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The Ultimate Guide To Risk Parity And Rising Interest Rates

Click to enlarge Risk Parity has had a phenomenal year-to-date. One popular provider of the strategy for retail clients is up nearly 9% while the S&P is up a little over 3%. This is primarily due to big rallies in both the bond and commodity markets, as the Fed has continued to ease off on interest rates while the global outlook has stabilized. YTD Performance of Major Asset Classes vs. Risk Parity (labeled “You”) Source: Yahoo Finance, Federal Reserve , WSJ , Hedgewise Despite this strong outperformance, the bond rally has raised a familiar worry: what happens when interest rates rise? Given the strategy has a heavier bond allocation than most traditional portfolios, does it continue to be a viable option? Fortunately, we have decades of historical data that show that rising interest rates are not a cause for great concern. In times of high inflationary pressure, like the 1970s, the strategy is protected by assets like commodities and inflation-protected bonds. While higher short-term rates do reduce the benefits of using leverage, our backtested model still performed at least as well as the S&P 500 throughout the 70s. The absolute “worst case” scenario is one in which rates are being driven up by continuously strong real growth, such as the post-WWII economy from 1950 to 1970. In this situation, both bonds and real assets like gold will tend to perform poorly while the stock market rockets ahead. Though Risk Parity will probably underperform the S&P 500 over such a stretch, you will still make solid returns ; they simply won’t be as high compared to a portfolio of 100% equities. In exchange for this possibility, you avoid the risk that the next 2008 may be right around the corner. While rising interest rates may seem like a foregone conclusion, recent history in Germany and Japan demonstrates that rates may be just as likely to fall. In short, it only makes sense to move away from Risk Parity if you are absolutely sure we will experience a booming, robust economy over the next 20 years and you can afford a few 40% downturns along the way. If you have this conviction, by all means, move to 100% equities. If you aren’t sure, though, recall that Risk Parity is a long term investment strategy that has consistently produced reasonable returns without the need to predict the future. Modeling Performance in the 1970s: Inflation Protection Works From 1970 to 1983, the Federal Funds rate rose from 4% to nearly 20%, or a whopping 1600 basis points. The US was facing a vicious combination of rising prices and falling economic activity, also known as “stagflation”. This provided an excellent environment to pressure test the Risk Parity framework, which you might expect to do terribly given its heavy bond allocation. However, just the opposite occurred: our model outperformed equities nearly the entire time . To create the historical model, we had to make a few key assumptions: We are using a modified form of our proprietary risk management framework, as there was not nearly the amount of market data available in the 70s as there is today. Our belief is that this is a handicap, and we expect our framework would perform even better than is shown here if we had the same data available. We limited the portfolio to nominal bonds (NYSEARCA: IEF ), equities (NYSEARCA: SPY ), and gold (NYSEARCA: GLD ) because inflation-protected bonds (NYSEARCA: TIP ) did not yet exist, nor did reliable data on the price of commodities like oil and copper. The assets that we had to exclude all tend to perform well in periods of high inflation, and would likely buoy performance within our full model. Risk Parity is typically available at multiple ‘risk levels’, the higher of which amplify expected returns through leverage. We ran an unleveraged “Low Risk” version of the model as well as a leveraged “High Risk” version. The portfolios are based on end-of-day index prices and do not account for live trading conditions. All dividends and coupon payments are included and assumed reinvested. Leverage is assumed to have a cost equal to the rate on one-year treasury bonds. The model does not include the cost of commissions or management fees. Performance of Risk Parity “Low Risk” and “High Risk” Models vs. S&P 500, 1970 to 1982 Click to enlarge Source: Hedgewise Analysis Despite one of the worst decades for bonds ever in history, both versions of the Risk Parity portfolio outperformed equities for nearly this entire stretch. This was possible for two reasons. First, ten-year bonds still achieved an annualized return of about 6% during this timeframe. Even though rising rates eroded the principal value of the bonds, this was counterbalanced by consistently higher yields. Second, assets that provide protection from inflation, like gold, performed incredibly well in this environment as the value of the US dollar plummeted. That said, it is interesting to note that based on total return over the entire timeframe, the “High Risk” portfolio failed to outperform the “Low Risk” portfolio even though it was far more volatile and leveraged. This makes sense when you realize that short-term interest rates were often higher than long-term rates during this period. In other words, you were often paying more in interest than you were making back. Does this mean that using leverage doesn’t make sense when interest rates are rising? Not necessarily. The “High Risk” portfolio actually was outperforming most of the time; the net result was highly influenced by the final period in which rates rose most rapidly. Still, it is accurate to say that leverage will be less useful compared to periods of flat or falling interest rates. Taken together, these facts lead to a few important takeaways. Even if you are relatively certain that inflation is about to pick up, Risk Parity would still be a great choice . In this kind of environment, higher risk level portfolios may occasionally fail to outperform the lower risk levels, though they would all generally perform well compared to the S&P 500. If you are absolutely convinced that we are heading for another period like the 70s, you might consider avoiding leverage, but it certainly wouldn’t make sense to abandon the strategy altogether. Before we move on, keep in mind that the decade of the 70s was the earliest period of rising rates in which we had enough data to do a proper simulation of our model. When studying the 50s and 60s, we must rely on a drastically more simplistic version. Still, this severely handicapped portfolio can effectively demonstrate some of the timeless concepts of the Risk Parity Framework. Modeling Performance in the 1950s and 1960s: The Boomer Years The Post-WWII economy in the US was incredibly robust. For nearly 20 years, we experienced strong real growth with relatively limited inflation and no major recessions. The S&P 500 grew by over 10% annually, while nominal bonds returned only 2% annually due to consistently rising real rates. You’d expect a portfolio of 60% bonds would make no sense; never mind adding leverage to the mix! However, such a portfolio still provided solid, steady returns with a lower risk of drawdowns . Using leverage also successfully increased returns, though not significantly. This was true even with no active risk management and during two of the worst performing decades for nominal bonds in history! To be clear, in hindsight, equities were the top performing asset class, and any mix besides 100% stocks probably underperformed. However, this fact misses the entire point of diversification: you just don’t know what is going to perform well next. Of course you will do better if you always switch into the asset class that is about to blow the others away, but you’ll often be wrong. Risk Parity allows you to consistently do well regardless of the environment. With that said, let’s take a look at the data from these decades. Here’s how we constructed the model this time: Since data was not available to implement active risk management, we assumed a static split of 40% stocks and 60% bonds for the Risk Parity portfolio. We took this same mix and added 75% leverage, for a final mix of 70% stocks and 105% bonds. This is a simple, static performance model that is limited to two assets. Performance of our full model in the same time period would likely have been better. Performance of 40% Stock / 60% Bond Mix and Leveraged 40/60 Mix vs. S&P 500, 1953 to 1970 Click to enlarge Source: Hedgewise Analysis As expected, the bond-heavy mix was unable to keep up with equities over this timeframe. However, both the unleveraged and the leveraged versions of the portfolio still performed reasonably well from an absolute standpoint. The unleveraged 40/60 mix averaged an annual return of 5.5% with less than half the volatility of the stock market and significantly smaller drawdowns. If your goal was capital preservation and moderate growth, this portfolio may have still been a better choice. While it’s easy to argue otherwise when you look over the 20 years, stocks experienced a number of significant declines during that timeframe that may have been unacceptable for someone close to retirement or with a shorter time horizon. For example, stocks lost as much as 31% during the dips in 1958, 1962, 1966, and 1968. If you needed to exit the market during these periods, or you were actively taking withdrawals out of your investments along the way, such losses could significantly damage your outlook. With our leveraged mix, we see a similar theme to what occurred during the 70s: you will still achieve higher returns using leverage, but not significantly so. Importantly, this dispels the myth that levering up a Risk Parity portfolio will be disastrous when bonds do poorly. The leverage is not harmful; it just isn’t as helpful compared to other times. Plus, remember that the modern day version of the portfolio would likely exhibit a much smaller performance gap compared to the one shown here. The key to this analysis is deciding what it means to you. First, consider how sure you are that stocks will be the top performing asset class over the next 20 years due to strong real growth and low inflation. If we experience any other kind of environment, Risk Parity will tend to outperform. Second, evaluate how damaging each worst-case scenario might be for you personally. If you moved to 100% equities at the peak of the dot-com bubble, it took you nearly a decade to recover your losses. If you utilized a simplistic version of Risk Parity during the Post-WWII era, you still made 6.6% instead of 10.4%. As with any kind of diversification, it only makes sense if you agree that the future is quite uncertain. As much as it may seem that bonds are about to enter a prolonged bear market, there’s a good deal of evidence that suggests quite the opposite. Where Have the Rising Interest Rates Gone? Supposedly, the bond bull market in the US has been on the verge of ending for about 4 years now. There was the so-called ‘taper tantrum’ in 2013, during which yields rocketed over 100bps when Bernanke announced the end of ‘Quantitative Easing’. Yet the US economy continued to sputter along slowly and global weakness brought yields back down. In late 2015, the Fed was expected to raise rates as many as 6 times in the near-future. Then, a global collapse in commodity prices and rapidly slowing growth in China caused them to back-off again. Meanwhile, ten-year bonds have continued to hover around 2%. 10-Year US Treasury Yields Since 2000 Click to enlarge The gut reaction to this graph is to think that we must be near the bottom. However, there is no reason that we can’t fall well below a 2% yield for decades. Japan, for example, has had ten-year yields under this level for almost 20 years. 10-Year Japanese Treasury Yields Since 1990 (2% yield emphasized) Click to enlarge Many are quick to point out that our economic history is quite a bit different than Japan’s. Instead, let’s take a look at Germany: 10-Year German Treasury Yields Since 2000 (2% yield emphasized) Click to enlarge The reality is that the entire world remains in a very fragile state. On a relative basis, yields in the US are actually still pretty high. In the EU, a number of countries have recently introduced negative interest rates to continue to combat recessionary pressure. The point is that we may be at the end of the bond bull market, but it’s also entirely possible that we are not. Conclusion: Rising Rates Are Not a Big Concern The evidence presented in this article helps clarify some extremely important concerns about Risk Parity. In the thirty-year stretch from the 1950s to the 1980s, adding leverage to a bond-heavy portfolio never resulted in disaster; it just had less of a positive effect on returns. During the most inflationary period in US history, our model outperformed the S&P 500 for a majority of the time. These facts boldly refute the idea that Risk Parity only ‘works’ during bond bull markets. As with any kind of diversification, there will always be periods when one asset is outperforming the others. In exchange for tolerating this, you get steadier, more reliable returns which do not depend on you predicting the future. You become less vulnerable to a crash in any given market. You’ll tend to make money even when interest rates are steadily rising, but you’ll make less than you could have if you had perfect foresight. Even if you do have a strong conviction that rates are about to rise, an unleveraged Risk Parity portfolio remains an excellent choice for investors with a shorter timeframe because of its significantly smaller drawdowns and steady historical returns. We would absolutely recommend such a portfolio over cash regardless of the market environment. For longer term investors, be wary about the likelihood that we are about to enter a period of growth similar to the post-WWII economy. As many countries in Europe and Asia have already demonstrated, another recession may be a far bigger risk. Finally, please keep in mind that this article focused on extreme scenarios, including the naïve construction of the model portfolios and the chosen start and end dates of the analysis. If the Risk Parity framework can hold up relatively well despite these handicaps, there’s little reason to keep worrying about the specter of rising interest rates. If you are interested in learning more about Risk Parity, check out this white paper overview . We’ll also be publishing the current construction of our “Low Risk” and “High Risk” portfolios early in May. Be sure to follow us if you’d like to receive it. Disclosure: I am/we are long SPY, IEF, TIPS, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: This information does not constitute investment advice or an offer to invest or to provide management services and is subject to correction, completion and amendment without notice. Hedgewise makes no warranties and is not responsible for your use of this information or for any errors or inaccuracies resulting from your use. To the extent that any of the content published may be deemed to be investment advice or recommendations in connection with a particular security, such information is impersonal and not tailored to the investment needs of any specific person. Hedgewise may recommend some of the investments mentioned in this article for use in its clients’ portfolios. Past performance is no indicator or guarantee of future results. This document is for informational purposes only. Investing involves risk, including the risk of loss. Information in this document has been compiled from data considered to be reliable, however, the information is unaudited and is not independently verified. Performance data is based on publicly available index or asset price information and does not represent a live portfolio except where otherwise explicitly noted. All dividend or coupon payments are included and assumed to be reinvested monthly.

Public Service Enterprise’s (PEG) CEO Ralph Izzo on Q1 2016 Results – Earnings Call Transcript

Public Service Enterprise Group Inc. (NYSE: PEG ) Q1 2016 Earnings Conference Call April 29, 2016 11:00 AM ET Executives Kathleen Lally – Investor Relations Ralph Izzo – Chairman, President and Chief Executive Officer Dan Cregg – Executive Vice President and Chief Financial Officer Analysts Neel Mitra – Tudor, Pickering Paul Patterson – Glenrock Associates Michael Weinstein – UBS Travis Miller – Morningstar Greg Gordon – Evercore ISI Jonathan Arnold – Deutsche Bank Gregg Orrill – Barclays Michael Lapides – Goldman Sachs Praful Mehta – Citigroup Ashar Khan – Visium Asset Management Shahr Pourreza – Guggenheim Partners Michael Goldenberg – Luminous Ben Budish – Jefferies Operator Ladies and gentlemen, thank you for standing by. My name is Brent, and I’m your event operator today. I would like to welcome everyone to today’s conference, Public Service Enterprise Group’s First Quarter 2016 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session for members of the financial community. [Operator Instructions] As a reminder, this conference is being recorded today, Friday, April 29, 2016, and will be available for telephone replay beginning at 2 O’clock PM Eastern today until 11:30 PM Eastern on May 6, 2016. It will also be available as an audio webcast on PSEG’s corporate website at www.pseg.com. I would now like to turn the conference over to Kathleen Lally. Please go ahead. Kathleen Lally Thank you, Brent. Good morning, everyone. Thank you for participating in PSEG’s call this morning. As you are aware, we released our first quarter 2016 earnings statements earlier today. The release and attachment are posted on our website at www.pseg.com, under the Investors section. We also posted a series of slides that detail operating results by company for the quarter. Our 10-K for the period ended March 31, 2016, is expected to be filed shortly. Please read the full disclaimer statement and the comments we have on the difference between operating earnings and GAAP results. As you know the earnings release and other matters that we will discuss in today’s call contain forward-looking statements and estimates that are subject to various risks and uncertainties, and although we may elect to update forward-looking statements from time-to-time, we specifically disclaim any obligation to do so, even if our estimates change, unless of course we’re required do so. Our release also contains adjusted non-GAAP operating earnings as well as adjusted EBITDA for PSEG Power. Please refer to today’s 8-K for our other filings for a discussion of the factors that may cause results to differ from management’s projections, forecast and expectations and for a reconciliation of operating earnings and adjusted EBITDA to GAAP results. I would now like to turn the call over to Ralph Izzo, Chairman, President and Chief Executive Officer of Public Service Enterprise Group and joining Ralph on the call is Dan Cregg, Executive Vice President and Chief Financial Officer. At the conclusion of their remarks, there will be time for your questions. Thank you. Ralph Izzo Thank you, Kathleen, and good morning everyone and thank you for joining us today. PSEG delivered solid results for the first quarter in the face of rather mild winter temperatures and low prices for natural gas and energy. Earlier this morning, we’ve reported operating earnings for the first quarter of 2016 of $0.91 per share versus operating earnings of $1.04 per share in last year’s first quarter. Extreme temperature differences between the first quarter of this year and the first quarter of last year provides the backdrop for this quarter’s operating results. The first quarter of 2016 was 10% warmer than normal and the fifth warmest on record. The month of March in particular was extremely mild with heating degree days 25% lower than normal. Weather for the first quarter was also 27% warmer than the first quarter of 2015, but last year was the coldest on record. Our results were strong in the face of this headwind. PSE&G’s execution on its expanded capital investment program continues to provide a growing source of earnings. PSE&G is expected to invest $3 billion in 2016 as part of its five-year $12 billion capital program. Transmission is the largest part of PSE&G’s effort, representing 60% of planned spending. PSE&G’s investment program and a continued focus on controlling costs will help drive our forecast for double-digit growth in PSE&G’s 2016 operating earnings. PSE&G’s execution of our capital program is expected to yield best-in-class growth rate in rate base of 8% per year for the five-year period ending 2020. PSEG’s continues to develop a pipeline of investment opportunities that also meet New Jersey’s policy objectives and have customer support. Now as for PSEG Power, it has been focused on operating in an environment of low gas prices for years. The availability and low price of gas and the need to meet more stringent reliability requirements has added new urgency to the company’s efforts to improve its cost structure and efficiency. Power’s capital program also represents an important response to today’s market. Power’s $2 billion of investment in three new combined cycle gas turbine will add approximately 1,800 megawatts of clean, reliable and efficient capacity to its fleet. Construction of the KEC plant in Maryland and the Sewaren Unit in New Jersey are on schedule to meet their 2018 operating date. Bridgeport Harbor is expected to be available for 2019 commercial operation date. The addition of this new capacity will transform Power’s fleet. Power’s base load nuclear capacity will be complemented by a flexible low cost fleet of combined cycle gas units capable of responding to the market. The fleet’s carbon footprint is also expected to decline with the addition of the new clean gas fired capacity as nuclear generation continues to represent approximately 50% of the fleet’s output. As I said, we remain focused on operating efficiently and safely. PSEG Power has made judicious reductions in its nuclear workforce and is working closely with the industry to identify additional means of reducing its cost structure to assure the availability of this clean nuclear resource well into the future. Our goal is to capture these savings for the year to help offset the impact of low gas prices on earnings. Separately from operations, we were very pleased with some recent actions in defense of competitive markets. In particular, we were delighted with the U.S. Supreme Court’s unanimous decision affirming the Fourth Circuit decision in Hughes versus Maryland. Since that decision the U.S. Supreme Court also dismissed the New Jersey case allowing to stand the lower court ruling that the so called LCAP contracts are unconstitutional. A recent action at FERC is also constructive. I am referring to the orders issues by FERC earlier this week, granting the complaints filed by EPSA and others, which called into question some approvals, granted by the Public Utility Commission of Ohio. A separate complaint brought by a number of generating companies regarding the scope of the minimum offer price rule under RPM is till pending at FERC. While owners of existing assets without of market contracts will not be directly restricted in the upcoming base residual auction regarding how they can bid the affected units. The lack of certainty regarding FERC approval of such contracts should at least neutralize some if not all of the incentives under the contracts to bid without regard to the unit’s actual cost of operations. We believe that a competitive market is the best approach for ensuring that there is a supply of electric capacity to meet customer demand at the lowest cost. Our companywide efforts are focused on building an infrastructure that improves system reliability, reduces emissions and supports the needs of customers. Our strategy is working and it is made possible by the contribution from our dedicated employees, who support our efforts in countless ways. Their focus on the mission of providing safe and reliable energy has allowed us to meet the needs of customers and shareholders. We are maintaining our operating earnings guidance for the full year of $2.80 to $3 per share. Our guidance assumes normal weather for the remainder of the year. As we move forward, the weather and market conditions during the third quarter will be important for both PSEG Power and PSE&G. Current market conditions and the complete absence of a winter require that we maintain our relentless focus on identifying cost efficiencies and maintaining strong operating performance. With that I’ll turn the call over to Dan, who will discuss our financials in greater detail. Dan Cregg Thanks you, Ralph, and good morning everyone. As Ralph said, PSEG reported operating earnings for the first quarter of 2016 of $0.91 per share versus operating earnings of $1.04 per share in last year’s first quarter. On Side 4 we’ve provided you with a reconciliation of operating earnings to net income for the quarter and we’ve provided you with information on Slide 8 regarding the contribution to operating earnings by business for the quarter. Additionally, Slide 9 contains a waterfall chart that takes you through the net changes quarter-over-quarter and operating earnings by major business. And I’ll now walk through each company in more detail. For PSE&G, shown on slide 11, we reported operating earnings for the first quarter of 2016 of $0.52 per share compared with $0.47 per share for the first quarter of 2015. PSE&G’s first quarter results reflect the impact of revenue growth associated with an expansion of its capital investment program, which will more than offset the effect of unfavorable weather conditions on electric and gas demand. Returns on PSE&G’s expanded investment in transmission added $0.04 per share to earnings in the quarter and the first quarter also benefited from the recovery of revenue on PSE&G’s distribution investment under its Energy Strong program. This increase in revenue improved quarter-over-quarter earnings comparisons by a $0.01 a share As Ralph mentioned, weather in the first quarter was warmer than normal and significantly warmer than conditions experienced last year. The negative impact of the extreme differences in weather on gas demand in revenue quarter-over-quarter was largely offset by the gas weather normalization cost. A decline in our electric sales in revenue however as a result of the extreme differences in weather reduced quarterly earnings comparisons by $0.02 per share. Lower taxes more than offset an increase in O&M expense due to the absence of insurance recovery of storm costs received in the year ago quarter. These items together added $0.02 per share to quarter-over-quarter earnings. Economic indicators continue to improve. Employment in New Jersey has increased for 28 consecutive months as the unemployment rate has declined to 4.3% and the housing market has also experienced an improvement. However, this improvement in economic growth was outweighed during the quarter by a mild weather. The variability in quarterly data for weather normalized electric and gas sales has been high given the extreme weather conditions making it difficult to discern a trend in demand when analyzing just the quarterly data but data for the trailing 12 months indicates weather normalized electric sales were flat for the period ended March of 2016. And in terms of weather normalized gas demand a 0.3% decline in sales in the first quarter was led by 1.5% decline in heating demand from the residential sector which also is influenced by the large weather adjustment quarter-over-quarter. But on a trailing 12-month basis gas sales increased by 1.8% year-over-year. PSE&G capital program remains on schedule and PSE&G invested approximately $725 million in the first quarter as part of its planned $3 billion capital investment for 2016. Also as you may recall PSE&G implemented $146 million increase in annual transmission revenue under the company’s transmission formula rate filing which took effect this past January. This increase in revenue adjusted to reflect the impact of bonus depreciation and updates of spending in prior years will be reflected in PSE&G’s earnings throughout the year. We’re maintaining our forecast of PSE&G’s operating earnings for 2016 of $875 million to $925 million. Moving to Power, as shown on slide 18, PSEG Power reported operating earnings for the first quarter of $0.36 per share and adjusted EBITDA of $416 million compared with $0.55 per share and adjusted EBITDA of $626 million for the first quarter of 2015. Adjusted EBITDA excludes the same items as our operating earnings measure as well as income tax expense, interest expense, depreciation and amortization and major maintenance expense at Towers Fossil generating facilities. The earnings release and slide 19, provides you with a detailed analysis of the impact on Power’s operating earnings quarter-over-quarter. We’ve also provided you with more detail on generation for the quarter on slide 21. PSEG Power’s first quarter results were impacted by the extremely mild weather conditions experienced this year in comparison to the year ago period. A decline in capacity revenue associated with the June 2015 retirement of the HEDD or High Electric Demand Date peaking units in PJM reduced quarter-over-quarter earnings by $0.04 per share. Lower output due to the mild weather conditions coupled with lower average prices on energy hedges reduced quarter-over-quarter earnings by $0.09 per share. And a weather related decline in total gas send out to commercial and industrial customers and lower prices combined to reduce quarter-over-quarter earnings on gas sales by $0.12 per share. Lower O&M expense improved quarter-over-quarter earnings by $0.05 per share and a reduction in interest expense added $0.01 to earnings per share. Now let’s turn to Power’s operations. Output from Power’s fleet declined 9% in the quarter as a result of the reduced demand and lower wholesale market prices. Output from the coal fleet reduced during the first quarter a decline of 1 terawatt hour from 2.5 terawatt hours in the year ago quarter as low gas prices affected the dispatch of coal. Output from the combined cycle fleet declined 0.2 terawatt hours to 3.7 terawatt hours with the decline in demand. The nuclear fleet however experienced a 0.6 terawatt hour improvement in output to 8.4 terawatt hours for the quarter. The fleet operated at an average capacity factor of 99.7% in the quarter and the nuclear fleets performance benefited from an improvement in availability at Salem as well as an increasing capacity at Peach Bottom. You may recall that the extended power upgrade work was completed at Peach Bottom last year and this work added 130 megawatts to our share of the station’s capacity. Power’s gas fired combined cycle fleet has access to low cost gas which continues to provide it with an advantage relative to market prices. However, the lack of demand and a lack of volatility in the market given the mild weather in an excess supply of gas pressured spot spreads which were significantly lower compared to last year’s levels. Overall Power’s gross margin declined to $43.80 per megawatt hour from $47.32 in the year ago quarter. Power is revising its forecast of output for 2016 to 52 terawatt hours to 54 terawatt hours from its prior forecast of 54 to 56 terawatt hour. The updated range for output incorporates the impact of the abnormally warm weather in the first quarter. This range also incorporates an anticipated expansion of the Salem 1 refuelling outage. A visual inspection during the current refuelling at Salem 1 which began on April 14 revealed damage to a series of bulbs located inside the reactor vessel. The need to conduct further testing to repair and replace the bulbs is expected to expand the refuelling outage. To provide some context as a rule of thumb, a delay in Salem’s refuelling outage of 30 days would reduce generation by approximately 0.5 terawatt hour. And under this scenario nuclear fleets’ capacity factor for the year would be reduced by about 1.5% to 91% from the current forecasted capacity factor of 92.5% for the year and the actual outage duration will be determined after ongoing inspection work is completed. As shown on slide 24 approximately 70% to 75% of anticipated production for the April to December period of 40 terawatt hours is hedged at an average price of $49 per megawatt hour. Our open position for the reminder of 2016 is more than adequate to cover the potential for a decline in output at Salem from our original forecast. For 2017, Power’s hedged 50% to 55% of its forecast generation of 54 terawatt hours to 56 terawatt hours at an average price of $49 per megawatt hour. And for 2018, approximately 20% to 25% for the forecast generation of 59 terawatt hours to 61 terawatt hours is hedged at an average price of $49 per megawatt hour. The forecast increase in generation in 2018 reflects the commercial operation of the Keys and Sewaren combined cycle units. The hedge data for 2016 continues to assume PSEG’ hedges representing 11 terawatt hours to 12 terawatt hours. As we mentioned to your last quarter, there are items included in our average hedged price which influence Power’s revenue but not support Power’s gross margin. Our average hedge price for the remainder of 2016 reflects an increase in cost elements such as transmission and renewables associated with serving our full requirement hedge obligations. The increase year-over-year in these non-margin revenue items is approximately 1 megawatt hours to 2 megawatt hours. We continue to forecast operating earnings for Power in 2016, of $490 million to $540 million and the forecast for operating earnings represents adjusted EBITDA of $1.320 billion to $1.4 billion for the full year which compares to $1.563 billion of adjusted EBITDA in 2015. I’ll briefly address as well enterprise and others’ operating results and for the first quarter we reported operating earnings of $0.03 per share compared with operating earnings of $0.02 per share recorded last year in the first quarter. The increase in operating earnings quarter-over-quarter reflects contractual payments associated with the operation of PSEG Long Island and certain tax items that PSEG Energy Holdings and we continue to forecast full year operating earnings for 2016 from PSEG, Enterprise and Other of $60 million. And finally with respect to financings and other, PSEG closed the quarter with $592 million of cash on the balance sheet with debt at the end of March representing 44% of our consolidated capital. During the quarter, PSE&G issued $850 million of securities consisting of $300 million of five-year notes at 1.9% and $550 million of 30-year notes at 3.8% while redeeming a $171 million of long-term debt. And we remain in a position to finance our current capital program without the need for the issuance of equity. We continue to forecast operating earnings for the full year of $2.80 to $3 per share. That concludes my comments and I will now turn the call back over to the operator for your questions. Question-and-Answer Session Operator Ladies and gentlemen, we will now begin the question-and-answer session for the members of the financial community [Operator Instructions] Your first question comes from the line of Neel Mitra with Tudor, Pickering. Please go ahead. Neel Mitra Hi, good morning. Ralph Izzo Good morning, Neel. Neel Mitra I just had a quick question on the lower generation in the first quarter from the milder weather, is that actually a net negative or a positive because you could not wanted to lead and then procure the power at a lower cost to fulfill the financial hedges? Ralph Izzo So the hedges are supplied at a lower cost even though we’ve locked in the price, so that’s good news. But as you know, we’re naturally long, so whenever demand is down that creates a drag for Power, is a more modest drag on the utility, it has a whether normalization on the gas business, but no such thing on the electric business. So reduced demanded due to mild whether would create a slight drag there. Neel Mitra So the opened position on Power is hurt just because it’s not running as much is that the way to look at that? Ralph Izzo Yes. That’s right. So you have lower dispatch prices, we have lower, lesser amount of run time. Neel Mitra Okay. And second question, I know you have a small stake in the PennEast Pipeline. Can you remind us when you have that going into service and then there have been recent reports on possible delay, what your thoughts are on that? Ralph Izzo So we have 10% position and we are now forecasting late 2018. Neel Mitra And what were you forecasting earlier? Ralph Izzo Late 2017. Neel Mitra Okay, great. Thank you. Ralph Izzo You’re welcome, Neel. Operator Your next question comes from the line of Paul Patterson with Glenrock Associates. Please go ahead. Paul Patterson Good morning. Ralph Izzo Good morning, Paul. Paul Patterson On the Salem implant and I apologize I heard you talk about, but I just want to make sure I understood it. How long is the extended outage that you guys are now expecting? Ralph Izzo So we don’t know yet Paul. The outage started I think it was April 14 and that would have been a fairly standard refuelling outage. We normally don’t give dates on that for obvious reasons due to market sensitivity. But we are in the middle right now of doing some testing to see how many of the bolts are damaged. And so until we finish that we won’t know exact how long the outage is, but I should point out even when we know we typically don’t announce that to the marketplace. Paul Patterson Okay. And then with – and you are still looking at how many bolts or what percentage of bolts have problems. Ralph Izzo That’s right. Paul Patterson And is there any read through to any other units do you think or any other sort of sense for about this? Ralph Izzo Yes, I mean so clearly Salem 2, but we did inspect Salem 2 in 2015, because I mean this is an industry, problem it’s been around since I think 1998, so this is not something that is unique to us or unheard of before. But if Salem 2 pass visual inspection in 2015 and Salem 1 was scheduled to have the more intrusive inspection in 2019, but we’re couple of years ahead of schedule there. I just remind you Salem 2 is six years younger than Salem 1 to the extent that this is a degradation over time that should have an influence. Paul Patterson Okay, thanks so much. Ralph Izzo No problem, Paul. Operator Your next question comes from the line of Michael Weinstein with UBS. Please go ahead. Michael Weinstein Hi, Ralph, how are you doing? Ralph Izzo Good. Michael Weinstein Hey, recently we saw ConEd enter agreement to purchase gas storage and pipeline assets in Pennsylvania and New York and we’ve also seen other large utilities making large acquisitions of gas assets and utilities. And given the PennEast interest that you have already what is your view on the current market for gas related acquisitions and what’s your own interest in expanding further? Ralph Izzo Yes, I would say that our interest in expanding further is low to zero. In terms of our position in PennEast, high candidly every gas LDC in New Jersey has a position in that and we just thought that it was important to help participate and bringing those consumer benefits to our gas customers as you know PSE&G has almost two million gas customers. It’s a really different business, Michael. I serve on a board of the company that’s involved in the pipeline business and I just think we’re really good at the netting that we do and I would like to stick to that. So, I’m not second guessing others, please don’t misinterpret. I mean they have their own unique reasons for moving in that direction. But typically the corporate structure is different there, mostly MLPs, they have a fairly different financial proposition and they are not without their challenges nowadays as well. So that may be a great time to go in to buy in. There is a graph of those citing challenges associated with this, we are experiencing that in PennEast. That was a major pipeline. And I am sure you are aware of in New York state obviously had an unpleasant surprise. So it’s a very challenging business with fairly different DNA than what we have in our company and I like the DNA and the match that our company has with the operations that we are responsible for. Michael Weinstein Does the current PE’s and the gas utility space on the LDC space, does that also put you off in terms of future opportunities? Ralph Izzo Yes. So that’s a different subject, but the short answer to that is yes. I mean, I understand that debt is fairly inexpensive. Dan, hopefully impressed you with the numbers he reported for our utility. And you can make acquisitions accretive at very, very attractive premiums to the target. But the question really is that obvious just because money is relatively inexpensive what are the alternative uses for that and simply paying a very, very rich premium and still having accretion may not be your best choice and we’ve been very clear. Our priorities are number one organic growth and number two supporting the dividend and then number three will be share repurchase. As I have said to many people paying a 20 plus PE to someone seems to me to be a bad idea when I know a great company that’s treating at a 14 or 15 PE that has the ticker symbol PEG. So again hopefully [indiscernible] because it’s the second guessing critical above the decisions, but those are the ones I am comfortable for us. Michael Weinstein Okay. One last question, in terms of the partnership with Vectren for competitive transmission in MISO, do you see any other opportunities to part with other local utilities for similar type of partnerships? Ralph Izzo Yes. So I can’t disclose any of that we haven’t public disclosed. But there is an approach that we are eager to pursue. I think that there is lot of value to be had by combining forces with someone who understands the local transmission grid and system with our expertise now having put over $2 billion to work on annual basis for good number of years in terms of cost and schedule management on transmission construction. I am very proud of our team and the work that they have done, but we don’t know the system everywhere in the country, such to the extent that we combine our project management as skills in our construction management know how with people systems knowledge that’s a win-win for everyone. Operator Your next question comes from the line of Travis Miller with Morningstar. Please go ahead. Travis Miller Hi, thanks. Ralph Izzo Hi, Travis. Travis Miller I wanted to think a little bit more about the $0.12 on the lower gas send out and fixed cost recovery business. How much is that just pure volume and how much is there something else there, either margin contractions there or some other factor there that might not be directly weather related? Ralph Izzo I ask Dan if he knows the split between the two. I mean, my short answer is it’s a combination of both. Dan Creeg And that’s right. I mean, Travis, I guess the way that may be the best way to try to think about where we are from that $0.12 impact that we saw this quarter is if you were to look at each of the last couple of quarters, you would have seen last year and the year before, there was a $0.05 and a $0.04 benefit that we picked up additively over the last two quarters. So, it’s very much the absence of a winter which has impact both on pricing and on volumes. I think the volumes were down about a third and when you have that impact as well as a margin compression. We really also didn’t see much volatility which doesn’t help in that market. So they all were contributions to the delta that you saw for this quarter. Travis Miller Okay, great, that’s helpful. And then Ralph without too much a dissertation here, you guys have put a lot of eggs in the transmission baskets certainly, previously and for the next three to five years. What are your thoughts on storage and how that might disrupt the transmission plans or alternatively offer you guys investment opportunities that wouldn’t be in transmission but could be in storage? Ralph Izzo Sure, I am a still sort of smarting from your suggestions that I am a bit long way [indiscernible]. Travis Miller I am interested in the dissertation, just not this morning. Ralph Izzo [Indiscernible] There is a lot we’re having. I literally just came for a presentation two weeks ago by a director of Lawrence Berkeley Labs on storage. And his claim, don’t ask me his name because I don’t remember but he is easy to look up, is that at least factor of too away from grid connected storage that makes the economic sense and what he has found is that that translates into anywhere from a 10-year to 20-year timeframe. Of course when you are talking about material science research event it’s difficult to put up with precision but we are agnostic Travis about what hardware one puts in place to serve customers. So I don’t care if its copper wires, super conducting ceramic wire, lead acid batteries, lithium batteries, slow batteries, I am running out of technologies to stop lathering and I am starting to tread on dissertation time frames but we were more than happy to pursue things that have economic merits that provides the reliability our customers are demanding. Travis Miller Okay, good question our this [ph] version. Ralph Izzo Thanks. Travis Miller Thank you very much. Operator Your next question comes from the line of Greg Gordon with Evercore ISI. Please go ahead. Greg Gordon Thanks, my questions have been asked and answered, thank you. Ralph Izzo Thanks Greg. Operator Your next question comes from the line of Jonathan Arnold with Deutsche Bank. Please go ahead. Jonathan Arnold Thanks same here. Thank you. Operator Your next comes from the line of Gregg Orrill with Barclays. Please go ahead. Gregg Orrill Yes thank you. Just around the hedges at Power, you increased some of the hedges over the last quarter and just wondering where you stand with where you would normally be at this point. How you are thinking about that? Ralph Izzo So Gregg as you know we try not to outguess the forward market. We do, however, we’ve said in the past there was a tendency of the market to take a data point from 48 hours ago and a data point from 24 hours go and extrapolate it for the next three years and sometimes that emotional responses not as formed by fundamentals as we would like but we always stay with some certain guidelines. We allow our team to drift up little bit if we think the market is begin a bit bullish and we allow them to drift down if we think the market is begin overly bearish and you will recall in April 14 was the former where you said we can go ahead and hedge a little bit towards the upside since the market is being somewhat bullish and it’s pretty safe to conclude that right now we are drifting towards the bottom of our guide post just given the anomalously one winter we had and the bearish that crept into the market. Now having said that that bearing this is not, totally unjustified given the guess those levels are. And then just the other thing to think about too Gregg is that for the BGS auction to the extent that that’s a contribution across our hedge horizon. That auction usually takes place every year in February. So, you see a little bit of a pickup in that regard in the first quarter’s change. Gregg Orrill Fair point, okay, thanks. Ralph Izzo Thank you. Operator Your next question comes from the line of Michael Lapides with Goldman Sachs. Please go ahead. Michael Lapides Hey, Ralph thanks for taking my question and congrats on a good start to the year. Can you on the Salem issue, can you talk a little bit about other plants over the years kind of seen similar issues and whether any of those turned into any more major related items or is having issues with kind of baffle bolts are very standard, very common occurrence. I have to be very honest as a non-nuclear engineer that where baffle bolts is a little baffling to me? Ralph Izzo Thanks Michael for the question. I’m glad you asked this. So, to my knowledge DC Cook had an issue in 2010, Indian Point had an issue starting a month or so ago. There have been a handful, I think like six or eight European plants. These are not to my knowledge, these are not life threatening issues, they’re literally 800 bolts typically that secure these metal plates we call them baffles to the reactor vessel and they’re under pressure. There is a pressure grade in because of the hot high temperatures steam that flows through the holes of these baffles and you just get a mechanical stress, in our case I think we have 832 bolts. They are typical of pressurized water reactors, so that’s why I mentioned earlier it’s a false question that we would have to look at Salem 2 again it is extra refueling outage although it passed visual inspection in 2015. It would be an issue for Hope Creek because that’s a boiling water reactor. So, I don’t want to suggest anything other than we have to complete the inspection but none of the prior instances has this been an issue that has threatened the plants going forward integrity or anything of that nature. Michael Lapides Got it, and coming to your regulated side of the ENG, you know as you guys do most years at your Analyst Day, you lay out a CapEx forecast that obviously shows you know in year three through five somewhat of a decline from years one through two, can you talk about the things, your goals in 2016 in terms of actually, I don’t want to call it back filling but the types of projects that you could see showing up in the 2018 to 2020 timeframe that might keep CapEx at a more similar level to 16 and 17 or even at a higher level, what are the types of projects what you have to do from the regulatory construct process to get those approved? Ralph Izzo Sure, so there is a whole host to that Michael; there is ongoing renewable portfolio standard commitments that could result in some additional solar work. There are couple of special projects that we haven’t named publically on the distribution system that involve major customers that would benefit the entire customer base that we will be pursuing. There is always new and additional work that comes out of it PJM, RTEP [ph] and that’s the kind of stuff you will see us looking at and potentially announcing in 2016. However, the major backfill in the out years of the plan won’t be announced in 2016 because they are pretty new and that will be continuation of our gas system monetization plan and a continuation of Energy Strong. And reason why we won’t announce those in 2016 is because we are only a year and half since Energy Strong and we are only six months into GSMP and those were both three-year programs give or take a few months on some unique aspects. So you’re right to say that we have historically backfilled the years four and five. I think there is a very high probability we’ll do the same this time. But I think that’s in terms of the goals for 2016, it will be more some significant distribution projects that we have and potentially some solar work that to keep the state on its RPS targets, you’ll see as a percent in the near-term. Michael Lapides Got it. Thank you Ralph. Much appreciated. Ralph Izzo Sure. Operator Your next question comes from the line of Praful Mehta with Citigroup. Please go ahead. Praful Mehta Thanks you. Hi, guys. Ralph Izzo Hi, Praful. Praful Mehta So quickly on the storage point, I know it was an interesting debate and you’ve made a bunch of relevant points, so that was very thoughtful. I’m just wanted to understand you were mentioning storage more from a transmission perspective. But just take it back to storage more from a generation perspective. If you did have the 10 to 20 year window horizon as you talked about, how would you think of the implications for your gas lead and just generally for the markets in general? If you did think storage was coming, whenever, 10 years or 20 years down the road, how do you see the implications for the power generation for your fleet and just generally in the U.S.? Ralph Izzo Yes. I think there are three uses for storage. One is to the extent that one has some localized distribution reinforcement that can be more economically achieved for the storage rather than fluctuation enhancement. Second would be your classic arbitrage between peak and off-peak, however which has become less of an economic driver now days just given the abundance of natural gas. Third could be sort of a similarity that which is to offset the intermittency associated with renewables, but in terms of using batteries as speakers I mean I think that you just have to take a look again it’s a dollar per KW and my goodness yes I’m – keeping getting more and more efficient and storage seems to be losing in that race so its to keep up with them. So I think there are multiple applications I didn’t mean to suggest that we would only consider one what I was trying to point out is whether the application is a supply side or whether it’s a customer reliability side, whether its providing peaking services, other ancillary services. We don’t have a religious fervor around one technology or another we look at them all the time. Praful Mehta Fair enough that’s really helpful. And then secondly from a M&A perspective there is number of generation assets clearly in the market and potentially more coming and you’ve talked about at some point of separation as well. So how do you fit all that in are you looking to get to critical mark is there opportunity here to apply some asset critical mark there you think you can at some point separate how are you thinking about that opportunity right now? Ralph Izzo Yes I mean that’s pretty much what we’ve told the world right that we see three very changeable tactical reasons for remaining integrated its the financial synergies between powers, our cash generation and utilities cash needs. It’s the customer build synergies between the customer Power serves and the customers that PSEG’s serve and power prices were down PSEG’s distribution rates go up quite candidly. And the last but not least is the benefit of scale associated with the corporate support functions and as Power continues to pursue growth opportunities outside PJMEs the first two issues become less important right. You have more customers that are not PSE&G customers that we will be serving in the New England and the New York State. You have more need for Power’s funds from operations going to Power as opposed to going over to the utility and as both companies get bigger then the corporate supports synergies become less on a percentage basis. As the reason why I say outside of PJMEs is because we’re pretty much preemptive from making any acquisitions within PJMEs and given the slow growth in demand, we’re not big fans of Greenfield development in PJMEs it’s just you quickly run into an oversupply situation. Having said all of that, we have demonstrated that we’re pretty bad at acquiring assets. By that I mean we seem to have a more conservative view of where the market is going and are consistently outbid, Keys being the one exception to that which I believe was largely because of our confidence in our ability to manage construction risk that perhaps others did not posses and also some of the portfolio benefit going to us in terms of PJM West. So, we all the time at generation assets, we have an, I was not saying anti coal bias, that sounds very political and I didn’t mean it that way. But just given the direction of environmental regulation, you wouldn’t see us taking a look at any co expansions in terms of new assets. But we do look in our target markets which would be the rest of PJM, New England and New York State. We just have to get it at the right price and we’re going to remain disciplined in what that means for us. Praful Mehta Got it. That’s very helpful, Ralph, thank you so much. Operator Your next question comes from the line of Ashar Khan with Visium Asset Management. Please go ahead. Ashar Khan Good morning and good results. Can you just ask you one thing which [indiscernible] mentioned why their outage is lasting a little bit longer, is that they didn’t have the equipment on site and I didn’t know what that meant exactly, but I just wanted to ask you Ralph, are you guys do you have this stuff on site to replace everything so it won’t cause a longer outage? Ralph Izzo No it was so – hi Ashar. So the equipment is not routinely onsite, but we are in the process right now of securing that equipment while we do the ultrasonic testing. This is a highly radiated area. It’s inside the reactor vessel, but we are in conversations with at least two vendors who claim to be able to help us do the work and we’re confident we will be able to bring them on site. I mean this is – as I said there is at least 10 other reactors that had this issue in the past and. Ashar Khan No, I understand. And I was just trying to understand whether they were saying the delay was caused by equipment not begin on site? Ralph Izzo I think there is a robotic device that needs to go in and change out the bolts and replace those that fail the ultrasonic test. It’s not something you could send a person into the vessel. Ashar Khan Okay. Ralph Izzo From a clinical path perspective to the inspections that are ongoing now need to take place first so we have sometime of a critical task to be able to secure that kind of equipment. Ashar Khan Equipment, okay I appreciate it. Thank you. Operator Your next question comes from the line of Shahr Pourreza with Guggenheim Partners. Please go ahead. Shahr Pourreza Hi, questions were answered thanks. Ralph Izzo Thanks sure. Operator Your next question comes from the line of Michael Goldenberg with Luminous. Please go ahead. Ralph Izzo Hi, Mike. Michael Goldenberg Good morning. Ralph Izzo Good morning. Michael Goldenberg Hi just wanted to ask a question about your 2018 hedging. I wasn’t clear. If I just look at previous quarters and this quarter it seems like you hedge very little about 5% of your output, but if I did the math I get about $30 or $31 incremental hedging price. I’m not understanding if that’s the price or I’m doing something wrong there. Ralph Izzo And your comparison is what Michael. Michael Goldenberg Versus Q4, so in Q4 you were same percentage at $54 now you’re same percentage $49 so if I just do the simple math I get incremental hedging down at $31? Ralph Izzo We will have to go through the individual math which maybe we could follow up with you on but you also got a range of output where you’re within a higher low band. So, its going to vary, I know that some of that 2018 output is going to come from BGS which tends to have a higher price and then we run lower price environment as well, so it’s going to be some mix of that. Michael Goldenberg Got it. Thank you. Operator [Operator Instructions] . Your next question comes from the line of Ben Budish with Jefferies. Please go ahead. Ben Budish Hey, everybody good morning. Just I wondering if I’m maybe reading into your comments you made at the beginning of the call too much about kind of the importance of Q3, it seems like maybe you’re sort of guiding us to the low end of the range and I’m curious like strong Q3 might get us back to the midpoint or maybe we’re looking at sort of below the bottom end and a strong Q3 gets us back within, is there anymore color you can kind of give on that? Dan Creeg Yes so Ben, the range is the range and historically what we do is after Q1 we really don’t modify our numbers or push people up or down and just live with range. After Q2 sometimes we may move a nickel one way or another if we think that there is a definitive bias one way or another in terms of verbally guiding and then typically after Q3 is when we – if there is a need tighten the range one way or another. So we’re $2.80 to $3 it was a tough winter and we’ve got a lot of focus on our operations and cost efficiencies and the range always assumes that the rest of year is normal weather. We never assume that the weather is going to suddenly do something different than what the weather service predicts as anomaly. Ben Budish Okay great thank you. Operator Mr. Izzo and Mr. Cregg there no further questions at this time. Please continue with your presentation or any closing remarks. Ralph Izzo Sure thank you Brent. So thanks everyone for being on the call and the main message I hope you took away is my favorite message which is steady she goes. We have utility capital program that’s proceeding as planned, Power construction program with three combined cycle units is on schedule and on budget, our operations are strong throughout the enterprise and the balance sheet is as solid as ever. I know Kathleen and Dan have some travels coming in the next couple weeks and then the three of us have some travels coming up in the next couple of months. So hopefully we will get to you see you most if not all of you during those travels. Thanks a lot and we will talk soon. Operator Ladies and gentlemen, that does conclude your conference call for today. You may now disconnect. Thank you for participating. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. 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National Fuel Gas Company’s (NFG) CEO Ron Tanski on Q2 2016 Results – Earnings Call Transcript

National Fuel Gas Company (NYSE: NFG ) Q2 2016 Results Earnings Conference Call April 29, 2016 11:00 AM ET Executives Brian Welsch – Director of Investor Relations Ron Tanski – President and Chief Executive Officer Dave Bauer – Treasurer and Principal Financial Officer John McGinnis – Chief Operating Officer Analysts Kevin Smith – Raymond James Holly Stewart – Scotia Howard Becca Followill – U.S. Capital Advisors Operator Good day, ladies and gentlemen and welcome to the National Fuel Gas Company second-quarter 2016 earnings conference call. [Operator Instructions] I would now like to introduce your host for today’s conference, Mr. Brian Welsch, Director of Investor Relations. Please go ahead, sir. Brian Welsch Thank you, Christie and good morning. We appreciate you joining us on today’s conference call for a discussion of last evening’s earnings release. With us on the call from National Fuel Gas Company are Ron Tanski, President and Chief Executive Officer, Dave Bauer, Treasurer and Principal Financial Officer, and John McGinnis, Chief Operating Officer of Seneca Resources Corporation. At the end of the prepared remarks, we will open the discussion to questions. The second-quarter fiscal 2016 earnings release and April investor presentation have been posted on our investor relations website. We may refer to these materials during today’s call. We would also like to remind you that today’s teleconference will contain forward-looking statements. While National Fuel’s expectations, beliefs and projections are made in good faith, and are believed to have a reasonable basis, actual results may differ materially. These statements speak only as of the date on which they are made and you may refer to last evening’s earnings release for a listing of certain specific risk factors. With that I will turn it over to Ron Tanski. Ron Tanski Thanks, Brian and good morning everyone. Thanks for joining us for today’s call. As you saw in our earnings release last evening, we had a pretty steady second quarter although earnings were slightly down from last year. Earnings in our utility segment were lower due to warmer than normal weather and the lower commodity prices decreased earnings in our Exploration and Production segment. Dave Bauer will go into the details of the major earnings drivers later in the call. Overall, activities in the field for each of our operating segments moved right along as planned. We are just gearing up for the construction season for our regular pipeline renewal projects in our utility and our Pipeline and Storage segments. At the same time, we’ve slowed the drilling activities at Seneca Resources by moving to a single rig drilling program. Our reduced drilling level combined with getting a partner to fund a large portion of this year’s drilling program has cut our spending to allow us to leave within cash flow for the year. Our current plans allow us to stay to single drilling rig for at least a year before we need to ramp up drilling and completion activities again in order to have enough production to fill the pipeline capacity that will come online in November of 2017, the targeted completion date of our Northern Access pipeline. With respect to our Northern Access project, we received some good news from the Federal Energy Regulatory Commission. At April 14th, FERC issued its notices schedule for environmental review for the project and it confirmed their intention to develop an environmental assessment or EA for the project and announced the July 27, 2016 target date for the EA. Now that fits within our timeline for November 2017 in-service date. The other recent news on the regulatory front is the denial by the New York DEC of the Federal Water Quality Certification for the Constitution Pipeline project in Southeastern New York. We submitted our own permit filings to the New York DEC, the Pennsylvania Department of Environmental Protection and the U.S. Army Corps of Engineers for our project just last month. We delayed our filing by three months after a number of pre-filing meetings with the staff of the DEC in order to make sure that our application was complete and address their stated concerns. Based on those pre-filing meetings and gleaning what information we can from the Constitution denial letter, we feel our application is in pretty good shape. A big plus for our project is that more than 75% of the pipeline route will be co-located along existing utility corridors. We also believe that we worked well with the DEC in the past. We already owned and operated thousands of miles of pipeline assets in the state and during our ongoing maintenance and renewal of those lines we’ve dealt with them on a regular basis, addressing many project specific issues. Suffice it to say that we are confident that our project will continue to move along. On the federal rate regulatory front, our team has been busy filing the required cost and revenue study for our Empire Pipeline and answering interrogatories from FERC staff regarding the filing. The schedule is set out by the administrative law judge is a target completion date for the proceeding is set for February of 2017. So, we will keep you posted in future calls if anything major happens in that case. Switching to our utility and state rate regulation, our utility rate team filed a request for a rate increase in New York yesterday. This is the first rate increase request the utility has made since early 2007. The filing supports a $41.7 million increase in base rates, an increase of approximately $5.75 per month for an average residential customer. As is typical in the New York rate proceeding, any new rates would not become effective for 11 months. So, we wouldn’t expect any earnings impact until the second half of next fiscal year. We have a pretty clear line of sight through the end of this fiscal year with respect to our earnings projections and you can see that we’ve tightened up our earnings guidance range. With respect to our oil and gas production, we are well hedged for the remainder of this fiscal year and next fiscal year. And as you can see in the back pages of our earnings release, we are continuing our normal practice of layering in hedges for our oil and gas production as commodity prices in the futures market for our fiscal 2018 and beyond have begun to firm up. We see the market getting more bullish on commodity prices in the out years as production volumes have started to level off and the rig count stays low. For the foreseeable future, we will continue to watch our spending, protect our balance sheet and work to get our Northern Access pipeline build that will deliver Seneca’s production to an attractive pricing point. Now, I will turn the call over to John McGinnis, who will be stepping into the role of President at Seneca, when Matt Cabell’s retirement becomes effective next week. John McGinnis Thanks, Ron, and good morning everyone. For the fiscal second quarter, Seneca produced 39.2 Bcfe, which suggest over a Bcf more than we produced in our first quarter. In Pennsylvania, we curtailed approximately 9.1 Bcf of potential spot sales due to low prices and as a result, no spot gas was sold during the first half of our fiscal year. In April, however, prices have actually improved to the point but we have intermittently produced into the spot market at both our Tennessee and Transco receipt points. Though not a large volume totaling just over a Bcf, this was the first time we have sold meaningful spot volumes since December of 2014. In Pennsylvania after beginning the year with three rigs, we have now dropped to a single rig as of March. We plan on keeping this rig active for the remainder of the year to ensure we have sufficient inventory of DUCs to help fill Northern Access now scheduled to be online late next year. We have also reduced the activity level related to our completions crew to daylight-only operations. At this reduced pace, we typically complete five to six stages per day, which allows us to continue to recycle all of our produced water and avoid costly water disposal. Even with our frac crew operating at half pace, we continued to drop our well costs. For the first half of 2016, our development program has averaged under $5 million per well for a 7,400 foot lateral, which equates to costs of around $675 per foot. The key drivers for this continued drop in costs include the impact of the new frac contract executed in September of 2015 and a significant reduction in water costs. We now average less than a dollar per barrel in water costs, compared to about $3 per pad early in our development program. Moving now to the Utica/Point Pleasant, we have drilled and completed our first Clermont area at Utica horizontal at an estimated cost of just over $7 million. This well was drilled with a relatively short lateral length of 4,500 feet to better understand productivity on a per foot basis. Once we have completed all of 11 wells on this pad, 10 of which are in the Marcellus, we will bring this pad into production later this summer. The rig has recently moved to a new pad also in the Clermont area where we are currently drilling our second Utica well. This well is scheduled to be tested early in 2017. On the marketing front, when the opportunity arises, we continue to layer in fixed price sales and firm sales tied to financial hedges. This has allowed us to slowly grow production and realize acceptable pricing during an exceedingly difficult period for commodity prices. For the remainder of our fiscal 2016, the vast majority of our natural gas production forecast around 64 Bcf is locked in both physically and financially at an average realized price of $3.20. This $3.20 is net of firm transportation. We also have an additional 4 Bcf of basis protection and with the recent improvement in futures pricing, we are actively pursuing additional opportunities to add to our physical sales portfolio and hedge book. In California, production was nearly flat quarter-over-quarter, even though we have significantly cut our spending in California this year. We’re targeting to spend just under $40 million in 2016, almost a 30% reduction in compared to last year and half of what we spent just two years ago. All of our development activity is focused in Midway Sunset and will remain so until prices rebound. As a result of our recent farm-ins, however, we believe we can keep production flat to slightly growing over the next couple of years, even with these capital cuts. Thus far in 2016, we have cut E&P capital expenditures by almost 70% compared to 2015 levels to a forecasted range of $150 million to $200 million. Even with these cuts, we expect to grow our production slightly this year and maintain our DUC count ahead of Northern Access in-service date. The key drivers in achieving this result include our recent joint development agreement with IOG, dropping to a single rig and moving to daylight-only frac operations in Appalachia, combined with again, a significant reduction in our California capital expenditures. I’d like to now turn the call over to Dave Bauer. Dave Bauer Thanks, John. Good morning, everyone. Excluding the ceiling test charge, earnings for the quarter were $0.97 per share, down $0.05 from last year. The unseasonably warm weather in our service territory relative to last year’s record cold, lowered earnings by a combined $0.11 in our utility and Pipeline and Storage businesses. Meanwhile, our ongoing focus on cost control across the system helped to offset the continued weakness in oil and gas prices, which lowered earnings by about $0.25 per share. All told, considering the twin headwinds of weather and commodity pricing, both of which are largely beyond our control, the second quarter was a good one for National Fuel. Seneca’s production was up nearly 10% over last year’s quarter and 3% on a sequential basis. This increase is largely attributable to Seneca’s firm transportation capacity and associated firm sales related to the Northern Access 2015 project, which was placed in service late in calendar 2015. As a reminder, this was a joint project between our NFG Supply Corporation subsidiary and Tennessee Gas Pipeline designed to move a 140,000 dekatherms per day from our WDA acreage to the Canadian border at Niagara. For the quarter, this project contributed over $3 million in revenues to our Pipeline and Storage segment. In addition to benefiting Seneca and Supply Corp, the increase in Seneca’s production combined with our partner IOG’s share of the volumes from the joint development wells also helped our gathering business where revenues were up by $4.2 million or nearly 25%. Controlling operating costs was a focus across the system and we saw excellent results during the quarter. At Seneca, per unit LOE was $0.96 per Mcfe, down $0.07 from the first quarter. Most of this decrease was attributable to our California operations. In light of lower oil prices, our team has kept a tight lid on expenses, limiting our spending to only highly economic work-over activity and to areas that are critical to the safety and integrity of our assets. Also, lower natural gas prices caused steam fuel cost to be lower than we expected. In Appalachia, lower water disposal costs were also a factor. As John said, Seneca is now reusing almost 100% of our produced water. Road maintenance expense was also lower due to the relatively mild winter. Given all of these factors, we now expect our full-year per unit LOE rate will be in the range of $0.95 to a $1.05 per Mcfe, down $0.05 from our previous guidance. Seneca’s per unit G&A expense was $0.49 per Mcfe. During the quarter, Seneca implemented a reduction in force that trimmed our staffing complement by about 10%. As part of that effort, we paid out severance costs of about $1.5 million, which caused Seneca’s per unit G&A to be about $0.04 higher than it otherwise would’ve been. We’ll start to see lower personnel costs in the second half of the year. Per unit G&A for the rest of the fiscal year should be in the range of $0.35 to $0.40 per Mcfe. At utility, O&M costs were down over $5 million from last year. About a third of this decrease was caused by lower bad debt expense. A combination of historically warm weather and exceptionally low natural gas prices caused our customers winter heating bills to be the lowest they’ve seen in decades and has had a meaningful impact on our bad debt expense. The remainder of the decrease was caused by a variety of factors, including lower maintenance expense that was the result of the mild winter and lower pension and personnel-related expenses. In the Pipeline and Storage segment, revenues were up just about a $1 million from last year. While this may seem light, given the projects that were placed in service in the first quarter of the fiscal year, the swinging weather year-over-year had a significant impact on revenues from short-term firm services which decreased by approximately $5 million from last year. We expect larger favorable variances in revenue for the last two quarters of the year and still expect revenues in the segment to total between $300 million and $310 million for the full year. Looking to the remainder of the year, we are tightening our earnings and production guidance ranges. Our new earnings guidance while unchanged at the midpoint is a little tighter at $2.80 to $2.95, excluding ceiling test charges. Seneca’s updated production forecast is now a 158 to a 175 Bcfe. We up the low end of our previous guidance range of 150 to a 180 Bcfe to reflect new firm sales that were done this quarter, as well as some minor changes in our operations schedule. We lower the high end to reflect curtailments from the second quarter. As in prior quarters, the difference between the high and low end of our production range is driven entirely by curtailments. The low-end assumes we curtail a 100% percent of our spot production while the high-end assumes we have no curtailments. While we didn’t have any spot sales during the first six months of the year, as John mentioned we’ve sold about a Bcf spot sales in April which is encouraging. We have also made a modest change to our NYMEX natural gas price assumption which is now $2.15, down $0.10 from our previous guidance. Our oil price assumption is unchanged at $40 a barrel. We are well hedged for fiscal ‘16 for the remainder of the fiscal year and assuming the midpoint of our production guidance, we are about 80% hedged for natural gas and 55% for crude oil. Therefore, any changes in commodity prices should have a relatively modest impact on our cash flows. We continue to actively pursue incremental hedges in firm sales to lock in the economics of our program, as we grow into the volumes that are required to fill the Northern Access and Atlantic Sunrise projects. Just recently, we added a modest layer of Dawn and NYMEX-based hedges for 2018 to 2021 time period at about $3 per MMbtu. Consolidated capital spending for fiscal ‘16 is expected to be in the range of $445 million to $545 million, down $20 million from our previous range. Substantially, all of the change is related to the timing of spending between 2016 and 2017. Details of capital spending plans by segment are included in the new IR deck on our website. From a liquidity standpoint, we continued to be in great shape. Assuming the midpoint of our earnings and capital spending guidance, we expect we are very close within cash flows for the fiscal year. With that I will close and ask the operator to open the line for questions. Question-and-Answer Session Operator Thank you. [Operator Instructions] Our first question comes from the line of Kevin Smith of Raymond James. Your line is open. Kevin Smith Thank you and good morning, gentlemen. John McGinnis Hi, Kevin. Kevin Smith John, congrats first on joining the earnings call but with that, I will kick off the question. Can you discuss current shut-in volumes in the Marcellus and maybe how much you’ve been able to sell to spot since differentials have been tightening? John McGinnis Say that again. I’m sorry, you are breaking up. Kevin Smith I apologize about that. Can you discuss current shut-in volumes in the Marcellus and then maybe how much you’ve been able to sell into spot and what that’s looked like over the last month? John McGinnis Yes. We’ve sold essentially nothing in spot for the second quarter, a little over a Bcf in April because prices had improved upon we could, both on Tennessee and Transco sell into the spot market. But recently though pricing has dropped off again so we are shut-in. But I think we are about $40 million to $50 million of available spot in our Tioga area and a little over 100, 120 in Lycoming if I remember correctly. Kevin Smith Got you. That’s helpful. And would you mind providing some more details about the new firm sales agreements? Basically what’s the length of those contracts? Dave Bauer Yes. Sure, Kevin. This is Dave. We did — well for fiscal ’16, we did about 5 Bcf of additional firm sales and then looking out into ’17, ’18, ’19, we did a bunch of fixed sales ranging, call it from 10 to 30 Bcf per year, kind of in the high but just under $2 range. Kevin Smith Okay. Great. That’s extremely helpful. That’s all I had. Thanks. Dave Bauer Sure. Operator Thank you. [Operator Instructions] And we do have a question from the line of Holly Stewart of Scotia Howard. Your line is open. Holly Stewart Good morning, gentlemen. John McGinnis Hi, Holly. Holly Stewart Maybe just one on sort of what you see on the capacity market in Northeast PA. I mean the rig count, I think in Northeast PA has dropped to maybe three now. Just curious if you’ve seen a pickup in capacity being offered out there and sort of what you are looking at in terms of volume, maybe a pickup in order to bring some of that volume on — some of your shut-in volume online? John McGinnis I think it’s actually down to two rigs now. I was just looking at that the other day. It continues to fall. We haven’t seen any help on the capacity side as of yet. Whether producers are bringing on wells as they had shut in, we just — we haven’t seen additional, at least significant additional capacity available in that part of the state. Holly Stewart Okay. Okay. Great. And then maybe you could just help us think about the progression of production for the next few quarters, give us your wells turned to sales during this past quarter and then sort of the remaining target for the year? John McGinnis Yes. I can give you our target for the year. I can’t tell you what the second quarter was. We are targeting for fiscal ‘16 about 50 wells to drilled, 45 to be completed. We will end the year with about 60 to 65 DUCs. And in terms of the well count, back half of the fiscal year, we are looking at bringing on an additional about 25 wells. Holly Stewart Okay. Great. Thanks, John. John McGinnis Yes. Operator Thank you. And our next question is from Becca Followill of U.S. Capital Advisors. Your line is open. Becca Followill Hi guys. John McGinnis Hi Becca. Becca Followill You talked a little bit. I know you’ve had the one-rig program. What does it take to start to ramp that back up again? John McGinnis Well, part of why we want to keep a single rig going is that it keeps in the half, sort of the daylight-only or what I call a half frac crew is that it keep our DUC count relatively flat. And so really to ramp-up, it doesn’t really — we are not going to necessarily need to bring in an extra rig. What we will end up doing is we will go to 24-hour frac crew and potentially two frac crews, obviously — depending on the ops and the in-service date related to Northern Access. So really it’s more to bring in an additional frac crews as opposed to a rig count. Becca Followill Thank you. And then on the water permit, what is the timing you’re expecting to get that permit from the DEC? John McGinnis Well, assuming that it takes the full year, Becca, it would be the beginning of March of 2017. Are you getting that? Becca Followill Do you think it will take the full year? John McGinnis I think we’ve — that’s kind of what we have planned at the outside. We had the luxury of being on 98% of the route sites, so that we had what we think was a very, very complete application. Whether that state will move it along any faster, we can’t guarantee. We just know that there is a year timeframe from filing. So that’s what we are planning on. Becca Followill Thank you. And then lastly on the Empire open season. I think there was something in the slide deck about precedent agreements were tendered in February. So, can you talk a little bit about that expansion? John McGinnis Well, we are working through that. We did have a good open season for the Empire North project. It was — to a certain degree it was oversubscribed because certain parties tried to put together different combinations of transportation routes and so that’s really what we’re working through, Becca, in order to kind of rationalize the best flows and the best combination and get that worked in to precedent agreements. We don’t have any of them signed just yet and we just continue to work away at that. Becca Followill Okay. Thank you. Operator Thank you. And our next question is from Chris Sighinolfi of Jefferies. Your line is open. Unidentified Analyst Hey guys. Good morning. This is actually Chris Dillon [ph] on for Sighinolfi. How are you? John McGinnis Hi, Chris. Dave Bauer Good, Chris. Unidentified Analyst I was just wondering if you could provide an update on the JV and whether or not you feel like the partner is likely to exercise the option there as we approach that date and what I guess, kind of conversations you are having and what might be under consideration from their side? John McGinnis The relationship is great. We drilled 30 of the 42 wells. With those pads just — they are early. They are just now coming online. Our costs have been about 10% or more down which they are pleased with. We have conversations around entering into the second tranche, but really that’s a decision that they are going to make in July and that’s really all I can speak to right now on that. Unidentified Analyst Okay. That’s fair. That was it for me. Thanks guys. Operator Thank you. And that does conclude our Q&A session for today. I would like to turn the call back to Mr. Brian Welsch for any further remarks. Brian Welsch Thank you, Christie. We would like to thank everyone for taking the time to be with us today. A replay of this call will be available at approximately 3 p.m. Eastern Time on both our website and by telephone and will run through the close of business on Friday, May 6, 2016. To access the replay online, please visit our investor relations website at investor.nationalfuelgas.com. And to access by telephone call 1-855-859-2056 and enter the conference ID number 84814628. This concludes our conference call for today. Thank you and goodbye. Operator Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. 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