Good day, and welcome to the ONE Gas First Quarter Earnings Conference Call. Today's conference is being recorded. And now at this time, I'd like to turn the conference over to Mr. Brandon Lohse. Please go ahead, sir.
OGS ONE Gas
Good morning and thank you for joining us on our first quarter 2021 earnings conference call. This call is being webcast live, and a replay will be made available later today. After our prepared remarks, we will be happy to take your questions. A reminder that statements made during this call that might include ONE Gas expectations or predictions should be considered forward-looking statements and are covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, the Securities Act of 1933 and the Securities and Exchange Act of 1934, each as amended. Actual results could differ materially from those projected in any forward-looking statements.
For a discussion of factors that could cause actual results to differ, please refer to our SEC filings.
Joining us on the call this morning are Pierce Norton, President and Chief Executive Officer; Caron Lawhorn, Senior Vice President and Chief Financial Officer; Curtis Dinan, Senior Vice President and Chief Commercial Officer; and Sid McAnnally, Senior Vice President and Chief Operating Officer. And now I'll turn the call over to Caron.
Thanks, Brandon, and good morning, everyone.
Before discussing our quarterly financial results, I wanted to start by providing an update on the aftermath of Winter Storm Uri.
As we shared during our previous conference call, we estimated that aggregated natural gas purchases for the month of February could approach $2.2 billion. The final amount ended up being closer to $2.1 billion, and of that amount, approximately $107 million was allocated to normal GAAP costs and flowed through our purchase GAAP mechanisms as usual.
As it relates to the extraordinary costs associated with the storm, which includes gas costs as well as related financing and other operational costs, our regulators have given us the authority to defer these costs as our regulatory assets.
As of March 31, we have deferred approximately $2 billion, including deferrals of approximately $1.3 billion in Oklahoma, $381 million in Kansas and $295 million in Texas.
Our purchased gas costs are recoverable through tariffs in each state where we operate. The period over which we will recover these deferred costs will be determined in future regulatory proceedings. In February, we entered into a $2.5 billion two-year unsecured term loan to provide us with additional liquidity to meet our gas purchase obligations. On March 11, we issued $2.5 billion of senior notes, consisting of $1.7 billion of two- and three-year fixed rate notes and $800 million of two-year floating rate notes. The proceeds from these senior notes were used for general corporate purposes, including payment of gas costs. The net proceeds reduced the commitments under the term loan, which was terminated concurrently with closing of the offering. These notes are redeemable in whole or in part on or after September 11, 2021.
As you'll hear from Curtis, legislation has been passed in Kansas and Oklahoma and is being considered by the legislature in Texas that allows us to file with our regulators for permission for either ONE Gas or a state agency to issue securitized bonds to permanently finance the costs of the winter storm at a lower cost than we would otherwise be able to achieve. Accordingly, the redemption feature associated with the bonds we issued in March provides us the flexibility to take advantage of securitization in each state with each having a different timetable for execution.
As the details around securitization gets finalized, we will be working with the rating agencies to gain clarity around impacts to our credit metrics, but we expect it to be viewed positively.
Moving on to our financial results and highlights for the first quarter, net income was $95.6 million or $1.79 per diluted share compared with $91.7 million or $1.72 per diluted share in the first quarter of 2020.
Our first quarter results reflect an increase in net margin of $9.1 million over the same period last year, due in part to new rates and customer growth primarily in Texas and Oklahoma. Net margin was $3.1 million lower as a result of weather normalization, net of the impact from increased sales volumes.
Our weather normalization adjustments are based on the difference between actual and normal weather measured by heating degree days.
For the most part, these adjustments are not impacted by actual volumes delivered to our sales customers. When weather is colder than normal, we generally see a pickup in net margin associated with actual volumes with weather normalization resulting in a reduction in net margin to bring us back towards normal.
During the first quarter, despite an increase in heating degree days of 12% to 25% across our three states compared to first quarter last year, sales volumes were up less than 14%. This contributed to the negative adjustment we experienced from weather normalization, exceeding the positive impact from higher volumes. We believe this is due, in part, to customer behavior during Winter Storm Uri.
During the storm, we asked our customers to conserve their natural gas usage to the extent possible, both to ensure we can maintain service and to minimize the impact of higher usage and natural gas prices on their bills.
In addition, there were electrical outages that prevented customers in certain areas from running their furnaces at all. Operating costs were 6% or $7.2 million higher compared with the same period last year due primarily to an increase in employee-related costs, which includes the cost of our nonqualified employee benefit plans and expenses related to the COVID-19 pandemic. When we normalize the first quarter 2021 and 2020 for the impact of the pandemic, including bad debt expense, COVID-related direct expenses, net of savings from travel and training, and the change in the value of the liability associated with our nonqualified employee benefit plans, the increase in operating cost is closer to 2.5%, which is consistent with our five-year guidance.
Our nonqualified employee benefit plans also impacted other expense net, which decreased $5.4 million compared with the same period last year due primarily to a $4.9 million reduction in expense resulting from the change in the value of investments associated with nonqualified employee benefit plans. This reduction in expense is largely offset by an increase in the associated liability for the plans, which, as already mentioned, is included in employee-related costs.
Our capital expenditures and asset removal costs decreased this quarter compared with the first quarter last year simply due to timing. Authorized rate base, reflecting our recent regulatory activity, is approximately $3.8 billion as of March 31. Authorized rate base is defined as the rate base reflected in completed regulatory proceedings, including full rate cases and interim rate filings. We project that for 2021, our estimated average rate base, which is defined as authorized rate base plus additional investments in our system and other changes in the components of our rate base that are not yet reflected in approved regulatory filings, will be approximately $4.23 billion, with 42% in Oklahoma, 29% in Kansas and 29% in Texas. Also in March, unrelated to the winter storm, we amended and restated our previous $700 million revolving unsecured credit facility with a $1 billion facility that now expires in March 2026. In connection with the execution of that agreement, all commitments under our 364 day, $215 million credit agreement were terminated. Yesterday, the ONE Gas Board of Directors declared a dividend of $0.58 per share, unchanged from the previous quarter.
Finally, we are reaffirming our 2021 financial guidance, including net income of $198 million to $210 million, earnings per diluted share of $3.68 to $3.92, and capital investments of $540 million. We reiterate that despite the weather events, the fundamentals of our business haven't changed.
Now I'll turn it over to Curtis to update you on the latest developments on the regulatory and commercial sides of our business.
Thank you, Caron, and good morning, everyone.
Let's start with a brief overview of current winter storm-related regulatory and legislative activity.
During the first quarter, we received emergency regulatory orders in Kansas, Oklahoma and Texas authorizing utilities to defer extraordinary storm-related costs. This includes the costs related to procuring and transporting natural gas supplies, other costs necessary to ensure stability and reliability of our gas system and related financing costs. Those orders require us to make future filings requesting recovery of deferred cost. We anticipate making those filings during the second quarter and we'll have a clear indication of the recovery period in each jurisdiction, including the impact of customer bills as those filings are processed.
As a reminder, we did not earn a return on the cost of gas. It is a straight pass-through to our customers and allows the Company, our customers, regulators and legislators to be aligned in finding the best solution for storm-related cost recovery.
As Caron indicated, our government relations and regulatory staff have been working with state governments and regulatory commissions in all three states to develop legislation related to securitization of the deferred cost regulatory assets described earlier.
We are pleased to report that in April, legislation in Kansas and Oklahoma was signed into law permitting utilities to pursue securitization to finance extraordinary expenses related to extreme weather events. The Texas legislature is currently considering House Bill 1520, which amends the existing utilities code to allow gas utilities to use securitization to finance extraordinary expenses. That bill has passed the house and will next be assigned to a committee in the Senate. Securitized bonds will receive lower interest rates and be viewed positively by credit rating agencies. Ratepayers will benefit from the lower cost of securitized debt and the utilities will benefit from a credit-positive financing vehicle, thereby benefiting rate payers in the long run. There are nuances to each of these bills that are important to note. The Kansas bill gives the Kansas Corporation Commission the authority to oversee and authorize the issuance of ratepayer-backed securitized bonds that are issued by a public utility. The process entails submitting an application to the KCC for a financing order, whereby the KCC will have 180 days to consider an application. Once approved, we will begin the process to issue securitized bonds. In Oklahoma, the bill provides authority to a state agency, rather than to individual companies, to issue ratepayer-backed bonds. On April 29, Oklahoma Natural Gas submitted an application requesting authorization from the Oklahoma Corporation Commission to securitize its costs associated with Winter Storm Uri. Oklahoma Natural Gas intends to file a subsequent motion with supporting testimony requesting a financing order pursuant to this legislation. Upon filing the subsequent motion, the OCC will have 180 days to issue a financing order. Once this order has been issued, the Oklahoma Development Finance Authority has up to 24 months to complete the process to issue the securitized bonds. And in Texas, similar to Oklahoma, the bill permits the state to issue ratepayer-backed bonds to finance extraordinary cost. Within 60 days of the passage of this proposed legislation, Texas Gas Service will submit an application to the Texas Railroad Commission for a financing order. The RRC would have 90 days to consider the application, and if approved, the Texas Public Financing Authority would begin the process of issuing securitized bonds.
Now shifting to our regulatory activity. In February, Texas Gas Service filed for a $10.7 million increase related to its Gas Reliability Infrastructure program in the Central Gulf service area. If approved, new rates would take effect in June 2021. In March, we made a GRIP filing in the West Texas service area, requesting an increase of $9.7 million to be effective July 2021. And finally, in April, in the Rio Grande Valley and North Texas service areas, we filed cost of service adjustments for $4.6 million and $2.2 million, respectively. If approved, both are expected to become effective in August 2021. In Oklahoma, we are required by our performance-based rate tariff to file a full rate case on or before June 30 this year. The rate case will be based on a calendar 2020 test year.
Lastly, in Kansas, the Energy Choice Act to the Senate Bill 24 recently became law, ensuring our customers in Kansas will retain the ability to choose natural gas service.
With the passage of this law, both Oklahoma and Kansas now have energy choice legislation in place and a similar bill is currently under consideration in the Texas legislature.
Moving on to commercial activities. Continuing the record-setting pace of 2020, we have sustained growth in our customer base across our service territories and added more customers in 2021 compared to the same period in 2020.
As we look ahead into the remainder of 2021, we do not see this trend slowing down. And finally, as you may have seen from the recent press release, we are pleased to announce a renewable natural gas alliance with Vanguard Renewables to develop and expand farm-based RNG projects across Kansas, Oklahoma and Texas. This alliance will provide a clean and renewable energy option for our customers while diverting greenhouse gas-producing food waste from landfills and incineration, instead, recycling these wastes into RNG and low-carbon fertilizer through farm-based anaerobic digestion. Initial steps include the development of potential RNG projects. It is important to ONE Gas that we manage project opportunities with a partner that can ultimately execute on the commercialization of these opportunities. This enhances our strategy to use our gas delivery system to transport methane that would otherwise escape into the atmosphere, resulting in reduced emissions, while offering customers access to renewable sources of energy.
We are also in active discussions with five city-owned wastewater treatment plants and landfills within our service areas about the possibility of capturing methane emissions from those facilities for transportation on our system. Similar to the farm-based projects, these RNG opportunities will help municipalities meet their emission goals and also generate incremental revenue for the cities. And now I'll turn it over to Sid for a quick update on operations.
Thanks, Curtis. I'll start by adding a bit of color regarding our capital execution in the first quarter.
As Caron mentioned, our first quarter capital spend was lower than the first quarter of last year. The differential is partially due to weather, but it's more a matter of timing with the more capital-intensive projects scheduled to begin later this year than last year. We're well positioned to execute our planned schedule and to meet our guidance for capital spend.
As we've shared previously, our replacement program is driven by probabilistic risk ranking, which gives us the ability to both improve system reliability while also reducing our projected greenhouse gas emissions by replacing higher leak rated pipe.
Turning to field operations. We're always looking for opportunities to leverage technology in the execution of our work. Last year, we successfully piloted advanced leak detection technology that allows us to more efficiently identify and categorize sources of emissions.
We will continue development and deployment of this technology throughout our territory, meaning that, combined with our probabilistic risk ranking replacement program, we now have highly efficient technology deployed that positively impacts capital planning and maintenance activities in our field operations, supporting both our safety goals and our environmental goals. I'll turn it over to Pierce for closing remarks.
Thank you, Caron, Curtis and Sid. When an extreme event, like Winter Storm Uri occurs, it gives everyone an opportunity to conduct an in-depth post-incident analysis to determine the variables that had the greatest impact and to determine how to mitigate the effects of similar events in the future.
As a reminder, during the storm, our systems were extremely reliable and performed as they were designed, losing fewer than 900 customers for less than 24 hours. What was unique about Winter Storm Uri and drove the extraordinary natural gas prices was the combination of three things: the extreme sustained load demand we experienced on our own systems; disruptions of gas supply due to production freeze offs; and unforeseen natural gas electric generation demand that exceeded the industry's normal gas supply load in winter months.
Although thorough post-instant evaluation processes will take time, we have already begun to explore ideas and evaluate opportunities around those supply variables that are within our control to harden our gas supply portfolio over time.
As we close today, I'd like to spend a couple of minutes talking about our progress related to ESG, primarily on the E component.
For decades, we've invested the majority of our capital dollars to improve our systems reliability, which has also reduced emissions. More recently, we have deployed innovative technologies to further reduce emissions.
We are reporting our progress through our website and annual sustainability report.
However, we're taking a different approach when it comes to communicating our long-term environmental goals. We want to understand our potential before we commit to what we can achieve.
While we understand the sense of urgency for us to reduce both our direct and indirect emissions, we are first developing our strategy, which is being led by our technical and commercial teams along with third-party consultants that will allow us to quantify our opportunities and identify possible time lines to reach such goals.
Our strategy will be grounded in the understanding of how best to utilize the resources already available, which includes existing technologies and our assets.
Our core confidence revolves around optimizing our gas delivery systems. In the near term, we will continue with our demand side, in-use conservation efforts through our energy efficiency programs, and deploying operational best practices like our vintage pipeline replacement program, which is and will continue to be fundamental to our greenhouse gas emissions reduction plan.
Our longer-term initiatives include researching and utilizing innovative solutions, such as renewable natural gas and hydrogen through our existing natural gas delivery infrastructure. And of course, all this is supported by our ongoing commitment to improving disclosures, data quality and reporting transparency. To be clear, we share in the aspiration of reaching net zero emissions and are committed to and are doing our part toward reaching a clean energy future. Delivering a sustainable energy future goes beyond the impact on the environment. It also must incorporate low-cost energy with resilient and reliable systems.
We are part of an innovative industry, one that has transformed itself over the course of its history. We know natural gas and our delivery systems will serve a critical role as we transform into a cleaner energy future, which will require many types of energy sources collaborating together, an energy future that provides the most secure, reliable, affordable and cleaner solutions for everyone.
Finally, I'd like to express my gratitude to our 3,700 dedicated and engaged employees, their focus and commitment to provide safe and reliable natural gas service every day for our more than 2.2 million customers is to be commended. Thank you for living out our core values, in serving our customers and communities every day. Thank you all for joining us this morning.
Now operator, we're ready for questions.
[Operator Instructions] And we'll take our first question from Gabe Moreen with Mizuho.
Maybe if I could start a question in terms of the securitization and the path forward there. Can you maybe talk about what you expect, I guess, customer bill impacts will be ultimately on an annual basis once you were able to implement the securitization by the various jurisdictions? And maybe also the second part to that question, can you just talk about whether you're comfortable based on those customer bill impacts sort of in your five-year CapEx trajectory that you had laid out previously, whether or not that's something you still think you can execute on?
So Gabe, this is Curtis, and I'll take the first one around the customer bill impacts. And it's really premature to know that until we make those initial filings and continue the discussion with our regulators. Obviously, everyone wants to minimize the impact, but also to be able to collect those amounts within a reasonable period of time. And as we get nearer to making those filings, we'll start to get a better sense of it as well as when we work our way through the process.
In terms of the impact on our capital cost over the longer term, as Caron reiterated in her comments, the fundamental business hasn't changed, and we don't see that impacting our capital spending program.
Maybe if I can pivot to RNG and the joint venture with Vanguard, just how that's going to work from, I guess, the standpoint of recovery? Is that something an investment you are looking to potentially rate base in some of your jurisdictions? Or is it really an investment you're making looking to do outside of any regulated sort of construct and maybe try to pass it to customers? Or basically, I'm trying to figure out how it's going to work from an investment standpoint to sort of earning your return on those investments?
Sure. Great question, Gabe. And the way to think about that is really nothing is precluded in the longer term. There's not a preset course.
The first part of the alliance with Vanguard is to complete an analysis of all the sources of RNG across our service territories, so we can high-grade where those opportunities are, both in terms of the volumetric potential as well as the ease of bringing that into our system and assessing the customer demand for that product.
So there are corporations, for example, that have emission reduction goals that will be interested in these types of projects, so there will be a focus on those.
So that -- until we complete that initial assessment and get that inventory in place and then start to work through what potential projects would look like, I really can't answer the second part of your question in terms of how best to position those projects from a regulatory standpoint.
So I think the easiest way to think about it is all those options are on the board, and we'll continue to work through those.
[Operator Instructions] We will take a follow-up question from Aga Zmigrodzka with UBS.
Can you please provide more color on the covered impact in 1Q? And if you expect any other impacts from the pandemic for the rest of the year?
Aga, this is Caron. We did not have significant impact in the first quarter. We're still monitoring our bad debt expense.
We are just now resuming disconnects in Oklahoma and Kansas, and they're still suspended in Texas.
So still working on the bad debt side. The COVID cleaning and direct expenses, those are all -- they were already considered in our guidance and plan for the year, and those are turning out to be as we expected. And we're not seeing -- other than the bad debt expense, we're not seeing a significant adverse impact on any customers that impacts our load.
So we don't expect material impacts. What we can see, like the expenses and the bad debt backed into our guidance, we don't see anything else material at this point.
[Operator Instructions] We'll take a follow-up from Gabe Moreen with Mizuho.
Just one more follow-up for me, if I could, on just sort of where -- I know the discussions and the big push has been around securitization sort of in the near term. But maybe any thoughts and color on discussions with the regulators around gas supply and where that's trending by jurisdiction, wondering what changes are going to be made there?
So Gabe, there have been some conversations around that. I wouldn't say they're real detailed at this point.
As Pierce indicated, we're still completing our post-incident review. And through that, we would expect to make changes and talk to our regulators about those.
So yes, in short, there have been some questions. We're still completing our investigation and developing our recommendations. And we'll see some of that happening over the short term, and some of those will be long-term changes we make as well.
Gabe, this is Pierce. The only thing I'd add to that is that we -- ever since 2014, we've continued to look for opportunities to connect to other pipelines, in and around all of our cities.
I think the total ends up being somewhere around 18 additional connections that we made. Those connections served us extremely well. We'll go back. We'll take a look at its storage. We'll take a look at additional interconnects. All the kind of the normal cast of characters is what we'll be looking at, and we'll be looking to also, at this point, I can't really elaborate, just some innovative ideas to maybe harden on the supply side and our interconnects and potentially storage.
Thank you. That does conclude today's question-and-answer session. I'd like to turn the conference back over to Mr. Lohse for any additional or closing remarks.
Thank you all again for your interest in ONE Gas.
Our quiet period for the second quarter starts when we close our books at the end of June and extends until we release earnings in early August. We'll provide details on the conference call at a later date. Have a great day.
Thank you. That does conclude today's conference. We do thank you all for your participation.
You may now disconnect.