For the quarterly period ended March 31, 2010

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 1-3880

6363 Main Street Williamsville, New York		14221
(Address of principal executive offices)		(Zip Code)

(716) 857-7000 (Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common stock, $1 par value, outstanding at April 30, 2010: 81,920,814 shares.

 

 

INDEX

		Page
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
a.  Consolidated Statements of Income and Earnings Reinvested in the Business — Three and Six Months Ended March 31, 2010 and 2009			6 - 7
b.  Consolidated Balance Sheets — March 31, 2010 and September 30, 2009			8 - 9
c.  Consolidated Statements of Cash Flows — Six Months Ended March 31, 2010 and 2009			10
d.  Consolidated Statements of Comprehensive Income — Three and Six Months Ended March 31, 2010 and 2009			11
e.  Notes to Consolidated Financial Statements			12 - 31
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			32 - 55
Item 3. Quantitative and Qualitative Disclosures About Market Risk			55
Item 4. Controls and Procedures			55
Part II. Other Information
Item 1. Legal Proceedings			55
Item 1A. Risk Factors			56 - 57
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			57 - 58
Item 3. Defaults Upon Senior Securities			•
Item 5. Other Information			•
Item 6. Exhibits			58
Signatures			59
EX-10.1
EX-12
EX-31.1
EX-31.2
EX-32
EX-99

•

The Company has nothing to report under this item.

     Reference to “the Company” in this report means the Registrant or the Registrant and its subsidiaries collectively, as appropriate in the context of the disclosure. All references to a certain year in this report are to the Company’s fiscal year ended September 30 of that year, unless otherwise noted.

     This Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934. Forward-looking statements should be read with the cautionary statements and important factors included in this Form 10-Q at Item 2 — MD&A, under the heading “Safe Harbor for Forward-Looking Statements.” Forward-looking statements are all statements other than statements of historical fact, including, without limitation, statements regarding future prospects, plans, objectives, goals, projections, strategies, future events or performance and underlying assumptions, capital structure, anticipated capital expenditures, completion of construction and other projects, projections for pension and other post-retirement benefit obligations, impacts of the adoption of new accounting rules, and possible outcomes of litigation or regulatory proceedings, as well as statements that are identified by the use of the words “anticipates,” “estimates,” “expects,” “forecasts,” “intends,” “plans,” “predicts,” “projects,” “believes,” “seeks,” “will,” “may,” and similar expressions.

Part I. Financial Information

See Notes to Condensed Consolidated Financial Statements

See Notes to Condensed Consolidated Financial Statements

See Notes to Condensed Consolidated Financial Statements

Item 1.		Financial Statements (Cont.)

National Fuel Gas Company
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 1 — Summary of Significant Accounting Policies

Principles of Consolidation. The Company consolidates its majority owned entities. The equity method is used to account for minority owned entities. All significant intercompany balances and transactions are eliminated.

     The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassification. Certain prior year amounts have been reclassified to conform with current year presentation.

Earnings for Interim Periods. The Company, in its opinion, has included all adjustments that are necessary for a fair statement of the results of operations for the reported periods. The consolidated financial statements and notes thereto, included herein, should be read in conjunction with the financial statements and notes for the years ended September 30, 2009, 2008 and 2007 that are included in the Company’s 2009 Form 10-K. The consolidated financial statements for the year ended September 30, 2010 will be audited by the Company’s independent registered public accounting firm after the end of the fiscal year.

     The earnings for the six months ended March 31, 2010 should not be taken as a prediction of earnings for the entire fiscal year ending September 30, 2010. Most of the business of the Utility and Energy Marketing segments is seasonal in nature and is influenced by weather conditions. Due to the seasonal nature of the heating business in the Utility and Energy Marketing segments, earnings during the winter months normally represent a substantial part of the earnings that those segments are expected to achieve for the entire fiscal year. The Company’s business segments are discussed more fully in Note 7 — Business Segment Information.

Consolidated Statement of Cash Flows. For purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of generally three months or less to be cash equivalents.

     At March 31, 2010, the Company accrued $15.3 million of capital expenditures in the Exploration and Production segment, the majority of which was in the Appalachian region. This amount was excluded from the Consolidated Statement of Cash Flows at March 31, 2010 since it represented a non-cash investing activity at that date.

     At September 30, 2009, the Company accrued $9.1 million of capital expenditures in the Exploration and Production segment, the majority of which was in the Appalachian region. The Company also accrued $0.7 million of capital expenditures in the All Other category related to the construction of the Midstream Covington Gathering System. These amounts were excluded from the Consolidated Statement of Cash Flows at September 30, 2009 since they represented non-cash investing activities at that date. These capital expenditures were paid during the quarter ended December 31, 2009 and have been included in the Consolidated Statement of Cash Flows for the six months ended March 31, 2010.

     At March 31, 2009, the Company accrued $7.7 million of capital expenditures in the Exploration and Production segment, the majority of which was in the Appalachian region. The Company also accrued $0.9 million of capital expenditures at March 31, 2009 related to the completion of the Empire Connector project. These amounts were excluded from the Consolidated Statement of Cash Flows at March 31, 2009 since they represent non-cash investing activities at that date.

Item 1.		Financial Statements (Cont.)

     At September 30, 2008, the Company accrued $16.8 million of capital expenditures related to the construction of the Empire Connector project. This amount was excluded from the Consolidated Statement of Cash Flows at September 30, 2008 since it represented a non-cash investing activity at that date. These capital expenditures were paid during the quarter ended December 31, 2008 and have been included in the Consolidated Statement of Cash Flows for the six months ended March 31, 2009.

Hedging Collateral Deposits. This is an account title for cash held in margin accounts funded by the Company to serve as collateral for open hedging positions. At March 31, 2010, the Company had hedging collateral deposits of $8.5 million related to its exchange-traded futures contracts and $5.2 million related to its over-the-counter crude oil swap agreements. It is the Company’s policy to not offset hedging collateral deposits paid or received against the derivative financial instruments liability or asset balances.

Cash Held in Escrow. On July 20, 2009, the Company’s wholly-owned subsidiary in the Exploration and Production segment, Seneca, acquired Ivanhoe Energy’s United States oil and gas operations for approximately $39.2 million in cash (including cash acquired of $4.3 million). The cash acquired at acquisition includes $2 million held in escrow at March 31, 2010 and September 30, 2009. Seneca placed this amount in escrow as part of the purchase price, and in accordance with the purchase agreement, this amount will remain in escrow for one year from the closing of the transaction provided there are no pending disputes or actions regarding obligations and liabilities required to be satisfied or discharged by Ivanhoe Energy. If no disputes occur, this cash will be released to Ivanhoe Energy.

Gas Stored Underground — Current. In the Utility segment, gas stored underground — current is carried at lower of cost or market, on a LIFO method. Gas stored underground — current normally declines during the first and second quarters of the year and is replenished during the third and fourth quarters. In the Utility segment, the current cost of replacing gas withdrawn from storage is recorded in the Consolidated Statements of Income and a reserve for gas replacement is recorded in the Consolidated Balance Sheets under the caption “Other Accruals and Current Liabilities.” Such reserve, which amounted to $87.9 million at March 31, 2010, is reduced to zero by September 30 of each year as the inventory is replenished.

Property, Plant and Equipment. In the Company’s Exploration and Production segment, oil and gas property acquisition, exploration and development costs are capitalized under the full cost method of accounting. Under this methodology, all costs associated with property acquisition, exploration and development activities are capitalized, including internal costs directly identified with acquisition, exploration and development activities. The internal costs that are capitalized do not include any costs related to production, general corporate overhead, or similar activities. The Company does not recognize any gain or loss on the sale or other disposition of oil and gas properties unless the gain or loss would significantly alter the relationship between capitalized costs and proved reserves of oil and gas attributable to a cost center.

     Capitalized costs include costs related to unproved properties, which are excluded from amortization until proved reserves are found or it is determined that the unproved properties are impaired. Such costs amounted to $135.1 million at March 31, 2010. All costs related to unproved properties are reviewed quarterly to determine if impairment has occurred. The amount of any impairment is transferred to the pool of capitalized costs being amortized.

     Capitalized costs are subject to the SEC full cost ceiling test. The ceiling test, which is performed each quarter, determines a limit, or ceiling, on the amount of property acquisition, exploration and development costs that can be capitalized. The ceiling under this test represents (a) the present value of estimated future net cash flows, excluding future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet, using a discount factor of 10%, which is computed by applying current market prices of oil and gas (as adjusted for hedging) to estimated future production of proved oil and gas reserves as of the date of the latest balance sheet, less estimated future expenditures, plus (b) the cost of unevaluated properties not being depleted, less (c) income tax effects related to the differences between the book and tax basis of the properties. If capitalized costs, net of accumulated depreciation, depletion and amortization and related deferred income taxes, exceed the ceiling at the end of any quarter, a permanent impairment is required to be charged to earnings in that quarter. The Company’s

Item 1.		Financial Statements (Cont.)

capitalized costs exceeded the full cost ceiling for the Company’s oil and gas properties at December 31, 2008. As a result, the Company recognized a pre-tax impairment of $182.8 million at December 31, 2008. Deferred income taxes of $74.6 million were recorded associated with this impairment. At March 31, 2010, the Company’s capitalized costs were below the full cost ceiling for the Company’s oil and gas properties. As a result, an impairment charge was not required at March 31, 2010.

Accumulated Other Comprehensive Loss. The components of Accumulated Other Comprehensive Loss, net of related tax effect, are as follows (in thousands):

Earnings Per Common Share. Basic earnings per common share is computed by dividing income available for common stock by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For purposes of determining earnings per common share, the only potentially dilutive securities the Company has outstanding are stock options and SARs. The diluted weighted average shares outstanding shown on the Consolidated Statements of Income reflects the potential dilution as a result of these stock options and SARs as determined using the Treasury Stock Method. Stock options and SARs that are antidilutive are excluded from the calculation of diluted earnings per common share. For both the quarter and six months ended March 31, 2010, there were no stock options excluded as being antidilutive. There were 145,450 and 84,058 SARs excluded as being antidilutive for the quarter and six months ended March 31, 2010, respectively. For both the quarter and six months ended March 31, 2009, there were 765,000 stock options excluded as being antidilutive. In addition, there were 402,858 and 365,000 SARs excluded as being antidilutive for the quarter and six months ended March 31, 2009, respectively.

Stock-Based Compensation. During the quarter and six months ended March 31, 2010, the Company granted 520,500 performance-based SARs having a weighted average exercise price of $52.10 per share. The weighted average grant date fair value of these SARs was $12.06 per share. These SARs may be settled in cash, in shares of common stock of the Company, or in a combination of cash and shares of common stock of the Company, as determined by the Company. These SARs are considered equity awards under the current authoritative guidance for stock-based compensation. The accounting for those SARs is the same as the accounting for stock options. The performance-based SARs granted during the quarter and six months ended March 31, 2010 vest and become exercisable annually in one-third increments, provided that a performance condition is met. The performance condition for each fiscal year, generally stated, is an increase over the prior fiscal year of at least five percent in certain oil and natural gas production of the Exploration and Production segment. The weighted average grant date fair value of these performance-based SARs granted during the quarter and six months ended March 31, 2010 was estimated on the date of grant using the same accounting treatment that is applied for stock options, and assumes that the performance conditions specified will be achieved. If such conditions are not met or it is not considered probable that such conditions will be met, no compensation expense is recognized and any previously recognized compensation expense is reversed.

     There were no stock options granted during the quarter or six months ended March 31, 2010. The Company granted 4,000 restricted share awards (non-vested stock as defined by the current accounting literature) during the quarter and six months ended March 31, 2010. The weighted average fair value of such restricted shares was $52.10 per share.

Item 1.		Financial Statements (Cont.)

New Authoritative Accounting and Financial Reporting Guidance. In September 2006, the FASB issued authoritative guidance for using fair value to measure assets and liabilities. This guidance serves to clarify the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect that fair-value measurements have on earnings. This guidance is to be applied whenever assets or liabilities are to be measured at fair value. On October 1, 2008, the Company adopted this guidance for financial assets and financial liabilities that are recognized or disclosed at fair value on a recurring basis. The FASB’s authoritative guidance for using fair value to measure nonfinancial assets and nonfinancial liabilities on a nonrecurring basis became effective during the quarter ended December 31, 2009. The Company’s nonfinancial assets and nonfinancial liabilities were not impacted by this guidance during the six months ended March 31, 2010. The Company has identified Goodwill as being the major nonfinancial asset that may be impacted by the adoption of this guidance. The impact of this guidance will be known when the Company performs its annual test for goodwill impairment at the end of the fiscal year; however, at this time, it is not expected to be material. The Company has identified Asset Retirement Obligations as a nonfinancial liability that may be impacted by the adoption of the guidance. The impact of this guidance will be known when the Company recognizes new asset retirement obligations. However, at this time, the Company believes the impact of the guidance will be immaterial. Additionally, in February 2010, the FASB issued updated guidance that includes additional requirements and disclosures regarding fair value measurements. The guidance now requires the gross presentation of activity within the Level 3 roll forward and requires disclosure of details on transfers in and out of Level 1 and 2 fair value measurements. It also provides further clarification on the level of disaggregation of fair value measurements and disclosures on inputs and valuation techniques. Effective with this March 31, 2010 Form 10-Q, the Company has updated its disclosures to reflect the new requirements in Note 2 — Fair Value Measurements, except for the Level 3 roll forward gross presentation, which will be effective as of the Company’s first quarter of fiscal 2012.

     On December 31, 2008, the SEC issued a final rule on Modernization of Oil and Gas Reporting. The final rule modifies the SEC’s reporting and disclosure rules for oil and gas reserves and aligns the full cost accounting rules with the revised disclosures. The most notable changes of the final rule include the replacement of the single day period-end pricing used to value oil and gas reserves with a 12-month average of the first day of the month price for each month within the reporting period. The final rule also permits voluntary disclosure of probable and possible reserves, a disclosure previously prohibited by SEC rules. Additionally, on January 6, 2010, the FASB amended the oil and gas accounting standards to conform to the SEC final rule on Modernization of Oil and Gas Reporting. The revised reporting and disclosure requirements will be effective for the Company’s Form 10-K for the period ended September 30, 2010. Early adoption is not permitted. The Company is currently evaluating the impact that adoption of these rules will have on its consolidated financial statements and MD&A disclosures.

     In March 2009, the FASB issued authoritative guidance that expands the disclosures required in an employer’s financial statements about pension and other post-retirement benefit plan assets. The additional disclosures include more details on how investment allocation decisions are made, the plan’s investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period, and disclosure regarding significant concentrations of risk within plan assets. The additional disclosure requirements are required for the Company’s Form 10-K for the period ended September 30, 2010. The Company is currently evaluating the impact that adoption of this authoritative guidance will have on its consolidated financial statement disclosures.

     In June 2009, the FASB issued amended authoritative guidance to improve and clarify financial reporting requirements by companies involved with variable interest entities. The new guidance requires a company to perform an analysis to determine whether the company’s variable interest or interests give it a controlling financial interest in a variable interest entity. The analysis also assists in identifying the primary beneficiary of a variable interest entity. This authoritative guidance will be effective as of the Company’s first quarter of fiscal 2011. The Company is currently evaluating the impact that adoption of this authoritative guidance will have on its consolidated financial statements.

Item 1.		Financial Statements (Cont.)

Note 2 — Fair Value Measurements

     The FASB authoritative guidance regarding fair value measurements establishes a fair-value hierarchy and prioritizes the inputs used in valuation techniques that measure fair value. Those inputs are prioritized into three levels. Level 1 inputs are unadjusted quoted prices in active markets for assets or liabilities that the Company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly at the measurement date. Level 3 inputs are unobservable inputs for the asset or liability at the measurement date. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.

     The following table sets forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities (as applicable) that were accounted for at fair value on a recurring basis as of March 31, 2010 and September 30, 2009. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. In January 2010, the FASB issued amended authoritative guidance respecting disclosures related to fair value measurements. The amended guidance requires disclosure of financial instruments and liabilities by class of assets and liabilities (not major category of assets and liabilities). In addition, this amended guidance also requires enhanced disclosures about the valuation techniques and inputs used to measure fair value and disclosures of transfers in and out of Level 1 or 2. During the quarter ended March 31, 2010, the Company adopted this amended guidance.

Derivative Financial Instruments

     At March 31, 2010, the derivative financial instruments reported in Level 1 consist of NYMEX futures contracts used in the Company’s Energy Marketing and Pipeline and Storage segments (at September 30, 2009, the derivative financial instruments reported in Level 1 consist of NYMEX futures used in the Company’s Energy Marketing segment). Hedging collateral deposits of $8.5 million associated with these futures contracts have been reported in Level 1 as well. The derivative financial instruments reported in Level 2 consist of natural gas and some of the crude oil swap agreements used in the Company’s Exploration and Production segment and natural gas swap agreements used in the Energy Marketing segment at March 31, 2010 (at September 30, 2009, the derivative financial instruments reported in Level 2 consist of natural gas swap agreements used in the Company’s Exploration and Production and Energy Marketing segments). The fair value of these swap agreements is based on an internal, discounted cash flow model that uses observable inputs (i.e. LIBOR based discount rates and basis differential information, if applicable, at active natural gas/crude oil trading markets). At March 31, 2010, the derivative financial instruments reported in Level 3 consist of a majority of the Exploration and Production segment’s crude oil swap agreements (at September 30, 2009, all of the Exploration and Production segment’s crude oil swap agreements were reported as Level 3). Hedging collateral deposits of $5.2 million associated with these oil swap agreements have been reported in Level 1. The fair value of the crude oil swap agreements is based on an internal, discounted cash flow model that uses both observable (i.e. LIBOR based discount rates) and unobservable inputs (i.e. basis differential information of inactive crude oil trading markets). Based on an assessment of the counterparties’ credit risk, the fair market value of the price swap agreements reported as Level 2 and Level 3 assets have been reduced by $1.2 million and $0.9 million at March 31, 2010 and September 30, 2009, respectively. The fair market value of the price swap agreements reported as Level 2 and Level 3 liabilities at March 31, 2010 have been reduced by $0.2 million and the price swap agreements reported as Level 2 liabilities at September 30, 2009 have been reduced by less than $0.1 million based on an assessment of the Company’s credit risk. These credit reserves were determined by applying default probabilities to the anticipated cash flows that the Company is either expecting from its counterparties or expecting to pay to its counterparties.

     The tables listed below provide reconciliations of the beginning and ending net balances for assets and liabilities measured at fair value and classified as Level 3 for the quarter and six months ended March 31, 2010 and 2009, respectively. For the quarter ended March 31, 2010, no transfers in or out of Level 1 or Level 2 occurred.

Other Investments. Investments in life insurance are stated at their cash surrender values or net present value as discussed below. Investments in an equity mutual fund and the stock of an insurance company (marketable equity securities), as discussed below, are stated at fair value based on quoted market prices.

     Other investments include cash surrender values of insurance contracts (net present value in the case of split-dollar collateral assignment arrangements) and marketable equity securities. The values of the insurance contracts amounted to $54.3 million at March 31, 2010 and $54.2 million at September 30, 2009. The fair value of the equity mutual fund was $17.0 million at March 31, 2010 and $15.8 million at September 30, 2009. The gross unrealized loss on this equity mutual fund was $0.1 million at March 31, 2010 and $1.0 million at September 30, 2009. Management does not consider this investment to be other than temporarily impaired. The fair value of the stock of an insurance company was $7.8 million at March 31, 2010 and $8.3 million at September 30, 2009. The gross unrealized gain on this stock was $5.4 million at March 31, 2010 and $5.9 million at September 30, 2009. The insurance contracts and marketable equity securities are primarily informal funding mechanisms for various benefit obligations the Company has to certain employees.

Derivative Financial Instruments

     The Company is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative instruments is commodity price risk in the Exploration and Production, Energy Marketing and Pipeline and Storage segments. The Company enters into futures contracts and over-the-counter swap agreements for natural gas and crude oil to manage the price risk associated with forecasted sales of gas and oil. The Company also enters into futures contracts and swaps to manage the risk associated with forecasted gas purchases, storage of gas, and withdrawal of gas from storage to meet customer demand. The duration of the Company’s hedges do not typically exceed 3 years.

     The Company has presented its net derivative assets and liabilities on its Consolidated Balance Sheets at March 31, 2010 and September 30, 2009 as shown in the table below.

     The following table discloses the fair value of derivative contracts on a gross-contract basis as opposed to the net-contract basis presentation on the Consolidated Balance Sheets at March 31, 2010 and September 30, 2009.

Cash flow hedges

     For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (loss) and reclassified into earnings in the period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

     As of March 31, 2010, the Company’s Exploration and Production segment had the following commodity derivative contracts (swaps) outstanding to hedge forecasted sales (where the Company uses short positions (i.e. positions that pay-off in the event of commodity price decline) to mitigate the risk of decreasing revenues and earnings):

     As of March 31, 2010, the Company’s Pipeline and Storage segment has the following commodity derivative contracts (futures contracts) outstanding to hedge forecasted sales (where the Company uses short positions to mitigate the risk associated with natural gas price decreases and its impact on decreasing revenues and earnings):

Commodity		Units
Natural Gas		0.9 Bcf (all short positions)

     As of March 31, 2010, the Company’s Exploration and Production segment had $35.1 million ($20.6 million after tax) of gains included in the accumulated other comprehensive income (loss) balance. It is expected that $24.7 million ($14.5 million after tax) of those gains will be reclassified into the Consolidated Statement of Income within the next 12 months as the expected sales of the underlying commodities occur. See Note 1, under Accumulated Other Comprehensive Income (Loss), for the after-tax gain pertaining to derivative financial instruments (Net Unrealized Gain (Loss) on Derivative Financial Instruments in Note 1 includes the Exploration and Production, Energy Marketing and Pipeline and Storage segments).

     As of March 31, 2010, the Company’s Energy Marketing segment had $1.1 million ($0.7 million after tax) of gains included in the accumulated other comprehensive income (loss) balance. It is expected that $0.2 million ($0.1 million after tax) of these gains will be reclassified into the Consolidated Statement of Income within the next 12 months as the sales and purchases of the underlying commodities occur. See Note 1, under Accumulated Other Comprehensive Income (Loss), for the after-tax gain pertaining to derivative financial instruments (Net Unrealized Gain (Loss) on Derivative Financial Instruments in Note 1 includes the Exploration and Production, Energy Marketing and Pipeline and Storage segments).

     As of March 31, 2010, the Company’s Pipeline and Storage segment had $0.5 million ($0.3 million after tax) of gains included in the accumulated other comprehensive income (loss) balance. It is expected that the full amount will be reclassified into the Consolidated Statement of Income within the next 12 months as the expected sales of the underlying commodities occur. See Note 1, under Accumulated Other Comprehensive Income (Loss), for the after-tax gain pertaining to derivative financial instruments (Net Unrealized Gain (Loss) on Derivative Financial Instruments in Note 1 includes the Exploration and Production, Energy Marketing and Pipeline and Storage segments).

Fair value hedges

     The Company’s Energy Marketing segment utilizes fair value hedges to mitigate risk associated with fixed price sales commitments, fixed price purchase commitments, and commitments related to the injection and withdrawal of storage gas. With respect to fixed price sales commitments, the Company enters into long positions to mitigate the risk of price increases for natural gas supplies that could occur after the Company enters into fixed price sales agreements with its customers. With respect to fixed price purchase commitments, the Company enters into short positions to mitigate the risk of price decreases that could

Item 1.		Financial Statements (Cont.)

occur after the Company locks into fixed price purchase deals with its suppliers. Fair value hedges related to the injection and withdrawal of storage gas impact purchased gas expense. As of March 31, 2010, the Company’s Energy Marketing segment had fair value hedges covering approximately 7.1 Bcf (5.9 Bcf of fixed price sales commitments (all long positions) and 1.2 Bcf of fixed price purchase commitments (all short positions)). For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk completely offset each other in current earnings, as shown below.

     The Company may be exposed to credit risk on any of the derivative financial instruments that are in a gain position. Credit risk relates to the risk of loss that the Company would incur as a result of nonperformance by counterparties pursuant to the terms of their contractual obligations. To mitigate such credit risk, management performs a credit check, and then on a quarterly basis monitors counterparty credit exposure. The majority of the Company’s counterparties are financial institutions and energy traders. The Company has over-the-counter swap positions with eleven counterparties of which ten of the eleven counterparties are in a net gain position. On average, the Company has $4.8 million of credit exposure per counterparty in a gain position. The Company had not received any collateral from these counterparties at March 31, 2010 since the Company’s gain position on such derivative financial instruments had not exceeded the established thresholds at which the counterparties would be required to post collateral.

     As of March 31, 2010, nine of the eleven counterparties to the Company’s outstanding derivative instrument contracts (specifically the over-the-counter swaps) had a common credit-risk related contingency feature. In the event the Company’s credit rating increases or falls below a certain threshold (the lower of the S&P or Moody’s Debt Rating), the available credit extended to the Company would either increase or decrease. A decline in the Company’s credit rating, in and of itself, would not cause the Company to be required to increase the level of its hedging collateral deposits (in the form of cash deposits, letters of credit or treasury debt instruments). If the Company’s outstanding derivative instrument contracts were in a liability position and the Company’s credit rating declined, then additional hedging collateral deposits would be required. At March 31, 2010, the fair market value of the derivative financial instrument assets with a credit-risk related contingency feature was $31.1 million according to the Company’s internal model (discussed in Note 2 — Fair Value Measurements). At March 31, 2010, the fair market value of the derivative financial instrument liability with a credit-risk related contingency feature was $11.8 million according to the Company’s internal model (discussed in Note 2 — Fair Value Measurements). The Company’s internal model may yield a different fair value than the fair value determined by the Company’s counterparties. The Company’s

Item 1.		Financial Statements (Cont.)

requirement to post hedging collateral deposits is based on the fair value determined by the Company’s counterparties. For its over-the-counter crude oil swap agreements, which are in a liability position, the Company was required to post $5.2 million in hedging collateral deposits at March 31, 2010. This is discussed in Note 1 under Hedging Collateral Deposits.

     For its exchange traded futures contracts, which are in a liability position, the Company had posted $8.5 million in hedging collateral as of March 31, 2010. As these are exchange traded futures contracts, there are no specific credit-risk related contingency features. The Company posts hedging collateral based on open positions and margin requirements. This is discussed in Note 1 under Hedging Collateral Deposits.

Note 4 — Income Taxes

     The components of federal and state income taxes included in the Consolidated Statements of Income are as follows (in thousands):

     Total income taxes as reported differ from the amounts that were computed by applying the federal income tax rate to income before income taxes. The following is a reconciliation of this difference (in thousands):