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For new National Fuel CEO David Bauer, it pays to be nimble

David P. Bauer is less than two months into his tenure as National Fuel Gas Co.'s top executive, but he's already shown that it pays to be nimble.

Bauer, who succeeded Ronald J. Tanski as National Fuel's president and CEO in July, already is making his mark on the Amherst energy company's focus at a time when low natural gas prices are a boon for consumers enjoying lower energy bills and a drain on its drilling business, which is selling the gas it produces at depressed prices.

So Bauer — and National Fuel — are adjusting.

The company earlier this month said it would cut back on its drilling operations in the shale gas-rich portions of northwestern Pennsylvania and instead pump more money into projects to expand its pipeline network, which offers more stable returns and also helps broaden the potential market for its abundant gas reserves.

"We're fortunate that we've got a diversified model," Bauer said. "We've got the ability to grow all three parts of our business in a big way."

But that doesn't mean the timing can't change with shifts in the natural gas market.

For the last two years, National Fuel had been on a push to ramp up its gas drilling operations, adding a second drilling rig in 2017 and a third in 2018. But with natural gas prices falling — prices were down 3% in the spring quarter — National Fuel was producing 25% more gas but getting less for it.

So Bauer decided it was time to make a shift in strategy, cutting the company's planned investment in the drilling business by $50 million and shifting the bulk of that money into pipeline projects.

"We're very well-connected and able to expand projects that can move gas to other markets," Bauer said.

In all, National Fuel has about $1 billion in pipeline projects either in development or on the drawing board. Its $24 million Line N pipeline expansion project will bring gas to a Shell Chemical plant about 35 miles north of Pittsburgh, adding $5 million in annual revenues beginning this year. Its $279 million FM100 pipeline expansion will add 30 miles of new pipe, mostly in McKean and Potter counties in Pennsylvania, and bring in about $35 million new revenue beginning in late 2021. And its $145 million Empire North expansion project will add about $25 million in annual revenue.

"We've got a great opportunity to expand our network," Bauer said. "Unfortunately, I don't see projects going through New York."

Whether that happens will depend on how regulators and the courts ultimately decide the fate of National Fuel's most controversial pipeline project: its $500 million Northern Access pipeline that would stretch from McKean County in Pennsylvania to Elma.

State regulators have moved to block the project, first in 2017 and most recently in a ruling issued earlier this month denying the company a water quality certificate needed for the pipeline to proceed.

But federal regulators have taken a more positive view of the Northern Access project. The Federal Energy Regulatory Commission has said the state Department of Environmental Conservation's refusal was invalid because the agency missed a deadline to issue it. In February, the Second Circuit Court of Appeals said the DEC should "more clearly articulate its basis for the denial."

What that means for the project is that its fate remains in limbo.

"At the end of the day, we believe federal law trumps state law," Bauer said. "Federal law is generally on our side."

But Bauer also expects the DEC to take National Fuel to court to try to block the project if the company tries to move forward with it — a delay that could add a year to 18 months to the timetable even if National Fuel beats back the state challenge.

"It's pretty clear that New York is going to oppose this project pretty much at any step of the way," Bauer told analysts during a conference call earlier this month. "So we're thinking that this is really a longer-term project, likely in the 2022, 2023 time frame. And given [the drilling business'] reduced level of activity, delay is not the worst thing in the world."

National Fuel isn't alone. The DEC has denied water quality certificates for several proposed natural gas pipelines after determining that they didn't comply with water quality standards. That includes a $1 billion downstate project whose denial prompted National Grid to stop processing new natural gas service applications in New York City and Long Island because the utility said it is concerned about having adequate gas supplies. Consolidated Edison imposed its own moratorium north of New York City in March.

The pipeline dispute is another example of how environmental policy in New York is shaping National Fuel's strategy. A decade ago, it was the state's ban on high-volume hydraulic fracturing that made New York's shale deposits off limits to gas drillers out of concern that the controversial drilling technique would lead to contaminated water supplies.

At that point, National Fuel shifted the focus of its drilling operations to the nearly 800,000 acres of land it controls in northwestern Pennsylvania. After spending years tapping into the Marcellus Shale, National Fuel now is drilling even deeper – about 5,000 feet deeper on average – to tap into the even more prolific gas deposits located in the Utica Shale underneath the Marcellus.

Even with National Fuel now scaling back its drilling, the company still expects its gas production to rise by about 15% next year as the new wells from its three-rig drilling program come online. With just two rigs, Bauer thinks National Fuel still can increase its production by 5% to 10% a year.

And even though gas prices are depressed, National Fuel has been able to reduce its costs by drilling many of its Utica Shale wells on the same drilling pads as its older Marcellus wells. That allows National Fuel to use the same roads, gathering pipeline system and other existing infrastructure for the new wells, saving an average of about $1 million per well in infrastructure costs.

"It makes a huge difference," Bauer said. "Our economics improve by about 10%."

National Fuel also owns the mineral rights on much of the acreage it controls, which means it doesn't have to pay royalties on the gas it produces from wells at those locations and it's not under a mandate to drill at a site within a certain time period or risk losing the rights to drill there.

That means that many of National Fuel's well sites can be profitable even with gas prices around $2 per 1,000 square feet. It also gives National Fuel the flexibility to scale back, or ramp up, its drilling as prices rise and fall.

"We don't want to give it away," Bauer said.

With gas prices down, National Fuel's profits have been relatively flat, rising 2% through the first three quarters of this fiscal year. Earnings are flat at its drilling business, while they're down at the pipeline unit and up in the utility segment. The company expects its earnings to fall by about 1% during the fiscal year that starts in October.

Its share price also has lagged, tumbling by almost 17% over the past year, while the Standard & Poor's 500 index has gained about 1%. The underperformance is even worse over the last five years, with National Fuel shares dropping by 37%, compared with a 47% gain by the S&P 500.

Of course, the drop in natural gas prices has been good news for consumers, whose heating costs have been cut almost in half over the past 10 years as the abundant gas supplies from Pennsylvania have outstripped demand and driven prices lower, even as the company spends about $100 million a year to replace an average of about 150 miles of utility pipelines annually.

Those lower prices are saving utility customers about $400 million a year, and are pushing up demand at the utility's generally mature customer base. National Fuel's utility business has been adding 4,000 to 5,000 customers annually.

"We're doing our best to continue to expand our system," Bauer said.

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