Illustration by Jing Jing Tsong
In 1918, World War I came to an end. The Boston Red Sox defeated the Chicago Cubs in the World Series. Robert Goddard demonstrated tube-launched, solid-propellant rockets. Huge oil and natural gas fields discovered in the Texas Panhandle sparked boom towns, attracted entrepreneurs, inspired new markets and revitalized existing gas companies.
And the American Gas Association was formed to advance the interests of the industry and its investor-owned companies.
Natural gas companies have long been stable fixtures in financial markets. Today’s companies still offer stability amid uncertainty, but with a twist, say the experts. Investors in the 21st century are viewing natural gas through a new lens, as companies dismantle old boundaries between customer service and investor value, driving earnings growth while maintaining focus on their core missions.
Most utilities are “growing at a pretty good clip, and that increasingly becomes part of our story,” said Steven P. Rasche, executive vice president and chief financial officer of Spire, headquartered in St. Louis.
“As an organization, you can’t be successful without your customers getting a better experience. We look for a win-win-win. We expect our customers to win, our communities and states to win, and our investors to win.”
Even before AGA’s founding, gas companies were playing major roles in the creation and growth of stock markets. Spire traces its roots to Laclede Gas Light Company, founded in 1857 in Missouri. Laclede listed on the New York Stock Exchange in 1889, making Spire successor to the eighth-longest-listed stock on the NYSE.
“Ultimately, our success is standing on the shoulders of everybody who has come before us,” said Rasche. “To a person, we all understand that our primary job is to make sure that when customers turn on the hot water, or they turn on the heat or they turn on their stove, that the gas is going to be there. That has been a tried-and-true focus for not only our company but all utilities—to deliver for our customers reliably, safely and at a good value.”
In 1823, New York Gas Light Company received a state charter to install natural gas lines in lower Manhattan, replacing whale oil lamps in streets and homes. One year later, New York Gas Light was listed on the NYSE. Now, as Con Edison, the company holds the NYSE’s record as its longest-listed stock.
Today, Con Edison reaches into history to remind investors of its 43 years of consecutive dividend growth.
“Con Edison, like most utilities, seeks to be a stable, reliable investment,” said spokesperson Allan Drury. “While the needs of customers change and technology gives us new ways to meet those needs, our mission for investors continues to be stability and a strong dividend.”
Any institution that perseveres for 100-plus years endures its ups and downs. Navigating the choppy waters of competition, changing technology, war, price variations and shifts in consumer preferences requires strategic thinking and calm steering.
A decade ago, in the mid-2000s, the combination of hydraulic fracturing and horizontal drilling spawned a resurgence of oil and natural gas production in North America that came to be known as the “shale gale.” The disruption brought about by the shale revolution had an impact beyond the price of natural gas, extending to global markets and geopolitics. It has fundamentally reshaped the oil and gas industries, both domestically and internationally.
Samuel Andrus, executive director of North American Natural Gas at IHS Markit, tells the story in numbers. Nationally, the price of gas in current dollars has dropped by two-thirds, from over $9 to under $3. The supply of $4 gas is expected to last 25 years, and demand will double from 75 billion cubic feet per day to 140 or 145 bcf.
“It’s a pretty phenomenal change from where we were expecting to go a decade ago to where we have gone,” Andrus said.
In this evolution, U.S. natural gas markets are connecting to global markets, not just through exports of liquefied natural gas but through the price and production relationship between oil and gas, Andrus added. Utilizing hydraulic fracturing technology borrowed from natural gas, the United States is now second only to Russia in world oil production. In the mid-2000s, natural gas production associated with the production of oil was about 4 bcf per day and declining. Today, associated gas production is closer to 22 bcf and growing. Further, as the global price of oil rises, “it’s going to stimulate more oil activity, which brings more associated gas, which increases gas supplies,” he said.
“With oil and associated gas production following the price of oil, a rising oil price increases associated gas production, and a falling oil price does the opposite, changing the supply-and-demand balance for natural gas,” Andrus added. “What we’re seeing develop is an inverse relationship between WTI [West Texas Intermediate, a grade of crude oil used as a benchmark in oil pricing] and Henry Hub.”
The “shale gale” shows few signs of abating, he said. “We’ve got enough natural gas contained in already-discovered plays to serve the needs for most of this century at prices below that of a decade ago.”
With all of this domestic gas, are markets increasing? Yes, said Andrus. While residential and commercial markets in North America are “not expected to grow, total demand will double over the next two decades, led by the industrial, power and transport sectors, and exports,” he said. “Where the distributors are going to see opportunity is in replacing pipe. Local distribution companies will be making a lot of investment to improve the operational cost and safety of their networks.”
As with many other gas companies, large segments of Con Edison’s capital expenditures are going underground. The company’s $1.9 billion budget for capital expenditures—called an “attractive capex” in a PowerPoint for investors—included $909 million in 2017 for gas, then $970 million in both 2018 and 2019.
The 20-year program is replacing about 100 miles of cast-iron and steel gas main per year. Accelerating the schedule from an earlier 34-year goal—and increasing annual systemwide inspections—heightened the focus on safety and also has “obvious financial implications,” said Drury.
“The main purpose of the pipe replacement is public safety,” he said. “But we do earn a return of about 9 percent on investments in our energy delivery systems.”
Milwaukee-based WEC Energy Group owns Peoples Gas, which dates to the formation of Chicago Gas Company in 1849. Peoples’ legacy includes its cast-iron gas distribution network, run by necessity at low pressure, with meters inside homes and businesses. A modernization project, now about 24 percent complete, is replacing 2,000 miles of pipeline at an average annual investment of $280 million to $300 million.
Modernization will improve reliability and safety, enhance environmental performance by reducing methane emissions and save money, WEC Energy Group CEO Allen L. Leverett told investors during the 2017 annual meeting of shareholders.
“Each of these metrics—safety and reliability, operating efficiency [lower operating and maintenance expense] and improved environmental performance—resonate well with our key stakeholders, including customers and shareholders,” he said.
At Spire, the “vast majority” of the nearly $500 million 2018 capital expenditure budget supports infrastructure upgrades, said Rasche. Investors “understand the story, and that’s a story for the gas industry overall.
“We see opportunities to upgrade infrastructure to make it more resilient and cost-effective, because it costs a lot less to operate a higher-pressure PVC system than a cast-iron system,” he said. “It’s our job to see where our customers need us to be and whether our distribution network is ready to meet those needs.”
Like many gas companies, Spire has “a great story to tell.” It’s a story that includes the company’s long history, regular and growing dividends and a legacy as one of the original Dow Jones industrials, said Rasche.
But times have changed, and utilities now confront questions of scale. In September 2017, Spire caught the attention of investors by rebranding its five legacy utilities under the Spire umbrella. Unification allowed migration of the most effective methods being used among all the entities and the cost-effective consolidation of customer service.
“Business investors intuitively understand that those create value,” Rasche said. Larger scale also attracts talent, he said, “so when we do need to access the capital markets for better equity, we have many investors who already know our story, know our successful past and are willing to invest and come along for the ride.”
Meanwhile, Con Edison’s technology investments include the largest project in the company’s history—a $1.4 billion project placing 4.8 million smart meters, including 1.2 million for gas, in customer homes and businesses.
Technology upgrades are “giving customers safe, reliable service, adapting to their changing needs and helping them use less—not more—energy,” said Drury. “We also seek to engage customers on the platforms of their choice: online, mobile, social media. We are always looking for new technologies that will help us with these goals.”
Looking back at more than 100 years of history provides a clear picture of natural gas and its role in fueling the United States and the world. But when trying to peer 100 years into the future, the crystal ball is still cloudy on the question, “How will natural gas and renewables coexist to meet demands for energy?”
Natural gas and power-generating renewables can “work collaboratively to keep the lights on,” as seen in California during the 2017 eclipse, said Andrus.
Still, those advocating a move toward 100 percent renewables are not looking at the entire picture, he said. Natural gas is “an integral part of keeping today’s grid reliable and a critical component to most of the modern conveniences we take for granted,” Andrus said. Without fossil fuels, there is “no heating, no cooling, no plastics, no TV, no cellphones, no cars, no planes. Life as we know it ceases to happen.”
Discussion is accelerating around electrification as a possible emissions-reduction solution, but the idea comes up against the fact that approximately 60 million U.S. homes currently use natural gas for space and water heating needs, said AGA’s Richard Murphy, managing director, Sustainable Growth.
“If you start thinking about the ambition for electrifying residential space and water heating, those 60 million homes would be subject to a major upheaval to replace natural gas space and water heating with electric alternatives,” Murphy said. “The costs of transitioning and replacing all that equipment would be significant.”
“We need to be honest about the pace at which we can physically progress from how we create and consume energy today to how we want to create and consume energy in the future,” added Andrus. “The costs to realize this vision are pretty high. For wealthy countries and individuals, paying up for more expensive technologies is not a huge problem because energy is not a significant part of their annual income, but for the poor it’s a problem. When 10, 20 or 30 percent of your income goes to energy for home heat and light, raising the costs by quickly transitioning from cheaper gas and coal generation to more expensive renewables can be very detrimental to the health and welfare of the poor. This is particularly pronounced in developing countries.”
Even in the United States, many of those 60 million homes that currently rely on natural gas for space and water heating would incur “significant increases in operating costs if forced to convert to electric space and water heating alternatives,” said Murphy. “In addition to the incremental direct costs to consumers, electrification of the residential market would necessitate massive increases in electric infrastructure in many regions of the country in order to serve the incremental electric demand. The costs associated with the expansion of the electric grid would ultimately be passed along to consumers.”
Andrus concluded that there are “tradeoffs” among efficiency, reliability, diversity and affordability as described in a U.S. Department of Energy staff report to Secretary Rick Perry. “If you want to remove fossil fuels from the domestic and international generation fleet, policy choices will need to be made on the affordability and reliability side of the equation.”
The “shale gale” has reduced the cost of power from what it otherwise would have been and is allowing for a transition to occur without a significant economic shock. It has also changed the energy security dynamic and removed some of the geopolitical issues from the debate, Andrus said.
The beauty of gas, added Spire’s Rasche, “is that we all have opportunities to invest and grow in a number of ways.” At Spire, that includes the gas utilities, which are 97 percent of the company’s revenue, plus a natural gas marketing company that is “another growing part of our portfolio.”
“We do see other opportunities to invest and grow in the natural gas space, especially in pipelines and storage,” he said. “We’re going to stay focused on what we do best. That will allow us to get a good return on our investments while serving our customers even better.”
Meanwhile, in the frigid finale to 2017, Con Edison customers set two records for natural gas demand in one three-day period. Peak demand has risen by 30 percent since 2011, and another 20 percent increase is expected by 2037.
The trend has prompted Con Edison to devise the Smart Solutions for Natural Gas Customers Program, a planned $100 million investment in solutions to manage peak demand growth, meet resource constraints, mitigate risk and enhance system flexibility. A Con Edison request for proposals issued in December 2017 seeks proposals with the goal of averting major gas pipeline construction and aligning with New York City and state environmental goals.
The extent of renewables in the final mix depends on the proposals submitted and accepted, “but we think there is potential, and that’s why we included it in the RFP,” said Drury. “The more successful we are in managing peak demand for energy, the more we can manage our need for new infrastructure.”
As natural gas maintains its bearings amid the “shale gale” and honors its past while looking toward the future, industry players weigh blended strategies that balance the priorities of the company, investors and customers.
“We strive to get better every day,” said Rasche. “On balance, we have to be able to pair improved customer service with financial and operational success. Then pair that with helping our communities and states to benefit and grow, which ultimately raises the tide for all boats.”
In the 1980s, the American Gas Association and its members devised a strategy to win the hearts and minds of investors by sharing the story of how natural gas is a harbor for strong, stable investments. But at that time, there was little access to investment opportunities amid the relatively small market capitalization of gas utilities.
So, AGA Regulatory Affairs staff tested how a natural gas index might have performed over the previous 20 years. The eye-popping average of 9 percent a year inspired AGA to seek a market partner willing to launch a gas index fund.
The Hennessy Gas Utility Fund (ticker symbol GASFX), originally named the American Gas Index Fund, was born in 1989, possibly the first of its kind among trade associations. Today, the fund remains a mainstay, with an average total return of 9.73 percent a year through 2017. Hennessy Funds, the successor to that first management firm, remains at the helm.
Beginning with 110 companies, the fund launched with about $25 million in assets. Now holding 53 companies after consolidations, the fund has grown, reaching about $1.3 billion today.
“All of a sudden, we had a very abundant supply of natural gas,” said Winsor “Skip” Aylesworth, fund manager from 2001 until his retirement in early 2018. “The fund grew as that happened.” The positives compounded as natural gas emerged as a clean alternative to oil and coal.
Mergers and acquisitions also add welcomed diversity, according to fund co-manager Ryan Kelley, who has taken the helm since Aylesworth’s retirement. The fund today comprises buckets of pure gas utilities, major pipeline companies and combined firms that encompass electricity generation, gas distribution and “growing renewables portfolios.”
“Over time, the fund has diversified, and going forward, I expect to see M&A activity continue,” said Kelley. “It is one industry, but the stocks that make up the industry are now quite varied.”
For investors, the fund offers the attractive prospect of price appreciation plus annual dividend yields, now around 2.3 percent.
“On the cusp of its 30th anniversary, the fund was always intended to be an ‘investment tortoise,’ ” said Aylesworth. “That is, it plods forward steady and slow, providing investors steady and long-term returns. While ‘investment rabbits or hares’ may double your money quickly and provide good ‘cocktail talk,’ they may pause and do not provide long-term growth.”
Aylesworth added that he and Kelley are “quite proud of the fund’s 30-year performance of growth.”
Functioning within a highly regulated industry also offers investors the assurance that “nobody can start a new utility company and take away everyone’s business,” said Kelley. “You’re not going to have an Amazon come along and threaten the natural gas industry.
“Five years ago, we had low and stable prices and ample supplies,” he said. “It was going to be a healthy, growing business. It’s the same story today. It hasn’t changed, and in the late ’80s, it was roughly the same story. There has been a very consistent, positive message throughout the history of the fund and AGA.”
