TOPIC #4
Gas Utility Developments: Where To From Here?
Evolving regulatory and market conditions create an uncertain outlook for natural gas local distribution companies (LDCs).
Major Industry Trends Keeps LDCs Focused on Customer Affordability
- Throughout the 2010s, consistently low natural gas commodity prices, due in part to the shale boom boosting production, offset growing costs for pipeline integrity improvement programs. However, over the past several years, a more cautious approach to production increases and geopolitics factors have affected global gas markets, causing increased price volatility and the possible end of sustained low prices.
- Gas prices have moderated after their highs in 2022 (see Figure 4.1), and many analysts predict prices will continue to trend toward pre-pandemic levels. However, gas prices over the longer term remain uncertain due to fundamental supply and demand factors:
- Anticipated reliance on natural gas through the energy transition, but eventual flattening of demand (over an undefined period) as more renewable resources come online
- Higher production in the United States, with more disciplined production capex
- Increasing U.S. liquefied natural gas (LNG) export capacity will attempt to support strong global LNG demand in the near term as Europe seeks alternative gas sources to offset Russian piped gas
- Impacts of methane regulation on cost of gas
- Generalized impacts of inflation (wages and materials) and higher interest rates on commodity costs
- While low gas prices have kept customer bills low despite increasing costs for LDC capex, recent higher gas costs have increased customer bills, highlighting the need for LDCs to continue to manage costs aggressively.
Figure 4.1: Weekly Henry Hub Natural Gas Spot Price (Week of Jan. 1, 2010-Mar. 17, 2023) ($/MMBtu)
Sources: AGA; EGI
KEY TAKEAWAYS
There is significant uncertainty in the gas LDC sector, as the years’ long trend of low commodity prices has been upended by recent global market disruptions. Rising costs have forced utilities to continue to emphasize cost efficiency to ensure affordability despite increased gas commodity price volatility.
Spurred by methane reduction objectives and safety needs, gas utilities continue to invest in system modernization. However, debates over the role of natural gas continue, spurring concern about a static or declining customer base and potential stranded costs.
To support a lower carbon regime, renewable natural gas, non-pipeline alternatives, and hydrogen offer ways to reduce emissions while maintaining the use of existing infrastructure.
There is significant uncertainty in the gas LDC sector, as the years’ long trend of low commodity prices has been upended by recent global market disruptions. Rising costs have forced utilities to continue to emphasize cost efficiency to ensure affordability despite increased gas commodity price volatility.
Spurred by methane reduction objectives and safety needs, gas utilities continue to invest in system modernization. However, debates over the role of natural gas continue, spurring concern about a static or declining customer base and potential stranded costs.
To support a lower carbon regime, renewable natural gas, non-pipeline alternatives, and hydrogen offer ways to reduce emissions while maintaining the use of existing infrastructure.
Figure 4.2: Selected U.S. Natural Gas Distribution Utility Statistics by Region (2021)
Source: ScottMadden LDC Database
Continued State Divergence on Natural Gas Bans
- A dichotomy exists in states’ attitudes toward the future use of natural gas. As of mid-February 2023, there were six states in which either the whole state or certain localities had enacted restrictions on gas hookups for new buildings along with electrification mandates (see Figure 4.3). Four more states and the District of Columbia are developing similar restrictions. Currently, Washington is the only state with a statewide all-electric construction mandate.
- In contrast, as of mid-February 2023, 20 states had enacted legislation prohibiting gas bans. More states have introduced similar legislation to prohibit bans; however, in many of those cases, the legislation failed to advance.
- Notably, the two largest states in terms of residential natural gas volume—New York and California—are among states in which some localities have enacted bans on gas hookups for new construction (see Figure 4.4). New York is currently considering banning new gas hookups statewide, with a measure that is on track to be added to the state’s coming budget.
Figure 4.3: State Legislation on Gas Bans
Note: As of Feb 17, 2023.
Source: S&P Capital IQ Pro
Figure 4.4: Residential Natural Gas Consumption by State (2021) (MMcf)
Source: EIA
Beyond Debates on Gas Bans: States and Utilities Explore the Future of Gas
- While debates over permitting natural gas as an energy source in new construction persist, state policymakers, regulators, utilities, and other stakeholders in various jurisdictions are examining the future role of natural gas, including infrastructure investment programs and decarbonization efforts.
- One conundrum for the utility industry is that regulation in some states pushes for utility investment in electrification, while expecting utilities to maintain natural gas infrastructure for both reliability and safety.
- The push for electrification affects the number of gas customers and, depending upon its extent, could shrink the overall customer base. Despite this, gas companies are expected to maintain their current infrastructure, which in the case of a reduced customer base, spreads costs over fewer customers.
- Further, for combination utilities, managing gas infrastructure and an increasing push to electrify their customer bases could create additional cost-to-serve challenges.
- Some states and utilities have either planned for or conducted expansive studies into the future of gas in their respective energy mixes. For example, in response to an executive order from the governor, the New Jersey Board of Public Utilities initiated a proceeding in March 2023 to determine how the gas industry can best meet the state’s goal of 50% emissions reduction from 2006 levels by 2030. The proceeding will consider what role natural gas should play in emissions reduction, as well as how the industry can manage changes to its business and customer base.
- Some jurisdictions have approached decarbonization issues through various discrete policies and initiatives. A few examples are shown in Figure 4.5.
Figure 4.5: Selected Regulatory and Utility Actions on Decarbonization in the Gas LDC Sector
Focusing on Operating Efficiency
- As mentioned above, the uptick in natural gas prices in 2022 and its potential effect on gas bill headroom to cover other expenses has led gas utilities to focus on ways to keep rates affordable. One area of interest is keeping O&M expenses flat or reducing them through operational efficiencies, leveraging process and technology improvements.
- It is notable that from 2019 to 2021, O&M costs declined across the LDC industry (see Figures 4.6A-B). The year 2020 was expected to be an exception, with significantly lower O&M due to COVID-19; however, O&M spend did not return to pre-pandemic levels in 2021, reflecting continued efforts at maintaining an efficient cost structure.
Figure 4.6A: Total U.S. Investor-Owned Natural Gas Distribution Company Operation & Maintenance Expense* Per Mile of Distribution Main ($)
Note: *Less production costs.
Source: ScottMadden LDC Database
Figure 4.6B: Total Miles of Mains for U.S. Investor-Owned Natural Gas Local Distribution Utilities
A Few Strategic Transactions: Are More Coming?
- Accompanying the uncertainty surrounding the long-term role of gas utilities and selected local opposition to growth of gas use, some utility and financial players are making strategic bets on LDC properties.
- Recently, J.P. Morgan purchased South Jersey Industries (SJI) in a deal finalized February 1, 2023. SJI is a holding company whose subsidiaries operate gas distribution systems that served more than 384,000 customers at the end of 2021. In statements made by both parties, the transaction is noted as bringing together SJI’s environmental goals with J.P. Morgan’s resources and expertise.
- Similarly, Summit Utilities (also owned by J.P. Morgan) purchased CenterPoint’s gas assets in a deal that was finalized in January 2021. Through this deal, Summit acquired distribution assets, which included 17,000 miles of gas mains that serve approximately 525,000 customers. After the completion of the deal, CenterPoint’s CEO stated: “Completing the sale of these natural gas distribution businesses will help us achieve a number of our strategic goals, including efficiently funding our long-term capital investment plans…and allowing us to focus our efforts on executing our plan across fewer jurisdictions.”
- Southwest Gas Holdings divested its Mountain West subsidiary in a deal finalized in February 2023. Mountain West’s assets were comprised of roughly 2,000 miles of interstate gas transmission pipelines, totaling about 8 Bcf/d of transmission capacity. Southwest Gas stated the sale was “a significant step toward returning Southwest Gas to its core regulated utility business,” continuing that its planned spin-off of Centuri will help further that goal.
- Some owners of gas utilities continue to evaluate whether to keep those businesses in their portfolios. Expect to see continued realignment as gas players decide their long-term strategies.
Carbon Reduction, Safety, and Reliability Drives Spending
- As natural gas works out its role in the energy transition, one of the transition’s major goals—carbon reduction—has grown into a driver of capital expenditures for LDCs. In 2020, leaks from natural gas and petroleum systems made up 32% of methane emissions in the United States. For both emissions reduction and safety, LDCs continue to focus on pipeline replacement and modernization programs, with the following recent trends for reporting U.S. gas utilities:
- From 2019 to 2021, main leaks repaired declined 10.4%, service leaks repaired declined 3.6%, and hazardous main leaks repaired declined 11.3%.
- The number of known system leaks scheduled for repair has increased 6.8% from 2019 to 2021. Presumably, this increase in scheduled repairs is intended to remedy this backlog.
- Finally, the total number of main miles has increased only slightly (2.5% over the same period), indicating that the majority of capital being deployed is for replacements.
Figure 4.7: Proposed and Operational Renewable Natural Gas (RNG) Projects in North America (as of Nov. 21, 2022)
Source: The Coalition for Renewable Natural Gas
Carbon Reduction, Safety, and Reliability Drives Spending (Cont.)
- In order to incentivize the reduction of methane emissions from gas systems, recent legislation has created programs to appropriate funds to speed up emissions reductions and to levy fees on companies that do not keep their emissions in check.
- The Inflation Reduction Act (IRA) appropriated $1.55 billion for the Methane Emissions Reduction Program, which will fund grants and technical assistance to accelerate emissions reduction from petroleum and natural gas systems.
- The IRA also established a methane emissions fee in Sec. 60113. The program imposes a maximum annual methane waste rate of 25,000 metric tons of CO2-equivalent per facility and imposes penalty charges starting at $900/metric ton of methane in 2024 and increasing to$1,500/metric ton by 2026 for excess emissions.
- Options like RNG, NPAs, and in the future, hydrogen, have been receiving increasing attention.
- RNG specifically has received major interest from many LDCs, with some having operational projects (see Figure 4.7).
- NPAs are a tool LDCs are using to minimize spending and reduce emissions. NPAs exist both on the demand side and supply side and consist of activities or investments that delay, reduce, or avoid the need to build or upgrade traditional gas infrastructure (see Figure 4.8).
- Hydrogen, discussed in detail below, offers a carbon free fuel which can make use of the extensive gas infrastructure that will continue to exist regardless of the role of gas in the future of the energy industry.
Figure 4.8: Examples of Non-Pipes Alternatives
Source: ICF International
Looking to the Future: Hydrogen
- Many energy transition observers and advocates expect hydrogen to be a fuel of the future, with the potential to replace natural gas and make use of the extensive gas infrastructure that currently exists. It is currently in the early development stages. However, there is significant investment on the horizon, both from utilities and legislators.
- Utilities have for years been investigating and investing in pilot projects working on the production of blue and green hydrogen, which have differing levels of emissions, fuel blending, hydrogen hubs, and hydrogen microgrids (see Figure 4.8).
- Hydrogen has also received interest from policymakers. The Infrastructure Investment and Jobs Act includes $8 billion for Regional Clean Hydrogen Hubs, $1 billion for a Clean Hydrogen Electrolysis Program, and $500 million for Clean Hydrogen Manufacturing and Recycling Initiatives. Additionally, the IRA created production tax credits of up to $3/kg for clean hydrogen plants.
- The Regional Clean Hydrogen Hubs (H2Hubs) program is designed to create networks of hydrogen producers, consumers, and local connective infrastructure to accelerate the use of hydrogen. The DOE envisions selecting 6 to 10 H2Hubs for a combined total of $6–$7 billion in federal funding. Overseen by the DOE’s Office of Clean Energy Demonstrations, the program received 79 concept papers through late 2022 requesting a total of $60 billion in federal funding, with 33 papers encouraged and 46 discouraged. Full applications were due on April 7, 2023. At this time, it is unclear who was awarded funding and whether any winner’s partners included gas utilities.
Figure 4.9: Selected Gas Utility Hydrogen Projects
Source: The Coalition for Renewable Natural Gas
IMPLICATIONS
Gas utilities face multiple challenges and opportunities. The direction of gas commodity prices is uncertain after a long period of plentiful and cheap natural gas. Capital programs (and related costs) are needed to upgrade and replace infrastructure for leak reduction, to reduce methane emissions, and for safety and reliability. Depending upon the utility’s jurisdiction, there are mixed and evolving policy postures regarding the role of end-use gas in the energy transition.
To navigate this environment, gas LDCs will have to consider various management priorities, including:
- Evaluation of gas utility implications of changes in regulatory policies and customer demands
- Capital cost management and oversight
- Constructive relationships with stakeholders, particularly with respect to investments that enhance efficiency and decarbonization, such as NPAs, RNG, and (over the longer term) hydrogen
- Communication of the value of gas as an end-use energy resource, particularly for heating and hard to decarbonize applications
- Long-term strategies that consider scale economies, balance sheet strength, steady returns, and other factors that inform transaction decisions
- O&M cost management and commodity risk management approaches that keep customers’ bills stable and affordable
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