Exploration and Production
If this discussion had taken place in March, six months into 1999, the
tone and message would have been considerably different. Oil prices were
excessively low at $9.03 per bbl and natural gas prices of $1.92 per Mcf were
dropping significantly because of record storage volumes resulting mostly from a
warmer than normal winter. This segment had only contributed about $.01 per
share to the Company's earnings.
What a difference six months makes! By the end of 1999 oil prices were
moving toward $25.00 per bbl and natural gas prices increased to approximately
$2.80 per Mcf . This segment's earnings for 1999 of $7.1 million, or $.18 per
share, contributed 6% of Company earnings, and we also finished the year with a
stellar production record. Total revenue this year was $147.0 million which was
18% higher than 1998. Production increased 17% from 1998 levels to 61.3 Bcf
equivalent. A total of 118 wells were drilled this year, and our team, aided by
3-D seismic technology achieved a 91% success rate. We replaced 187% of 1999
production with new reserves from our exploration program, and total reserves
increased 7% in 1999 to 776 Bcf equivalent.
Performance improvements in our California operations were truly
impressive in 1999. After completing our three acquisitions in 1998, initial
operating costs were nearly $6.00 per bbl of oil. At the end of 1999, those
costs were reduced to $4.07 per bbl . Production had also significantly
improved, primarily due to a 95-well drilling program completed this year. At
the end of 1999, daily oil production had increased 17% from initial production
to 7,333 barrels per day.
In the Gulf Coast, our successful offshore exploration program
continued. New discoveries at Vermilion 309, Vermilion 253, West Delta 78, High
Island 365, and Galveston 225 contributed to the reserve replacement discussed
above. The most significant of these was the announced discovery at Vermilion
253 where the first well had over 900 feet of oil and gas pay sands. Production
platforms and facilities are being installed, and we anticipate production to
begin in late Spring 2000.* Drilling will continue on both Vermilion 253 and 309
in 2000 with more production expected to be placed on line from these blocks.*
Cost controls and an extremely efficient operation helped make us one
of the lowest cost operators in the Appalachian region. The nearly 450,000 acres
controlled by Seneca Resources Corporation (Seneca) in Pennsylvania and New York
are a potential untapped opportunity.* However, the relatively low reserves per
well and the long lives of the wells mean that we have to be convinced that gas
prices would reach a sustainable $3.00 per Mcf before we will commence large
scale development.*
Total production for Seneca for 2000 is expected to increase over 20%
to 74.4 Bcf equivalent in a ratio of approximately 64% gas and 36% oil, and
nearly 60% of this production is locked in through financial hedges.* Capital
spending, exclusive of acquisitions, is anticipated to be $112.2 million with
approximately 84% targeted for the Gulf Coast Region and the remainder for an
additional 40 development well program which has begun in our West Coast
operations.*
Although 2000 could be as volatile as 1999, we expect it to present
many opportunities as consolidation, strategic selling and asset monetization
continue in the exploration and production sector.* The management and employees
of Seneca will concentrate on continuing our success in reducing production
costs, enhancing reserve replacement and growing your Company through the drill
bit and through acquisitions.* Seneca is prepared to take advantage of these
opportunities.*
Timber
The Timber segment is an increasingly important source of earnings.*
This year's earnings of $4.8 million, or $.12 per share, increased nearly 151%
from 1998.
This past July we acquired approximately 36,300 acres of land, timber
and minerals from PennzEnergy Company for approximately $47.0 million. This
property is largely quality timber acreage located within the "cherry corridor"
of Pennsylvania.
Presently, we are conducting a timber inventory, or "cruise," of all
our holdings in order to better optimize the value of our timber assets. Many of
our trees are nearing their economic maturity and detailed information is
required to plan the most efficient realization of this value. We presently
estimate that we own over 400 million board feet of hardwood timber, consisting
mostly of cherry, maple and oak. Even after the cruise is completed and our
plans are developed, it is likely that the maximum level of production will not
be achieved for many years because of the sheer physical magnitude of carefully
dealing with over 140,000 acres.* However, in the interim, we expect to sell
certain noncore portions of our holdings in order to reduce debt.*
Pipeline and Storage
Currently the third largest segment in terms of net plant, this
segment continued to be a strong contributor to Company earnings, second only to
the Utility. Net income of $39.8 million, or $1.03 per share, provided nearly
35% of 1999 Company earnings.
In anticipation of the growing demand for natural gas in the East Coast
markets, a portion of this year's capital budget was spent expanding the
throughput capacity of our Ellisburg, Pennsylvania compressor station from 369
MMcf per day to over 431 MMcf per day. This additional capacity is designed to
increase both pipeline throughput and storage customer access to Leidy Hub, a
key link to the East Coast. We also anticipate expanding capacity incrementally
in the Niagara Spur as demand increases.*
Discussion at this Fall's annual meeting of the Interstate Natural Gas
Association of America centered on the increasing use of gas-powered
combined-cycle electric generation plants and gas peaking units and the
anticipated construction of new power plants, the vast majority of which will be
gas-fired.* Some of the reasons for gas-fired electric generation include
reduced environmental air quality issues from coal-fired generation and
efficiencies from technological advances in combined-cycle turbines and other
types of gas-fired units.* This anticipated movement towards gas-fired
generation presents tremendous growth opportunities for gas pipeline companies.*
Much of this new power plant construction is expected to be directed
to, and constructed near, the East Coast markets.* The question then becomes,
where will these power generators get the gas for these new plants? We expect
that some of it will come from the Gulf Coast, but that supply is likely to
mainly feed the West Coast, lower Rockies, and the Southeast.* Much of the gas
is therefore expected to come from the hubs near Chicago which are fed by
Canadian producers via the Northern Border Pipeline Expansion, completed in
1998, and the Alliance Pipeline, which is currently under construction.* With
this influx of Canadian gas, Chicago should have pent up capacity, while markets
on the East Coast are expected to have pent up demand.* Consequently, capacity
needs to be made available to move gas from Chicago eastward.* Another pipeline
project, Vector, has received approval from the Federal Energy Regulatory
Commission (FERC) to build a pipeline from Chicago to Dawn, Ontario. Designed to
transport 1 Bcf per day of gas, we understand the Vector Pipeline has
approximately half of its capacity subscribed to Eastern Canadian markets.* We
expect the remaining capacity from Vector should most logically come across the
Niagara River and through our system.*
Of course, we are convinced that the best route for the Canadian gas is
still through the Independence Pipeline. We are pursuing this $680 million
project with our partners, affiliates of Transcontinental Gas Pipe Line
Corporation (one of the Williams Companies) and ANR Pipeline Company (a
subsidiary of The Coastal Corporation).* This pipeline, when constructed, should
be the key link in a chain of pipelines from the Canadian Rockies to the East
Coast.* In November 1999 the project received the FERC final Environmental
Impact Statement which is a very positive step toward project certification. We
are awaiting final certification of the project. We believe that by supplying
over 900,000 Dth per day of gas to the East Coast markets, this pipeline will be
instrumental in capitalizing on the anticipated movement by the power generation
industry toward gas-fired generation.*
Your Company is, indeed, the "Gateway to the East" more so than it has
ever been. We stand directly between the gas supplies heading from Western
Canada to the East Coast markets, and we believe our pipeline and storage
facilities are strategically located to take advantage of this growth
opportunity.*
Utility
This segment's earnings of $56.9 million, or $1.47 per share,
contributed the largest portion, approximately 49%, of the Company's net income
in 1999. This is a remarkable achievement since our two year rate settlement in
New York required an annual rate reduction of $7.2 million, and required us to
set aside $7.2 million of 1999 revenues to fund future restructuring expenses
incurred as New York State separates the sale of gas from transportation.
Our continuing emphasis on cost containment has been instrumental in
helping us to achieve better than expected results thanks to the efforts of our
employees. By embracing the message of change, they helped us to further reduce
total operating and maintenance expenses below last year's figures. This
accomplishment is all the more noteworthy in light of the increased expense
caused by our early retirement initiatives.
During 1999, the local and national media made much of customer choice
for utility customers. Electric choice initiatives in New York and Pennsylvania
jumped into the spotlight as regulatory agencies launched public education
programs and electric marketers began advertising campaigns for retail
customers. The publicity suggests that there is a great deal of customer choice
activity going on in the business, with customers switching suppliers and
telemarketers pitching utility service and nontraditional products to an
ever-growing pool of eligible utility customers. In fact, however, the reality
is somewhat less exciting. While we have seen an increase in customer choice
activity - currently over 70,000 of our more than 733,000 customers have
switched to transportation service - we continue to manage the transition to
competition as an evolutionary, considered process. Choice as an end unto itself
is a dubious proposition, and we remain focused on building restructured
services that preserve reliability and provide a framework for fair competition.
These efforts have yielded a successful choice program that we expect will
continue to produce benefits for the Utility, the Company and our customers as
the industry's restructuring proceeds.*
In an environment of rapid change, we have maintained the Utility's
steadfast dedication to superior customer service. For instance, new programs
were established in New York and Pennsylvania to provide gas appliance repairs
or replacement for some of our neediest customers. We continued to work with
local social service agencies to bring the benefits of competition to thousands
of public assistance customers who might otherwise be overlooked as a potential
market. We organized a Transportation Services Department in order to better and
more efficiently serve the needs of our transportation customers. We continued
to enhance our field procedures to allow more customers to initiate or transfer
service without having to provide access to Company personnel. Finally, our
traditional service performance measures continued to improve or remain at
historically high levels.
We have also scrutinized the Utility's practices and procedures in
order to identify opportunities for technology improvement and efficiency gains.
Currently, we are installing a new PeopleSoft(R) system that will greatly
enhance our ability to retrieve and efficiently process financial and accounting
information. Additionally, we are modifying our Customer Information System to
allow for more flexibility in customer and marketer billing functions. In the
field, technological advances have allowed our personnel to respond more
effectively and efficiently to many situations, from environmental site
monitoring to pipeline system repairs and maintenance. For example, by using a
"vacuum" truck for line repairs, we significantly reduced the cost of gas line
maintenance and site restoration costs. We are also using a "gas cam" which
allows our crews to "see" through a tiny camera inserted into a pipe, thereby
making corrosion and other line problems easier and less costly to isolate and
repair.
Finally, we are exploring a number of value added services and
products designed to increase revenues from our existing customer base. In the
Utility's service territories, National Fuel is a name that customers have long
trusted for reliable gas service and expert energy advice. Particularly during
these times of rapid change, opportunities for the Utility to offer
non-traditional products and services are at their greatest. As a result, we are
looking at energy end-use technologies, including microturbines and distributed
generation projects, retail billing services, pipeline insurance and appliance
leasing, among other things. Indications are promising that customers would be
strongly interested in these and other products and services offered by the
Utility.*
In these changing times, we believe it is particularly important that
we remain focused on the fundamentals. Thus, we will continue to emphasize our
strengths: cost containment, superior customer service, and a managed transition
to competition. At the same time, however, change presents new opportunities. We
look forward to exploring those opportunities during the next year and as the
business environment continues to evolve.
Energy Marketing
In what may be a unique record among gas company marketing affiliates,
each year since its inception in 1991 National Fuel Resources, Inc. (NFR) has
contributed positively to Company earnings. In 1999, net income of $2.1 million,
or $.05 per share, provided a return on its equity of 16.8%. As you can see from
the charts provided, over 75% of our customer growth is attributed to
residential gas customers, but the dramatic increase in volumes was accomplished
across-the-board with growth in all customer segments. NFR has a multi-state
presence and continues to expand its markets in New Jersey and Pennsylvania.
However, regulatory changes in New York have been most favorable, and, as a
result, our most dynamic growth has taken place there.
NFR has strategically acquired upstream pipeline capacity and storage
to assure reliable service to our customers at competitive prices.* Providing
energy solutions for customers cannot be limited to natural gas and related
value added services. We are also pursuing opportunities related to gas-fired
generation which could position us for future retail electric opportunities.*
While retail electric prospects are modest at the moment, we are confident that
a fully competitive market will unfold over time and we will be well positioned
for this opportunity.*
International
Net income of $2.3 million, or $.06 per share, is a gratifying result
from this relatively new segment. These earnings were $1.0 million or 78% higher
than 1998's earnings of $1.3 million. This year also marked the first full 12
months of sales and revenues from our investment in Prvni severozapadni
teplarenska, a.s. (PSZT).
Capital expenditures of $27.6 million were used primarily for the
construction of new boilers at our PSZT heating plant to comply with certain
clean air standards mandated by the Czech Republic. Our net plant in the Czech
Republic now stands at $203.5 million with total assets of $255.0 million.
The merger of Severoceske teplarny, a.s. (SCT) and PSZT is expected to
occur in 2000, and should provide efficiency improvements and cost reductions.*
Future growth could come from a joint venture or similar alliance, preferably
with a U.S.-based electric company.* We believe their knowledge of electricity
and our natural gas expertise will provide enhanced development opportunities.*
We are comfortable with our base in Prague which allows us to look at
numerous prospects within Eastern Europe. As you may know, projects here happen
later rather than sooner; thus, patience and a long-term view are key
considerations as we continue to evaluate potential energy projects.*
* This document contains "forward-looking statements" as defined by the
Private Securities Litigation Reform Act of 1995. Forward-looking
statements, including those designated by a "*", should be read with the
cautionary statements and important factors included in this Annual Report
on Form 10-K at Item 7, under the heading "Safe Harbor for Forward-Looking
Statements."
APPENDIX TO EXHIBIT 13 - This appendix contains a narrative description of image
and graphic information as contained in the business segment discussion included
in the paper copy of the Company's combined Annual Report to Shareholders/Form
10-K.
Images 1 - 6 are contained in a section devoted to the Exploration & Production
segment as follows:
1.) Image - Picture of James A. Beck, President, Seneca Resources
Corporation. The following quote appears under the picture: "In the
Gulf Coast, our successful offshore exploration program continued. The
most significant of these was . . . Vermilion 253 where the first well
had over 900 feet of oil and gas pay sands."
2.) Image - Picture of Seneca employees analyzing data, with the following
caption: Geologists and geophysicists use computer technology to
interpret three dimensional (3-D) seismic data in order to recommend
prospective oil and gas drilling sites. Pictured here: Scott Gorham and
Gerald Langille of Seneca's Houston office.
3.) Image - Picture of heavy oil pumping units with the following caption:
These pumping units are part of the heavy oil operation on Seneca's
Cherokee property at the Midway-Sunset Field. In 1999, Seneca drilled
51 wells at this site, which is located in California's San Joaquin
Basin.
4.) Image - Picture of Seneca employees reviewing 3-D seismic data with the
following caption: Recommendations from analysis of 3-D seismic data
are carefully reviewed and evaluated. Pictured here: Seneca Houston
personnel Linda Holmberg and John McKnight.
5.) Graph - Proved Developed and Undeveloped Reserves
Bar graph showing oil and gas proved developed and undeveloped reserves
(in billion cubic feet (Bcf) equivalent), at September 30, 1995 through
1999, as follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
Oil 137.2 154.5 107.9 399.5 454.9
Gas 221.5 207.1 232.4 325.1 320.8
----- ----- ----- ----- -----
358.7 361.6 340.3 724.6 775.7
6.) Graph - Oil and Gas Production
Bar graph showing oil and gas production (in billion cubic feet (Bcf)
equivalent), for the years 1995 through 1999, as follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
Oil 4.5 10.4 11.4 15.7 24.1
Gas 20.9 38.8 38.6 36.5 37.2
---- ---- ---- ---- ----
25.4 49.2 50.0 52.2 61.3
Images 7 - 9 are contained in a section devoted to the Timber segment as
follows:
7.) Image - Picture of Highland employee operating machinery in sawmill
with the following caption: Gregory Ochs operates the edger at the
Marienville, Pennsylvania sawmill. The four sawmills owned by the
Timber segment sold approximately 21.1 million board feet of logs and
lumber this year.
8.) Image - Picture of timber harvesting with the following caption: Much
of the timber harvested is taken from the 140,000 acres owned by
Seneca Resources.
9.) Graph - Timber Production
Bar graph showing timber production in millions of board feet for the
years 1995 through 1999, as follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
6.6 6.4 9.8 14.6 21.1
Images 10 - 14 are contained in a section devoted to the Pipeline and Storage
segment as follows:
10.) Image - Picture of Richard Hare, President, National Fuel Gas Supply
Corporation. The following quote appears under the picture: "Your
Company is, indeed, the "Gateway to the East" . . . We stand directly
between the gas supplies heading from Western Canada to the East Coast
markets . . ."
11.) Image - Picture of welding crew with the following caption: This year
National Fuel Gas Supply Corporation replaced 14,000 feet of Line K, a
major supply line which runs from Clarion, Pennsylvania to Buffalo, New
York. Here, a welding crew works on a section of the new 20-inch steel
pipe.
12.) Image - Map of northeast United States showing the proposed
Independence Pipeline Project, with the following caption: Plans are in
place to construct and operate the Independence Pipeline, a 370-mile
interstate pipeline, of which we are 1/3 owner. This pipeline would
transport about 900,000 Dth per day of natural gas from Defiance, Ohio
to Leidy, Pennsylvania.
13.) Image - Picture of gas flare-ups with the following caption: Dramatic
gas flare-ups at Summit Storage Field near Erie, Pennsylvania could be
seen from quite a distance. This operation removes deposits that have
accumulated in the wells and improves deliverability of natural gas out
of the storage field.
14.) Image - Picture of Compressor at Ellisburg, Pennsylvania with the
following caption: A $5.7 million investment was made in this 3,200
horsepower compressor at the Ellisburg, Pennsylvania Station, near the
Leidy Hub. Put into service in March 1999, this new equipment increased
capacity for both pipeline throughput and customer access to storage.
Images 15 - 23 are contained in a section devoted to the Utility segment as
follows:
15.) Image - Picture of David F. Smith, President, National Fuel Gas
Distribution Corporation. The following quote appears under the
picture: "While we have seen an increase in customer choice activity .
. . we remain focused on building restructured services that preserve
reliability and provide a framework for fair competition."
16.) Image - Picture of plastic pipe with the following caption: Plastic
pipe is now used more frequently by the Utility for mainline
replacement projects. In addition to being lighter and more flexible
than steel pipe, it is resistant to corrosion and lessens the time and
costs associated with pipe fitting and welding.
17.) Image -Picture of Utility employees working on a construction site with
the following caption: A new vacuum truck is now used throughout the
Utility service territory. This equipment, often used in place of a
backhoe, minimizes the size of construction sites thus reducing both
restoration costs and related customer complaints. Pictured here: Jurel
Hunt and Michael Siler of the Construction Department.
18.) Image - Picture of Utility employees working on gas service lines with
the following caption: The Utility works with local businesses to
support economic development. Over the summer, gas service lines were
relocated to facilitate expansion of the Buffalo Bills' Ralph Wilson
Fieldhouse in Orchard Park, New York. Pictured here: Orchard Park
Service Center personnel Kevin McCarthy and Patrick McNerney.
19.) Graph - Utility Operation and Maintenance Expense
Bar graph showing the Utility segment's operation and maintenance
expense (in millions of dollars) for 1995 through 1999, as follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
$194 $201 $187 $184 $182
20.) Image - Picture of Utility employees with the following caption:
Training and preliminary implementation has begun for the PeopleSoft(R)
Financials system. This new accounting and financial system is intended
to improve timeliness of reporting as well as to simplify access to
information. Pictured here: Marjorie Minotti instructs employee
implementation team members, from left, Mark Kraemer, Robert
Schneggenburger, Susan Bender, Joseph Short and Brian Hirsch.
21.) Image: Picture of Utility employees monitoring ground water with the
following caption: Utility employees closely monitor ground water
levels following a two year long environmental clean-up recently
completed at the Erie, Pennsylvania Service Center. Pictured here:
Tanya Alexander and Joseph Hartleb.
22.) Graph - New Service Commitments
Bar graph showing the Utility's percent of orders completed within 10
days, as follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
97.9% 99.1% 99.1% 99.8% 99.8%
23.) Graph - Non-Emergency Appointments
Bar graph showing the Utility's percent of appointments kept, as
follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
96.8% 97.0% 97.8% 98.5% 98.8%
Images 24 - 27 are contained in a section devoted to the Energy Marketing
segment as follows:
24.) Image - Picture of Robert J. Kreppel, President, National Fuel
Resources, Inc. The following quote appears under the picture:
"Regulatory changes in New York have been most favorable, and, as a
result, our most dynamic growth has taken place there."
25.) Image - Picture of homeowner with the following caption: Through
deregulation, gas marketers such as National Fuel Resources can offer
homeowners the opportunity to receive savings on their natural gas
bills.
26.) Graph - NFR Number of Customers
Bar graph showing number of customers of National Fuel Resources for
the years 1995 to 1999, as follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
Electric - - - 105 430
Residential Gas - - 370 3,872 13,300
Commercial/
Industrial Gas 246 672 937 1,499 3,750
---- --- ----- ----- ------
Total 246 672 1,307 5,476 17,480
27.) Graph - Natural Gas Marketing Volumes
Bar graph showing NFR's natural gas marketing volumes in Bcf for the
years 1995 to 1999, as follows:
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
18.8 20.2 21.0 26.5 34.5
Images 28 - 30 are contained in a section devoted to the International segment
as follows:
28.) Image - Picture of Bruce H. Hale, Vice President, Horizon Energy
Development, Inc. The following quote appears under the picture:
"Future growth could come from a joint venture or similar alliance,
preferably with a U.S.-based electric company."*
29.) Image - Picture of turbine generators with the following caption: At
our electric generation and district heating plant in Komorany, Czech
Republic, steam produced in nine high pressure boilers is used to fuel
these eight turbine generators before being delivered to the primary
pipeline as an energy source for industrial and municipal heating
customers.
30.) Image - Picture of PSZT employees with the following caption: PSZT
employees dispatch electricity to the local distribution grid from this
control center 24 hours a day and 365 days a year.