21% tax rate partially offset by a decrease in the enhanced oil recovery tax credit related to Seneca's California properties.
The Exploration and Production segment's earnings for the six months ended March 31, 2018 were $133.2 million, an increase of $64.4 million when compared with earnings of $68.8 million for the six months ended March 31, 2017. The increase in earnings primarily reflects the remeasurement of accumulated deferred income taxes ($76.5 million) combined with the current period earnings impact of the change in federal tax rate from 35% to a blended rate of 24.5% for fiscal 2018 on current income taxes ($7.6 million), both of which were the result of the 2017 Tax Reform Act. It also reflects higher crude oil prices after hedging ($4.5 million) and lower income tax expense, excluding the impact of the 2017 Tax Reform Act ($5.8 million). The decrease in income tax expense, excluding the impact of the 2017 Tax Reform Act, was largely due to the impact of temporary differences reversing after fiscal 2018 at a 21% tax rate partially offset by a decrease in the enhanced oil recovery tax credit related to Seneca's California properties. These factors, which contributed to increased earnings during the six months ended March 31, 2018 compared to the six months ended March 31, 2017, were partially offset by lower natural gas prices after hedging ($17.9 million), lower natural gas production ($7.6 million), lower crude oil production ($2.1 million), higher production expenses ($0.8 million), higher depletion expense ($1.0 million) and higher other operating expenses ($1.0 million). The increase in production expenses is primarily due to increased well repairs and workovers, coupled with increased steam fuel costs and increased repairs and maintenance, partially offset by decreased transportation expenses. The increase in depletion expense was due to an increase in capitalized costs partially offset by a decrease in production and an increase in reserves. The increase in other operating expenses was primarily due to an increase in computer expenses and an increase in personnel costs.
Pipeline and Storage
Pipeline and Storage Operating Revenues
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||||||||
(Thousands) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||||||||
Firm Transportation | $ | 57,562 | $ | 57,349 | $ | 213 | $ | 114,319 | $ | 114,098 | $ | 221 | ||||||
Interruptible Transportation | 388 | 393 | (5 | ) | 728 | 1,039 | (311 | ) | ||||||||||
57,950 | 57,742 | 208 | 115,047 | 115,137 | (90 | ) | ||||||||||||
Firm Storage Service | 18,526 | 17,804 | 722 | 36,365 | 35,077 | 1,288 | ||||||||||||
Interruptible Storage Service | 2 | — | 2 | 21 | 12 | 9 | ||||||||||||
Other | 280 | 209 | 71 | 620 | 684 | (64 | ) | |||||||||||
$ | 76,758 | $ | 75,755 | $ | 1,003 | $ | 152,053 | $ | 150,910 | $ | 1,143 | |||||||
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Pipeline and Storage Throughput
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||
(MMcf) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||
Firm Transportation | 199,679 | 213,367 | (13,688 | ) | 406,381 | 404,148 | 2,233 | |||||
Interruptible Transportation | 1,165 | 971 | 194 | 2,046 | 4,017 | (1,971 | ) | |||||
200,844 | 214,338 | (13,494 | ) | 408,427 | 408,165 | 262 | ||||||
2018 Compared with 2017
Operating revenues for the Pipeline and Storage segment increased $1.0 million for the quarter ended March 31, 2018 as compared with the quarter ended March 31, 2017. An increase in operating revenues due to demand charges for transportation service from Supply Corporation's Line D Expansion, which was placed in service on November 1, 2017, and an increase in both transportation and storage revenues due to Supply Corporation's greenhouse gas and pipeline safety surcharge effective November 1, 2017, were partially offset by a decline in transportation revenues due to a decline in demand charges for transportation services as a result of contract terminations.
Operating revenues for the Pipeline and Storage segment increased $1.1 million for the six months ended March 31, 2018 as compared with the six months ended March 31, 2017. An increase in operating revenues due to demand charges for transportation service from Supply Corporation's Line D Expansion, which was placed in service on November 1, 2017, and an increase in both transportation and storage revenues due to Supply Corporation's greenhouse gas and pipeline safety surcharge effective November 1, 2017, were partially offset by a decline in transportation revenues due partially to an additional 2% reduction in Supply Corporation's rates effective November 1, 2016, which was required by the rate case settlement approved by FERC on November 13, 2015, and a decline in demand charges for transportation services as a result of contract terminations.
Transportation volume for the quarter ended March 31, 2018 decreased by 13.5 Bcf from the prior year’s quarter. For the six months ended March 31, 2018, transportation volume remained relatively flat as compared with the prior year's six-month period ended March 31, 2017. The decrease in transportation volume for the quarter primarily reflects a reduction in capacity utilization by certain contract shippers combined with contract terminations. Volume fluctuations, other than those caused by the addition or termination of contracts, generally do not have a significant impact on revenues as a result of the straight fixed-variable rate design utilized by Supply Corporation and Empire.
The Pipeline and Storage segment’s earnings for the quarter ended March 31, 2018 were $22.7 million, an increase of $3.4 million when compared with earnings of $19.3 million for the quarter ended March 31, 2017. The increase in earnings was primarily due to lower income tax expense ($3.4 million) combined with the earnings impact of higher transportation and storage revenues of $0.6 million, as discussed above, and a decrease in interest expense ($0.3 million). Income tax expense was lower due to the current period earnings impact of the change in federal tax rate from 35% to a blended rate of 24.5% for fiscal 2018 as a result of the 2017 Tax Reform Act. The decrease in interest expense was largely due to lower intercompany long-term borrowing interest rates for the Pipeline and Storage segment. These earnings increases were slightly offset by a decrease in the allowance for funds used during construction (equity component) of $0.6 million which reflects the impact of a decrease in expansion projects currently in progress compared to the previous year's second quarter.
The Pipeline and Storage segment’s earnings for the six months ended March 31, 2018 were $61.2 million, an increase of $22.6 million when compared with earnings of $38.6 million for the six months ended March 31, 2017. The increase in earnings was primarily due to lower income tax expense ($21.0 million) combined with the earnings impact of higher storage revenues of $0.8 million, as discussed above, lower operating expenses ($2.1 million) and a decrease in interest expense ($0.6 million). Income tax expense was lower due to the remeasurement of accumulated deferred income taxes in the quarter ended December 31, 2017 ($14.1 million) combined with the current period earnings impact of the change in federal tax rate from 35% to a blended rate of 24.5% for fiscal 2018 ($6.9 million), both a result of the 2017 Tax Reform Act. The decrease in operating expenses primarily reflects lower pension and other post-retirement benefit costs partially offset by an increase in pipeline integrity program expenses. The decrease in interest expense was largely due to lower intercompany long-term borrowing interest rates for the Pipeline and Storage segment. These earnings increases were slightly offset by an increase in depreciation expense ($0.8 million), an increase in property taxes ($0.4 million) and a decrease in the allowance for funds used during construction (equity component) of $0.5 million. The increase in depreciation expense was due to incremental depreciation expense related to expansion projects that were placed in service within the last year combined with the non-recurrence of a reduction to depreciation expense recorded in the quarter ended December 31, 2016 to reflect a reduction in depreciation rates retroactive to July 1, 2016 in accordance with Empire's
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rate case settlement. The FERC issued an order approving the settlement on December 13, 2016. The decrease in allowance for funds used during construction reflects the impact of a decrease in expansion projects currently in progress compared to the previous year's six-month period.
Looking ahead, the Pipeline and Storage segment expects transportation revenues to be negatively impacted in fiscal 2019 in an amount up to approximately $14 million as a result of an Empire system transportation contract reaching its termination date in December 2018. The Company does not expect to renew the contract at existing rates given a change in market dynamics.
Gathering
Gathering Operating Revenues
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||||||||
(Thousands) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||||||||
Gathering | $ | 27,695 | $ | 27,936 | $ | (241 | ) | $ | 51,497 | $ | 55,776 | $ | (4,279 | ) | ||||
Processing and Other Revenues | 38 | 26 | 12 | 71 | 52 | 19 | ||||||||||||
$ | 27,733 | $ | 27,962 | $ | (229 | ) | $ | 51,568 | $ | 55,828 | $ | (4,260 | ) | |||||
Gathering Volume
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||
2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | |||||||
Gathered Volume - (MMcf) | 51,374 | 50,598 | 776 | 94,536 | 101,167 | (6,631 | ) | |||||
2018 Compared with 2017
Operating revenues for the Gathering segment decreased $0.2 million for the quarter ended March 31, 2018 as compared with the quarter ended March 31, 2017. Effective February 1, 2018, Midstream Corporation sold its Mt. Jewett, Owls Nest and Tionesta gathering systems at net book value, leading to a $0.3 million decrease in gathering revenues and a 0.2 Bcf decrease in gathered volume quarter over quarter. Midstream Corporation's remaining gathering systems at Covington, Trout Run, Clermont and Wellsboro had a combined revenue increase of $0.1 million and a combined increase in gathered volume of 1.0 Bcf quarter over quarter. While volume increased significantly, the slight increase in revenue can be attributed to gathering rate adjustments quarter over quarter. The 1.0 Bcf increase in gathered volume can be attributed to a net increase in Seneca's production quarter over quarter.
Operating revenues for the Gathering segment decreased $4.3 million for the six months ended March 31, 2018 as compared with the six months ended March 31, 2017, which was driven by a 6.6 Bcf decrease in gathered volume for all of its gathering systems. Midstream Corporation experienced a 4.7 Bcf decrease in gathered volume at its Trout Run gathering system, a 1.7 Bcf decrease in gathered volume at its Wellsboro gathering system, a 1.3 Bcf decrease in gathered volume at its Covington gathering system and a 0.2 Bcf decrease in gathered volume at its Mt. Jewett gathering system. These decreases were partially offset by a 1.3 Bcf increase in gathered volume at Midstream Corporation's Clermont gathering system. The decreases in the aforementioned volumes were largely due to a decrease in Seneca's production for the six months ended March 31, 2018 compared to the six months ended March 31, 2017.
The Gathering segment’s earnings for the quarter ended March 31, 2018 were $11.8 million, an increase of $1.5 million when compared with earnings of $10.3 million for the quarter ended March 31, 2017. The increase in earnings was mainly due to the impact of the 2017 Tax Reform Act, which led to the impact of the tax rate change on current income taxes ($1.9 million) offset by the impact of a remeasurement of accumulated deferred taxes ($0.4 million).
The Gathering segment’s earnings for the six months ended March 31, 2018 were $57.2 million, an increase of $35.9 million when compared with earnings of $21.3 million for the six months ended March 31, 2017. The increase in earnings was mainly due to the impact of the 2017 Tax Reform Act, which led to a remeasurement of accumulated deferred taxes ($34.5 million) and the impact of the tax rate change on current income taxes ($3.4 million). In addition, earnings benefited from lower income
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tax expense, excluding the aforementioned impacts of the 2017 Tax Reform Act ($1.1 million). These earnings increases were partially offset by lower gathering revenue ($2.8 million), as discussed above. Earnings were further reduced by an increase in depreciation expense ($0.3 million). The increase in depreciation expense was due to higher plant balances, primarily in Clermont.
Utility
Utility Operating Revenues
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||||||||
(Thousands) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||||||||
Retail Sales Revenues: | ||||||||||||||||||
Residential | $ | 207,089 | $ | 181,591 | $ | 25,498 | $ | 341,827 | $ | 297,977 | $ | 43,850 | ||||||
Commercial | 30,676 | 26,094 | 4,582 | 50,310 | 42,073 | 8,237 | ||||||||||||
Industrial | 1,829 | 1,018 | 811 | 2,701 | 1,535 | 1,166 | ||||||||||||
239,594 | 208,703 | 30,891 | 394,838 | 341,585 | 53,253 | |||||||||||||
Transportation | 51,845 | 49,006 | 2,839 | 88,154 | 85,667 | 2,487 | ||||||||||||
Off-System Sales | 318 | 3,354 | (3,036 | ) | 359 | 3,982 | (3,623 | ) | ||||||||||
Other | (2,279 | ) | 2,982 | (5,261 | ) | (4,602 | ) | 5,607 | (10,209 | ) | ||||||||
$ | 289,478 | $ | 264,045 | $ | 25,433 | $ | 478,749 | $ | 436,841 | $ | 41,908 | |||||||
Utility Throughput
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||
(MMcf) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||
Retail Sales: | ||||||||||||
Residential | 28,568 | 24,949 | 3,619 | 46,415 | 40,713 | 5,702 | ||||||
Commercial | 4,500 | 3,903 | 597 | 7,096 | 6,202 | 894 | ||||||
Industrial | 287 | 157 | 130 | 431 | 234 | 197 | ||||||
33,355 | 29,009 | 4,346 | 53,942 | 47,149 | 6,793 | |||||||
Transportation | 29,624 | 27,089 | 2,535 | 51,051 | 46,654 | 4,397 | ||||||
Off-System Sales | 119 | 1,122 | (1,003 | ) | 141 | 1,295 | (1,154 | ) | ||||
63,098 | 57,220 | 5,878 | 105,134 | 95,098 | 10,036 | |||||||
Degree Days
Three Months Ended March 31, | Percent Colder (Warmer) Than | |||||||||
Normal | 2018 | 2017 | Normal(1) | Prior Year(1) | ||||||
Buffalo | 3,290 | 3,208 | 2,866 | (2.5 | )% | 11.9 | % | |||
Erie | 3,108 | 3,075 | 2,627 | (1.1 | )% | 17.1 | % | |||
Six Months Ended March 31, | ||||||||||
Buffalo | 5,543 | 5,435 | 4,832 | (1.9 | )% | 12.5 | % | |||
Erie | 5,152 | 5,104 | 4,377 | (0.9 | )% | 16.6 | % | |||
(1) | Percents compare actual 2018 degree days to normal degree days and actual 2018 degree days to actual 2017 degree days. |
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2018 Compared with 2017
Operating revenues for the Utility segment increased $25.4 million for the quarter ended March 31, 2018 as compared with the quarter ended March 31, 2017. The increase largely resulted from a $30.9 million increase in retail gas sales revenues and a $2.8 million increase in transportation revenues. The increase in retail gas sales revenues was largely a result of higher volumes (due to colder weather) and an increase in the cost of gas sold (per Mcf). The increase in transportation revenues was primarily due to a 2.5 Bcf increase in transportation throughput due to colder weather. These increases were partially offset by a $3.0 million decrease in off-system sales (due to lower volumes) and a $5.3 million decrease in other revenues. The $5.3 million decrease in other revenues was largely due to a $5.3 million estimated refund provision recorded during the quarter ended March 31, 2018 for the current income tax benefits resulting from the 2017 Tax Reform Act. Due to profit sharing with retail customers, the margins related to off-system sales are minimal.
Operating revenues for the Utility segment increased $41.9 million for the six months ended March 31, 2018 as compared with the six months ended March 31, 2017. The increase largely resulted from a $53.3 million increase in retail gas sales revenues and a $2.5 million increase in transportation revenues. The increase in retail gas sales revenues was largely a result of higher volumes (due to colder weather) and an increase in the cost of gas sold (per Mcf). The increase in transportation revenues was primarily due to a 4.4 Bcf increase in transportation throughput due to colder weather, partially offset by the impact of regulatory adjustments. These increases were partially offset by a $3.6 million decrease in off-system sales (due to lower volumes) and a $10.2 million decrease in other revenues. The $10.2 million decrease in other revenues was largely due to an $11.3 million estimated refund provision recorded during the six months ended March 31, 2018 for the current income tax benefits resulting from the 2017 Tax Reform Act. Due to profit sharing with retail customers, the margins related to off-system sales are minimal.
The Utility segment’s earnings for the quarter ended March 31, 2018 were $33.4 million, an increase of $7.8 million when compared with earnings of $25.6 million for the quarter ended March 31, 2017. The increase in earnings was largely attributable to the new rate order issued by the NYPSC effective April 1, 2017 ($1.8 million), the impact of colder weather in fiscal 2018 compared to fiscal 2017 ($3.4 million), lower operating expenses of $1.2 million (primarily due to lower personnel costs which were slightly offset by higher amortization of environmental remediation costs that resulted from the new rate order) and $5.4 million from the current tax benefit associated with the 2017 Tax Reform Act. These increases were partially offset by the estimated refund provision for the current income tax benefits resulting from the 2017 Tax Reform Act ($3.9 million).
The impact of weather variations on earnings in the Utility segment’s New York rate jurisdiction is mitigated by that jurisdiction’s weather normalization clause (WNC). The WNC in New York, which covers the eight-month period from October through May, has had a stabilizing effect on earnings for the New York rate jurisdiction. In addition, in periods of colder than normal weather, the WNC benefits the Utility segment’s New York customers. For the quarter ended March 31, 2018, the WNC increased earnings by approximately $0.1 million, as the weather was warmer than normal. For the quarter ended March 31, 2017, the WNC increased earnings by approximately $2.5 million, as the weather was warmer than normal.
The Utility segment’s earnings for the six months ended March 31, 2018 were $54.4 million, an increase of $7.6 million when compared with earnings of $46.8 million for the quarter ended March 31, 2017. Higher earnings associated with the new rate order issued by the NYPSC effective April 1, 2017 ($2.8 million), the impact of colder weather in fiscal 2018 compared to fiscal 2017 ($4.7 million), lower operating expenses ($0.5 million), lower interest expense ($0.5 million) and the current tax benefit associated with the 2017 Tax Reform Act ($10.2 million) were partially offset by the impact of higher income tax expense of $1.9 million (largely due to higher state income taxes) and the estimated refund provision for the current income tax benefits resulting from the 2017 Tax Reform Act ($8.3 million). The decrease in operating expenses is primarily due to lower personnel costs, which were partially offset by higher amortization of environmental remediation costs that resulted from the new rate order. The decrease in interest expense was largely due to lower intercompany long-term borrowing interest rates for the Utility segment.
For the six months ended March 31, 2018, the WNC increased earnings by approximately $1.0 million, as the weather was warmer than normal. For the six months ended March 31, 2017, the WNC increased earnings by approximately $3.8 million, as the weather was warmer than normal.
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Energy Marketing
Energy Marketing Operating Revenues
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||||||||
(Thousands) | 2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | ||||||||||||
Natural Gas (after Hedging) | $ | 55,588 | $ | 50,945 | $ | 4,643 | $ | 94,319 | $ | 87,735 | $ | 6,584 | ||||||
Other | 5 | 11 | (6 | ) | 37 | 50 | (13 | ) | ||||||||||
$ | 55,593 | $ | 50,956 | $ | 4,637 | $ | 94,356 | $ | 87,785 | $ | 6,571 | |||||||
Energy Marketing Volume
Three Months Ended March 31, | Six Months Ended March 31, | |||||||||||
2018 | 2017 | Increase (Decrease) | 2018 | 2017 | Increase (Decrease) | |||||||
Natural Gas – (MMcf) | 16,112 | 14,120 | 1,992 | 28,091 | 25,248 | 2,843 | ||||||
2018 Compared with 2017
Operating revenues for the Energy Marketing segment increased $4.6 million for the quarter ended March 31, 2018 as compared with the quarter ended March 31, 2017. Operating revenues for the Energy Marketing segment increased $6.6 million for the six months ended March 31, 2018 as compared with the six months ended March 31, 2017. The increases for the quarter and the six month-period were primarily due to an increase in gas sales revenue due to an increase in volume sold to retail customers as a result of colder weather, offset slightly by a lower average price of natural gas period over period.
The Energy Marketing segment earnings for the quarter ended March 31, 2018 were $0.6 million, a decrease of $0.3 million when compared with earnings of $0.9 million for the quarter ended March 31, 2017. This decrease in earnings was primarily attributable to lower margin of $0.4 million. The decrease in margin largely reflects a decline in average margin per Mcf primarily due to stronger natural gas prices at local purchase points relative to NYMEX-based sales contracts. The 2017 Tax Reform Act did not have a significant impact on Energy Marketing segment earnings for the quarter ended March 31, 2018.
The Energy Marketing segment earnings for the six months ended March 31, 2018 were $1.6 million, a decrease of $1.1 million when compared with earnings of $2.7 million for the six months ended March 31, 2017. This decrease in earnings was primarily attributable to lower margin of $1.2 million. The decrease in margin largely reflects a decline in average margin per Mcf primarily due to stronger natural gas prices at local purchase points relative to NYMEX-based sales contracts. The 2017 Tax Reform Act did not have a significant impact on Energy Marketing segment earnings for the six months ended March 31, 2018.
Corporate and All Other
2018 Compared with 2017
Corporate and All Other operations had a loss of $3.1 million for the quarter ended March 31, 2018, which was $2.6 million higher than the loss of $0.5 million for the quarter ended March 31, 2017. The increase in loss for the quarter is primarily attributed to a remeasurement of accumulated deferred taxes under the 2017 Tax Reform Act ($2.7 million), the impact of tax rate changes associated with the 2017 Tax Reform Act ($0.1 million), and higher depreciation expense ($0.3 million). These decreases were partially offset by higher margins of $0.7 million from the sale of standing timber by Seneca's land and timber division.
For the six months ended March 31, 2018, Corporate and All Other operations had a loss of $17.1 million, a decrease of over $17.0 million when compared with earnings of less than $0.1 million for the six months ended March 31, 2017. The earnings decrease for the quarter is primarily attributed to a remeasurement of accumulated deferred taxes under the 2017 Tax Reform Act ($17.8 million) and higher depreciation expense ($0.2 million). These decreases in earnings were partially offset by higher margins of $1.0 million from the sale of standing timber by Seneca's land and timber division.
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Interest Expense on Long-Term Debt (amounts below are pre-tax amounts)
Interest on long-term debt decreased $1.8 million for the quarter ended March 31, 2018 as compared with the quarter ended March 31, 2017. For the six months ended March 31, 2018, interest on long-term debt decreased $2.8 million as compared with the six months ended March 31, 2017. These decreases are due to a decrease in the weighted average interest rate on long-term debt outstanding. The Company issued $300 million of 3.95% notes in September 2017 and repaid $300 million of 6.5% notes in October 2017.
CAPITAL RESOURCES AND LIQUIDITY
The Company’s primary sources of cash during the six-month periods ended March 31, 2018 and March 31, 2017 consisted of cash provided by operating activities and net proceeds from the sale of oil and gas producing properties.
Operating Cash Flow
Internally generated cash from operating activities consists of net income available for common stock, adjusted for non-cash expenses, non-cash income and changes in operating assets and liabilities. Non-cash items include depreciation, depletion and amortization, deferred income taxes and stock-based compensation.
Cash provided by operating activities in the Utility and Pipeline and Storage segments may vary substantially from period to period because of the impact of rate cases. In the Utility segment, supplier refunds, over- or under-recovered purchased gas costs and weather may also significantly impact cash flow. The impact of weather on cash flow is tempered in the Utility segment’s New York rate jurisdiction by its WNC and in the Pipeline and Storage segment by the straight fixed-variable rate design used by Supply Corporation and Empire.
Because of the seasonal nature of the heating business in the Utility and Energy Marketing segments, revenues in these segments are relatively high during the heating season, primarily the first and second quarters of the fiscal year, and receivable balances historically increase during these periods from the receivable balances at September 30.
The storage gas inventory normally declines during the first and second quarters of the fiscal year and is replenished during the third and fourth quarters. For storage gas inventory accounted for under the LIFO method, the current cost of replacing gas withdrawn from storage is recorded in the Consolidated Statements of Income and a reserve for gas replacement is recorded in the Consolidated Balance Sheets under the caption "Other Accruals and Current Liabilities." Such reserve is reduced as the inventory is replenished.
Cash provided by operating activities in the Exploration and Production segment may vary from period to period as a result of changes in the commodity prices of natural gas and crude oil as well as changes in production. The Company uses various derivative financial instruments, including price swap agreements and futures contracts in an attempt to manage this energy commodity price risk.
Net cash provided by operating activities totaled $286.8 million for the six months ended March 31, 2018, a decrease of $65.1 million compared with $351.9 million provided by operating activities for the six months ended March 31, 2017. The decrease in cash provided by operating activities reflects lower cash provided by operating activities in the Exploration and Production segment primarily due to lower cash receipts from crude oil and natural gas production as a result of lower natural gas prices and lower production.
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Investing Cash Flow
Expenditures for Long-Lived Assets
The Company’s expenditures for long-lived assets totaled $241.4 million during the six months ended March 31, 2018 and $184.7 million during the six months ended March 31, 2017. The table below presents these expenditures:
Total Expenditures for Long-Lived Assets | |||||||||||
Six Months Ended March 31, | 2018 | 2017 | Increase (Decrease) | ||||||||
(Millions) | |||||||||||
Exploration and Production: | |||||||||||
Capital Expenditures | $ | 159.3 | (1) | $ | 97.8 | (2) | $ | 61.5 | |||
Pipeline and Storage: | |||||||||||
Capital Expenditures | 37.4 | (1) | 36.8 | (2) | 0.6 | ||||||
Gathering: | |||||||||||
Capital Expenditures | 32.3 | (1) | 14.5 | (2) | 17.8 | ||||||
Utility: | |||||||||||
Capital Expenditures | 32.3 | (1) | 36.3 | (2) | (4.0 | ) | |||||
All Other: | |||||||||||
Capital Expenditures | — | 0.1 | (0.1 | ) | |||||||
Eliminations | (19.9 | ) | (0.8 | ) | (19.1 | ) | |||||
$ | 241.4 | $ | 184.7 | $ | 56.7 | ||||||
(1) | At March 31, 2018, capital expenditures for the Exploration and Production segment, the Pipeline and Storage segment, the Gathering segment and the Utility segment include $38.8 million, $9.0 million, $1.6 million and $2.5 million, respectively, of non-cash capital expenditures. At September 30, 2017, capital expenditures for the Exploration and Production segment, the Pipeline and Storage segment, the Gathering segment and the Utility segment included $36.5 million, $25.1 million, $3.9 million and $6.7 million, respectively, of non-cash capital expenditures. The capital expenditures for the Exploration and Production segment do not include any proceeds received from the sale of oil and gas assets to IOG under the joint development agreement. |
(2) | At March 31, 2017, capital expenditures for the Exploration and Production segment, the Pipeline and Storage segment, the Gathering segment and the Utility segment included $23.2 million, $5.8 million, $2.2 million and $5.7 million, respectively, of non-cash capital expenditures. At September 30, 2016, capital expenditures for the Exploration and Production segment, the Pipeline and Storage segment, the Gathering segment and the Utility segment included $25.2 million, $18.7 million, $5.3 million and $11.2 million, respectively, of non-cash capital expenditures. The capital expenditures for the Exploration and Production segment do not include any proceeds received from the sale of oil and gas assets to IOG under the joint development agreement. |
Exploration and Production
The Exploration and Production segment capital expenditures for the six months ended March 31, 2018 were primarily well drilling and completion expenditures and included approximately $146.6 million for the Appalachian region (including $120.7 million in the Marcellus Shale area) and $12.7 million for the West Coast region. These amounts included approximately $80.7 million spent to develop proved undeveloped reserves.
Looking ahead, the Exploration and Production segment will add a third horizontal drilling rig to its Appalachian operations in the third quarter of fiscal 2018. With the addition of this rig, Exploration and Production segment capital expenditures are expected to increase to approximately $360 million for fiscal 2018. The additional rig will be primarily dedicated to the redevelopment of the Clermont-Rich Valley acreage for the Utica Shale.
On December 1, 2015, Seneca and IOG - CRV Marcellus, LLC (IOG), an affiliate of IOG Capital, LP, and funds managed by affiliates of Fortress Investment Group, LLC, executed a joint development agreement that allows IOG to participate in the development of certain oil and gas interests owned by Seneca in Elk, McKean and Cameron Counties, Pennsylvania. On June 13, 2016, Seneca and IOG executed an extension of the joint development agreement. Under the terms of the extended agreement, Seneca and IOG will jointly participate in a program to develop up to 75 Marcellus wells, with Seneca serving as program operator. IOG will hold an 80% working interest in all of the joint development wells. In total, IOG is expected to fund approximately $305 million for its 80% working interest in the 75 joint development wells. Of this amount, IOG has funded $301.5 million as of March 31, 2018, which includes $181.2 million of cash ($137.3 million in fiscal 2016, $26.6 million in fiscal 2017 and $17.3 million for the six months ended March 31, 2018) shown as Net Proceeds from Sale of Oil and Gas Producing Properties on the Consolidated Statements of Cash Flows for fiscal 2016, fiscal 2017 and for the six months ended March 31, 2018, respectively. Such proceeds from sale represent funding received from IOG for costs previously incurred by Seneca to develop a portion of the
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75 joint development wells. The remainder funded joint development expenditures. For further discussion of the extended joint development agreement, refer to Item 1 at Note 1 - Summary of Significant Accounting Policies under the heading “Property, Plant and Equipment.”
The Exploration and Production segment capital expenditures for the six months ended March 31, 2017 were primarily well drilling and completion expenditures and included approximately $75.3 million for the Appalachian region (including $55.5 million in the Marcellus Shale area) and $22.5 million for the West Coast region. These amounts included approximately $34.3 million spent to develop proved undeveloped reserves.
Pipeline and Storage
The Pipeline and Storage segment capital expenditures for the six months ended March 31, 2018 were partially for additions, improvements and replacements to this segment’s transmission and gas storage systems. In addition, the Pipeline and Storage segment capital expenditures for the six months ended March 31, 2018 include expenditures related to Supply Corporation's Line D Expansion Project ($13.5 million), as discussed below. The Pipeline and Storage capital expenditures for the six months ended March 31, 2017 were mainly for expenditures related to Empire and Supply Corporation's Northern Access 2016 Project ($18.3 million) and Supply Corporation's Line D Expansion Project ($5.6 million) and also included additions, improvements, and replacements to this segment’s transmission and gas storage systems.
In light of the continuing demand for pipeline capacity to move natural gas from new wells being drilled in Appalachia — specifically in the Marcellus and Utica Shale producing areas — Supply Corporation and Empire have recently completed and are actively pursuing several expansion projects designed to move anticipated Marcellus and Utica production gas to other interstate pipelines and to on-system markets, and markets beyond the Supply Corporation and Empire pipeline systems. Preliminary survey and investigation costs for expansion, routine replacement or modernization projects are initially recorded as Deferred Charges on the Consolidated Balance Sheet. Management may reserve for preliminary survey and investigation costs associated with large projects by reducing the Deferred Charges balance and increasing Operation and Maintenance Expense on the Consolidated Statement of Income. If it is determined that it is highly probable that a project for which a reserve has been established will be built, the reserve is reversed. This reversal reduces Operation and Maintenance Expense and reestablishes the original balance in Deferred Charges. The amounts remain in Deferred Charges until such time as capital expenditures for the project have been incurred and activities that are necessary to get the construction project ready for its intended use are in progress. At that point, the balance is transferred from Deferred Charges to Construction Work in Progress, a component of Property, Plant and Equipment on the Consolidated Balance Sheet.
Supply Corporation and Empire are developing a project which would move significant prospective Marcellus production from Seneca's Western Development Area at Clermont to an Empire interconnection with TransCanada Pipeline at Chippawa and an interconnection with TGP's 200 Line in East Aurora, New York (“Northern Access 2016”). The Northern Access 2016 project would provide an outlet to Dawn-indexed markets in Canada and to the TGP line serving the U.S. Northeast. The Northern Access 2016 project involves the construction of approximately 99 miles of largely 24” pipeline and approximately 27,500 horsepower of compression on the two systems. The preliminary cost estimate for the Northern Access 2016 project is approximately $500 million. Supply Corporation, Empire and Seneca executed anchor shipper agreements for 350,000 Dth per day of firm transportation delivery capacity to Chippawa and 140,000 Dth per day of firm transportation capacity to a new interconnection with TGP's 200 Line on this project. On February 3, 2017, the Company received FERC approval of the project. On April 7, 2017, the NYDEC issued a Notice of Denial of the federal Clean Water Act Section 401 Water Quality Certification and other state stream and wetland permits for the New York portion of the project (the Water Quality Certification for the Pennsylvania portion of the project was received on January 27, 2017). On April 21, 2017, the Company appealed the NYDEC's decision with regard to the Water Quality Certification to the United States Court of Appeals for the Second Circuit, and on May 11, 2017, the Company commenced legal action in New York State Supreme Court challenging the NYDEC's actions with regard to various state permits. The Company also has pending with FERC a proceeding asserting, among other things, that the NYDEC exceeded the reasonable and statutory time frames to take action under the Clean Water Act and, therefore, waived its opportunity to approve or deny the Water Quality Certification. In light of these pending legal actions, the Company has not yet determined a target in-service date. The Company remains committed to the project. As of March 31, 2018, approximately $75.1 million has been spent on the Northern Access 2016 project, including $22.4 million that has been spent to study the project, for which no reserve has been established. The remaining $52.7 million spent on the project has been capitalized as Construction Work in Progress.
On November 21, 2014, Supply Corporation concluded an Open Season for an expansion of its Line D pipeline (“Line D Expansion”) that is intended to allow growing on-system markets to avail themselves of economical gas supply on the TGP 300 line, at an existing interconnect at Lamont, Pennsylvania, and provide increased capacity into the Erie, Pennsylvania market area. Supply Corporation has executed Service Agreements for a total of 77,500 Dth per day for terms of six to ten years and services began November 1, 2017. The project included construction of a new 4,140 horsepower Keelor Compressor Station and
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modifications to the Bowen compressor station at an estimated capital cost of approximately $28.2 million. The project also provides system modernization benefits. As of March 31, 2018, approximately $27.9 million has been spent on the Line D Expansion project, all of which is included in Property, Plant and Equipment on the Consolidated Balance Sheet at March 31, 2018.
Empire concluded an Open Season on November 18, 2015, and has designed a project that would allow for the transportation of 205,000 Dth per day of additional shale supplies from interconnections in Tioga County, Pennsylvania, to TransCanada Pipeline, and the TGP 200 Line (“Empire North Project”). This project is fully subscribed under long term agreements. Empire filed a Section 7(c) application with the FERC in February 2018. The Empire North Project has a projected in-service date in the second half of fiscal 2020 and an estimated capital cost of approximately $140 million to $145 million. As of March 31, 2018, approximately $1.8 million has been spent to study this project, all of which has been included in Deferred Charges on the Consolidated Balance Sheet at March 31, 2018.
Supply Corporation has entered into a foundation shipper Precedent Agreement to provide incremental natural gas transportation services from Line N to the ethylene cracker facility being constructed by Shell Chemical Appalachia, LLC in Potter Township, Pennsylvania. Supply Corporation has completed an Open Season for the project and has secured incremental firm transportation capacity commitments totaling 133,000 Dth per day on Line N and on the proposed pipeline extension of approximately 4.5 miles from Line N to the facility. Supply Corporation filed a prior notice application with FERC on March 23, 2018. The proposed in-service date for this project is as early as June 1, 2019 and capital costs are expected to be $20.2 million. As of March 31, 2018, approximately $0.6 million has been spent to study this project, all of which has been included in Deferred Charges on the Consolidated Balance Sheet at March 31, 2018.
Supply Corporation is currently in the pre-filing process at FERC for its FM100 Modernization Project, which is expected to upgrade 1950's era pipeline in northwestern Pennsylvania. Supply Corporation is expected to add an expansion component to this project, which is expected to create approximately 300,000 Dth per day of additional capacity on its system in Pennsylvania from a receipt point with NFG Midstream Clermont, LLC in McKean County to the Transcontinental Gas Pipe Line Company, LLC (“Transco”) system at Leidy, Pennsylvania. This additional capacity is expected to be offered to Transco under a lease and will be part of the capacity Transco will offer in connection with a to-be-announced expansion project that will make available capacity from receipt points along its Leidy Line to Zone 6 markets. Seneca will be an anchor shipper on Transco’s project, providing Seneca with an outlet to premium markets for its Marcellus and Utica production from both the Clermont-Rich Valley and Trout Run-Gamble areas. The preliminary cost estimate for the entire project is approximately $250 million to $300 million. As of March 31, 2018, approximately $0.9 million has been spent to study this project, all of which has been included in Deferred Charges on the Consolidated Balance Sheet at March 31, 2018.
Gathering
The majority of the Gathering segment capital expenditures for the six months ended March 31, 2018 were for the purchase of two compressor stations for Midstream Corporation's Covington Gathering System, as well as the continued buildout of Midstream Corporation’s Trout Run Gathering System and Midstream Corporation's Clermont Gathering System, as discussed below. The majority of the Gathering segment capital expenditures for the six months ended March 31, 2017 were for the construction of the Clermont Gathering System.
NFG Midstream Clermont, LLC, a wholly owned subsidiary of Midstream Corporation, is building an extensive gathering system with compression in the Pennsylvania counties of McKean, Elk and Cameron. The total cost estimate for the continued buildout will be dependent on the nature and timing of Seneca's long-term plans. As of March 31, 2018, approximately $289.6 million has been spent on the Clermont Gathering System, including approximately $8.3 million spent during the six months ended March 31, 2018, all of which is included in Property, Plant and Equipment on the Consolidated Balance Sheet at March 31, 2018.
NFG Midstream Trout Run, LLC, a wholly owned subsidiary of Midstream Corporation, continues to develop its Trout Run Gathering System in Lycoming County, Pennsylvania. The Trout Run Gathering System was initially placed in service in May 2012. The current system consists of approximately 48 miles of backbone and in-field gathering pipelines, two compressor stations and a dehydration and metering station. As of March 31, 2018, approximately $188.4 million has been spent on the Trout Run Gathering System, including approximately $11.0 million spent during the six months ended March 31, 2018, all of which is included in Property, Plant and Equipment on the Consolidated Balance Sheet at March 31, 2018.
NFG Midstream Wellsboro, LLC, a wholly owned subsidiary of Midstream Corporation, continues to develop its Wellsboro Gathering System in Tioga County, Pennsylvania. As of March 31, 2018, the Company has spent approximately $6.6 million in costs related to this project, all of which is included in Property, Plant and Equipment on the Consolidated Balance Sheet at March 31, 2018.
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Utility
The majority of the Utility segment capital expenditures for the six months ended March 31, 2018 and March 31, 2017 were made for main and service line improvements and replacements, as well as main extensions.
Project Funding
The Company has been financing the Pipeline and Storage segment and Gathering segment projects mentioned above, as well as the Exploration and Production segment capital expenditures, with cash from operations and both short and long-term borrowings. Going forward, while the Company expects to use cash on hand and cash from operations as the first means of financing these projects, the Company may issue short-term and/or long-term debt as necessary during fiscal 2018 to help meet its capital expenditures needs. The level of short-term and long-term borrowings will depend upon the amount of cash provided by operations, which, in turn, will likely be impacted by natural gas and crude oil prices combined with production from existing wells.
The Company continuously evaluates capital expenditures and potential investments in corporations, partnerships, and other business entities. The amounts are subject to modification for opportunities such as the acquisition of attractive oil and gas properties, natural gas storage facilities and the expansion of natural gas transmission line capacities. While the majority of capital expenditures in the Utility segment are necessitated by the continued need for replacement and upgrading of mains and service lines, the magnitude of future capital expenditures or other investments in the Company’s other business segments depends, to a large degree, upon market conditions.
Financing Cash Flow
The Company did not have any consolidated short-term debt outstanding at March 31, 2018 or September 30, 2017, nor was there any short-term debt outstanding during the six months ended March 31, 2018. The Company continues to consider short-term debt (consisting of short-term notes payable to banks and commercial paper) an important source of cash for temporarily financing capital expenditures, gas-in-storage inventory, unrecovered purchased gas costs, margin calls on derivative financial instruments, exploration and development expenditures, other working capital needs and repayment of long-term debt. Fluctuations in these items can have a significant impact on the amount and timing of short-term debt.
On September 9, 2016, the Company entered into a Third Amended and Restated Credit Agreement (Credit Agreement) with a syndicate of what now numbers 13 banks. This Credit Agreement provides a $750.0 million multi-year unsecured committed revolving credit facility through December 5, 2019. The Company also has a number of individual uncommitted or discretionary lines of credit with certain financial institutions for general corporate purposes. Borrowings under the uncommitted lines of credit are made at competitive market rates. The uncommitted credit lines are revocable at the option of the financial institutions and are reviewed on an annual basis. The Company anticipates that its uncommitted lines of credit generally will be renewed or substantially replaced by similar lines.
The total amount available to be issued under the Company’s commercial paper program is $500.0 million. The commercial paper program is backed by the Credit Agreement, which provides that the Company's debt to capitalization ratio will not exceed .65 at the last day of any fiscal quarter from October 1, 2017 through December 5, 2019. At March 31, 2018, the Company’s debt to capitalization ratio (as calculated under the facility) was .52. The constraints specified in the Credit Agreement would have permitted an additional $1.47 billion in short-term and/or long-term debt to be outstanding (further limited by the indenture covenants discussed below) before the Company’s debt to capitalization ratio exceeded .65.
A downgrade in the Company’s credit ratings could increase borrowing costs, negatively impact the availability of capital from banks, commercial paper purchasers and other sources, and require the Company's subsidiaries to post letters of credit, cash or other assets as collateral with certain counterparties. If the Company is not able to maintain investment-grade credit ratings, it may not be able to access commercial paper markets. However, the Company expects that it could borrow under its credit facilities or rely upon other liquidity sources, including cash provided by operations.
The Credit Agreement contains a cross-default provision whereby the failure by the Company or its significant subsidiaries to make payments under other borrowing arrangements, or the occurrence of certain events affecting those other borrowing arrangements, could trigger an obligation to repay any amounts outstanding under the Credit Agreement. In particular, a repayment obligation could be triggered if (i) the Company or any of its significant subsidiaries fails to make a payment when due of any principal or interest on any other indebtedness aggregating $40.0 million or more or (ii) an event occurs that causes, or would permit the holders of any other indebtedness aggregating $40.0 million or more to cause, such indebtedness to become due prior to its stated maturity. As of March 31, 2018, the Company did not have any debt outstanding under the Credit Agreement.
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None of the Company’s long-term debt at March 31, 2018 had a maturity date within the following twelve-month period. The Current Portion of Long-Term Debt at September 30, 2017 consisted of $300.0 million aggregate principal amount of 6.50% notes scheduled to mature in April 2018. The Company redeemed these notes on October 18, 2017 for $307.0 million, plus accrued interest.
The Company’s embedded cost of long-term debt was 5.16% and 5.53% at March 31, 2018 and March 31, 2017, respectively.
Under the Company’s existing indenture covenants at March 31, 2018, the Company would have been permitted to issue up to a maximum of $738.0 million in additional long-term indebtedness at then current market interest rates in addition to being able to issue new indebtedness to replace maturing debt. The Company's present liquidity position is believed to be adequate to satisfy known demands. However, if the Company were to experience a significant loss in the future (for example, as a result of an impairment of oil and gas properties), it is possible, depending on factors including the magnitude of the loss, that these indenture covenants would restrict the Company's ability to issue additional long-term unsecured indebtedness for a period of up to nine calendar months, beginning with the fourth calendar month following the loss. This would not preclude the Company from issuing new indebtedness to replace maturing debt. Please refer to the Critical Accounting Estimates section above for a sensitivity analysis concerning commodity price changes and their impact on the ceiling test.
The Company’s 1974 indenture pursuant to which $99.0 million (or 4.7%) of the Company’s long-term debt (as of March 31, 2018) was issued, contains a cross-default provision whereby the failure by the Company to perform certain obligations under other borrowing arrangements could trigger an obligation to repay the debt outstanding under the indenture. In particular, a repayment obligation could be triggered if the Company fails (i) to pay any scheduled principal or interest on any debt under any other indenture or agreement or (ii) to perform any other term in any other such indenture or agreement, and the effect of the failure causes, or would permit the holders of the debt to cause, the debt under such indenture or agreement to become due prior to its stated maturity, unless cured or waived.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has entered into certain off-balance sheet financing arrangements. These financing arrangements are primarily operating leases. The Company’s consolidated subsidiaries have operating leases, the majority of which are with the Exploration and Production segment and Corporate operations, having a remaining lease commitment of approximately $37.5 million. These leases have been entered into for the use of compressors, drilling rigs, buildings and other items and are accounted for as operating leases.
OTHER MATTERS
In addition to the legal proceedings disclosed in Part II, Item 1 of this report, the Company is involved in other litigation and regulatory matters arising in the normal course of business. These other matters may include, for example, negligence claims and tax, regulatory or other governmental audits, inspections, investigations or other proceedings. These matters may involve state and federal taxes, safety, compliance with regulations, rate base, cost of service and purchased gas cost issues, among other things. While these normal-course matters could have a material effect on earnings and cash flows in the period in which they are resolved, they are not expected to change materially the Company’s present liquidity position, nor are they expected to have a material adverse effect on the financial condition of the Company.
During the six months ended March 31, 2018, the Company contributed $27.6 million to its tax-qualified, noncontributory defined-benefit retirement plan (Retirement Plan) and $2.1 million to its VEBA trusts for its other post-retirement benefits. In the remainder of 2018, the Company may contribute up to $5.0 million to the Retirement Plan. In the remainder of 2018, the Company expects its contributions to the VEBA trusts to be in the range of $0.5 million to $1.0 million.
Market Risk Sensitive Instruments
On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act includes provisions related to the swaps and over-the-counter derivatives markets that are designed to promote transparency, mitigate systemic risk and protect against market abuse. Although regulators have issued certain regulations, other rules that may impact the Company have yet to be finalized.
The CFTC’s Dodd-Frank regulations continue to preserve the ability of non-financial end users to hedge their risks using swaps without being subject to mandatory clearing. In 2015, legislation was enacted to exempt from margin requirements swaps used by non-financial end-users to hedge or mitigate commercial risk. In 2016, the CFTC issued a reproposal to its position limit
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rules that would impose speculative position limits on positions in 28 core physical commodity contracts as well as economically equivalent futures, options and swaps. While the Company does not intend to enter into positions on a speculative basis, such rules could nevertheless impact the ability of the Company to enter into certain derivative hedging transactions with respect to such commodities. If we reduce our use of hedging transactions as a result of final regulations to be issued by the CFTC, our results of operations may become more volatile and our cash flows may be less predictable. There may be other rules developed by the CFTC and other regulators that could impact the Company. While many of those rules place specific conditions on the operations of swap dealers and major swap participants, concern remains that swap dealers and major swap participants will pass along their increased costs stemming from final rules through higher transaction costs and prices or other direct or indirect costs.
Finally, given the additional authority granted to the CFTC on anti-market manipulation, anti-fraud and disruptive trading practices, it is difficult to predict how the evolving enforcement priorities of the CFTC will impact our business. Should we violate any laws or regulations applicable to our hedging activities, we could be subject to CFTC enforcement action and material penalties and sanctions. The Company continues to monitor these enforcement and other regulatory developments, but cannot predict the impact that evolving application of the Dodd-Frank Act may have on its operations.
The accounting rules for fair value measurements and disclosures require consideration of the impact of nonperformance risk (including credit risk) from a market participant perspective in the measurement of the fair value of assets and liabilities. At March 31, 2018, the Company determined that nonperformance risk would have no material impact on its financial position or results of operation. To assess nonperformance risk, the Company considered information such as any applicable collateral posted, master netting arrangements, and applied a market-based method by using the counterparty's (assuming the derivative is in a gain position) or the Company’s (assuming the derivative is in a loss position) credit default swaps rates.
For a complete discussion of market risk sensitive instruments, refer to "Market Risk Sensitive Instruments" in Item 7 of the Company's 2017 Form 10-K. There have been no subsequent material changes to the Company’s exposure to market risk sensitive instruments.
Rate and Regulatory Matters
Utility Operation
Delivery rates for both the New York and Pennsylvania divisions are regulated by the states’ respective public utility commissions and typically are changed only when approved through a procedure known as a “rate case.” Although the Pennsylvania division does not have a rate case on file, see below for a description of the current rate proceedings affecting the New York division. In both jurisdictions, delivery rates do not reflect the recovery of purchased gas costs. Prudently-incurred gas costs are recovered through operation of automatic adjustment clauses, and are collected primarily through a separately-stated “supply charge” on the customer bill.
New York Jurisdiction
Distribution Corporation's current delivery rates in its New York jurisdiction were approved by the NYPSC in an order issued on April 20, 2017 with rates becoming effective May 1, 2017. On July 28, 2017, Distribution Corporation filed an appeal with New York State Supreme Court, Albany County, seeking review of the Order. The appeal contends that portions of the Order should be invalidated because they fail to meet the applicable legal standard for agency decisions. On December 11, 2017, the appeal was transferred to the Supreme Court, Appellate Division, Third Department. The Company cannot predict the outcome of the appeal at this time.
On December 29, 2017, the NYPSC issued an order instituting a proceeding to study the potential effects of the enactment of the 2017 Tax Reform Act on the tax expenses and liabilities of New York utilities, and the “regulatory treatment of any windfalls resulting from same in order to preserve the benefits for ratepayers.” In its order, the NYPSC stated that the effect of the 2017 Tax Reform Act on utilities’ taxation is likely to be material and complex and that the proceeding was needed to begin the process of addressing the impact on the State’s utilities and ratepayers. The order also declares that utilities are “put on notice that it is the [NYPSC]’s intent to ensure that net benefits accruing from the Tax Act are preserved for ratepayers, either through deferral accounting or another method, from the first day the Tax Act is put into effect. Utilities acting contrary to this intent do so at their own risk.” Pursuant to the order, a technical conference was held with the utilities in February 2018, and on March 29, 2018, the New York Department of Public Service Staff (Staff) issued a proposal for accounting and ratemaking treatment of the tax changes. Interested parties have been invited to comment on the Staff proposal, including whether and how to incorporate into utility rates any modifications necessary to reflect changes in federal tax law affecting utilities. Refer to Item 1 at Note 4 - Income Taxes for further discussion of the 2017 Tax Reform Act.
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Pennsylvania Jurisdiction
Distribution Corporation’s Pennsylvania jurisdiction delivery rates are being charged to customers in accordance with a rate settlement approved by the PaPUC. The rate settlement does not specify any requirement to file a future rate case.
By Secretarial Letter issued February 12, 2018, the PaPUC initiated a proceeding to determine the effects of the 2017 Tax Reform Act on the tax liabilities of PaPUC-regulated public utilities for 2018 and future years and the feasibility of reflecting such impacts on the rates charged to utility ratepayers. In connection with such letter, the PaPUC issued certain data requests to utilities regarding the 2017 Tax Reform Act, and Distribution Corporation filed responses in March 2018. On March 15, 2018, the PaPUC issued a Temporary Rates Order making Distribution Corporation's rates (along with the rates of other Pennsylvania public utilities not presently in a general rate increase proceeding) temporary for a period of six months, which may be extended by the PaPUC for an additional six months. The order states that due to the decrease in federal tax rates associated with the 2017 Tax Reform Act, it appears that existing utility rates may be excessive and, therefore, no longer just and reasonable. The order states that the PaPUC is making rates temporary to maximize its authority to establish any negative surcharge, refund or other rate adjustment deemed to be necessary, just and reasonable to account for the tax rate reductions associated with the 2017 Tax Reform Act, and is consistent with the approach that the PaPUC took following federal tax reform in 1986. The order further states that the PaPUC anticipates that after further review and analysis of the responses to data requests, financial information and public comments, it will direct utilities to file appropriate tariffs to account for the tax reductions associated with the 2017 Tax Reform Act that became effective January 1, 2018. Refer to Item 1 at Note 4 - Income Taxes for further discussion of the 2017 Tax Reform Act.
Pipeline and Storage
Supply Corporation currently has no active rate case on file. Supply Corporation's current rate settlement requires a rate case filing no later than December 31, 2019.
Empire currently has no active rate case on file. Empire’s current rate settlement requires a rate case filing no later than July 1, 2021.
On March 15, 2018, the FERC issued three documents regarding its plans to undertake review of the 2017 Tax Reform Act and its impact on pipelines: a Notice of Proposed Rulemaking which proposes to require pipelines to file a new form isolating the tax impact to each pipeline and also to make an election regarding the action the pipelines will take to address the lower tax rates, one of which is filing a Section 4 rate proceeding; a Policy Statement regarding the treatment of taxes by MLP entities; and a Notice of Inquiry regarding treatment of accumulated deferred income taxes and other tax issues associated with the 2017 Tax Reform Act. The Company cannot predict the outcome of any of these proceedings at this time. Refer to Item 1 at Note 4 - Income Taxes for further discussion of the 2017 Tax Reform Act.
Environmental Matters
The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and comply with regulatory requirements.
For further discussion of the Company's environmental exposures, refer to Item 1 at Note 6 — Commitments and Contingencies under the heading “Environmental Matters.”
Legislative and regulatory measures to address climate change and greenhouse gas emissions are in various phases of discussion or implementation. In the United States, these efforts include legislative proposals and EPA regulations at the federal level, actions at the state level, and private party litigation related to greenhouse gas emissions. While the U.S. Congress has from time to time considered legislation aimed at reducing emissions of greenhouse gases, Congress has not yet passed any federal climate change legislation and we cannot predict when or if Congress will pass such legislation and in what form. In the absence of such legislation, the EPA is regulating greenhouse gas emissions pursuant to the authority granted to it by the federal Clean Air Act. For example, in April 2012, the EPA adopted rules which restrict emissions associated with oil and natural gas drilling. The EPA previously adopted final regulations that set methane and volatile organic compound emissions standards for new or modified oil and gas emissions sources. These rules impose more stringent leak detection and repair requirements, and further address reporting and control of methane and volatile organic compound emissions. The current administration has issued executive orders to review and potentially roll back many of these regulations, and, in turn, litigation (not involving the Company) has been instituted to challenge the administration's efforts. The Company must continue to comply with all applicable regulations. In addition, the U.S. Congress has from time to time considered bills that would establish a cap-and-trade program to reduce emissions of greenhouse
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gases. A number of states have adopted energy strategies or plans with goals that include the reduction of greenhouse gas emissions. For example, New York’s State Energy Plan includes Reforming the Energy Vision (REV) initiatives which set greenhouse gas emission reduction targets of 40% by 2030 and 80% by 2050. Additionally, the Plan targets that 50% of electric generation must come from renewable energy sources by 2030. Similarly, Pennsylvania has a methane reduction framework for the oil and gas industry which will result in permitting changes with the stated goal of reducing methane emissions from well sites, compressor stations and pipelines. With respect to its operations in California, the Company currently complies with California cap-and-trade guidelines, which increases the Company's cost of environmental compliance in its Exploration and Production segment operations. Legislation or regulation that aims to reduce greenhouse gas emissions could also include carbon taxes, restrictive permitting, increased efficiency standards, and incentives or mandates to conserve energy or use renewable energy sources. Federal, state or local governments may, for example, provide tax advantages and other subsidies to support alternative energy sources, mandate the use of specific fuels or technologies, or promote research into new technologies to reduce the cost and increase the scalability of alternative energy sources. These climate change and greenhouse gas initiatives could increase the Company’s cost of environmental compliance by requiring the Company to retrofit existing equipment, install new equipment to reduce emissions from larger facilities and/or purchase emission allowances. They could also delay or otherwise negatively affect efforts to obtain permits and other regulatory approvals with regard to existing and new facilities, impose additional monitoring and reporting requirements, and reduce demand for oil and natural gas. But legislation or regulation that sets a price on or otherwise restricts carbon emissions could also benefit the Company by increasing demand for natural gas, because substantially fewer carbon emissions per Btu of heat generated are associated with the use of natural gas than with certain alternate fuels such as coal and oil. The effect (material or not) on the Company of any new legislative or regulatory measures will depend on the particular provisions that are ultimately adopted.
New Authoritative Accounting and Financial Reporting Guidance
For discussion of the recently issued authoritative accounting and financial reporting guidance, refer to Item 1 at Note 1 — Summary of Significant Accounting Policies under the heading “New Authoritative Accounting and Financial Reporting Guidance.”
Safe Harbor for Forward-Looking Statements
The Company is including the following cautionary statement in this Form 10-Q to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company. Forward-looking statements include statements concerning plans, objectives, goals, projections, strategies, future events or performance, and underlying assumptions and other statements which are other than statements of historical facts. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature. All such subsequent forward-looking statements, whether written or oral and whether made by or on behalf of the Company, are also expressly qualified by these cautionary statements. Certain statements contained in this report, including, without limitation, statements regarding future prospects, plans, objectives, goals, projections, estimates of oil and gas quantities, strategies, future events or performance and underlying assumptions, capital structure, anticipated capital expenditures, completion of construction projects, projections for pension and other post-retirement benefit obligations, impacts of the adoption of new accounting rules, and possible outcomes of litigation or regulatory proceedings, as well as statements that are identified by the use of the words “anticipates,” “estimates,” “expects,” “forecasts,” “intends,” “plans,” “predicts,” “projects,” “believes,” “seeks,” “will,” “may,” and similar expressions, are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995 and accordingly involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. The Company’s expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, but there can be no assurance that management’s expectations, beliefs or projections will result or be achieved or accomplished. In addition to other factors and matters discussed elsewhere herein, the following are important factors that, in the view of the Company, could cause actual results to differ materially from those discussed in the forward-looking statements:
1. | Delays or changes in costs or plans with respect to Company projects or related projects of other companies, including difficulties or delays in obtaining necessary governmental approvals, permits or orders or in obtaining the cooperation of interconnecting facility operators; |
2. | Governmental/regulatory actions, initiatives and proceedings, including those involving rate cases (which address, among other things, target rates of return, rate design and retained natural gas), environmental/safety requirements, affiliate relationships, industry structure, and franchise renewal; |
3. | Changes in laws, regulations or judicial interpretations to which the Company is subject, including those involving derivatives, taxes, safety, employment, climate change, other environmental matters, real property, and exploration and production activities such as hydraulic fracturing; |
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4. | Changes in the price of natural gas or oil; |
5. | Impairments under the SEC’s full cost ceiling test for natural gas and oil reserves; |
6. | Financial and economic conditions, including the availability of credit, and occurrences affecting the Company’s ability to obtain financing on acceptable terms for working capital, capital expenditures and other investments, including any downgrades in the Company’s credit ratings and changes in interest rates and other capital market conditions; |
7. | Factors affecting the Company’s ability to successfully identify, drill for and produce economically viable natural gas and oil reserves, including among others geology, lease availability, title disputes, weather conditions, shortages, delays or unavailability of equipment and services required in drilling operations, insufficient gathering, processing and transportation capacity, the need to obtain governmental approvals and permits, and compliance with environmental laws and regulations; |
8. | Increasing health care costs and the resulting effect on health insurance premiums and on the obligation to provide other post-retirement benefits; |
9. | Changes in price differentials between similar quantities of natural gas or oil at different geographic locations, and the effect of such changes on commodity production, revenues and demand for pipeline transportation capacity to or from such locations; |
10. | Other changes in price differentials between similar quantities of natural gas or oil having different quality, heating value, hydrocarbon mix or delivery date; |
11. | The cost and effects of legal and administrative claims against the Company or activist shareholder campaigns to effect changes at the Company; |
12. | Uncertainty of oil and gas reserve estimates; |
13. | Significant differences between the Company’s projected and actual production levels for natural gas or oil; |
14. | Changes in demographic patterns and weather conditions; |
15. | Changes in the availability, price or accounting treatment of derivative financial instruments; |
16. | Changes in laws, actuarial assumptions, the interest rate environment and the return on plan/trust assets related to the Company’s pension and other post-retirement benefits, which can affect future funding obligations and costs and plan liabilities; |
17. | Changes in economic conditions, including global, national or regional recessions, and their effect on the demand for, and customers’ ability to pay for, the Company’s products and services; |
18. | The creditworthiness or performance of the Company’s key suppliers, customers and counterparties; |
19. | The impact of potential information technology, cybersecurity or data security breaches; |
20. | Economic disruptions or uninsured losses resulting from major accidents, fires, severe weather, natural disasters, terrorist activities or acts of war; |
21. | Significant differences between the Company’s projected and actual capital expenditures and operating expenses; or |
22. | Increasing costs of insurance, changes in coverage and the ability to obtain insurance. |
The Company disclaims any obligation to update any forward-looking statements to reflect events or circumstances after the date hereof.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Refer to the "Market Risk Sensitive Instruments" section in Item 2 – MD&A.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be
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disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. The Company’s management, including the Chief Executive Officer and Principal Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chief Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2018.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings
For a discussion of various environmental and other matters, refer to Part I, Item 1 at Note 6 — Commitments and Contingencies, and Part I, Item 2 - MD&A of this report under the heading “Other Matters – Environmental Matters.”
For a discussion of certain rate matters involving the NYPSC, refer to Part I, Item 1 of this report at Note 9 — Regulatory Matters.
Item 1A. Risk Factors
The risk factors in Item 1A of the Company’s 2017 Form 10-K, as amended by Item 1A of Part II of the Company's Form 10-Q for the quarter ended December 31, 2017, have not materially changed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On January 2, 2018, the Company issued a total of 6,921 unregistered shares of Company common stock to nine non-employee directors of the Company then serving on the Board of Directors of the Company, 769 shares to each such director. All of these unregistered shares were issued under the Company’s 2009 Non-Employee Director Equity Compensation Plan as partial consideration for such directors’ services during the quarter ended March 31, 2018. These transactions were exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as transactions not involving a public offering.
Issuer Purchases of Equity Securities
Period | Total Number of Shares Purchased (a) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Plans or Programs | Maximum Number of Shares That May Yet Be Purchased Under Share Repurchase Plans or Programs (b) | |
Jan. 1 - 31, 2018 | — | N/A | — | 6,971,019 | |
Feb. 1 - 28, 2018 | 356 | $49.66 | — | 6,971,019 | |
Mar. 1 - 31, 2018 | — | N/A | — | 6,971,019 | |
Total | 356 | $49.66 | — | 6,971,019 | |
(a) | Represents shares of common stock of the Company tendered to the Company by holders of stock options, SARs, restricted stock units or shares of restricted stock for the payment of option exercise prices or applicable withholding taxes. During the quarter ended March 31, 2018, the Company did not purchase any shares of its common stock pursuant to its publicly announced share repurchase program. |
(b) | In September 2008, the Company’s Board of Directors authorized the repurchase of eight million shares of the Company’s common stock. The repurchase program has no expiration date. The Company has not repurchased any shares since September 17, 2008 and has no plans to make further purchases in the near future. |
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Item 6. Exhibits
Exhibit Number | Description of Exhibit | |
4.1 | ||
12 | ||
31.1 | ||
31.2 | ||
32• | ||
99 | ||
101 | Interactive data files submitted pursuant to Regulation S-T: (i) the Consolidated Statements of Income and Earnings Reinvested in the Business for the three and six months ended March 31, 2018 and 2017, (ii) the Consolidated Statements of Comprehensive Income for the three and six months ended March 31, 2018 and 2017, (iii) the Consolidated Balance Sheets at March 31, 2018 and September 30, 2017, (iv) the Consolidated Statements of Cash Flows for the six months ended March 31, 2018 and 2017 and (v) the Notes to Condensed Consolidated Financial Statements. | |
• In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management’s Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the material contained in Exhibit 32 is “furnished” and not deemed “filed” with the SEC and is not to be incorporated by reference into any filing of the Registrant under the Securities Act of 1933 or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing, except to the extent that the Registrant specifically incorporates it by reference.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NATIONAL FUEL GAS COMPANY | |
(Registrant) | |
/s/ D. P. Bauer | |
D. P. Bauer | |
Treasurer and Principal Financial Officer | |
/s/ K. M. Camiolo | |
K. M. Camiolo | |
Controller and Principal Accounting Officer | |
Date: May 4, 2018
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