BY M. DIANE MCCORMICK
As investors demand evidence that corporations commit to the “E” in “ESG,” natural gas utilities are well positioned to polish their environmental credentials in a world pivoting to a sustainable, decarbonized future.
Development of cleaner energy sources paired with heightened emphasis on reducing greenhouse gas emissions means natural gas utilities remain vital players in the future energy mix, said Ryan Kelley, chief investment officer, senior vice president and portfolio manager, Hennessy Funds.
“We’re going to continue to reduce carbon dioxide emissions,” he said. “We are going to continue to reduce methane emissions. We are going to continue to improve our environment impact, and it’s going to be a combination of natural gas, renewables, new technologies and less leakage. We can get many more electric cars on the road and get rid of a lot of gasoline-burning vehicles, and we still need to have both natural gas and renewables because they work so well together.”
With a consistent record of healthy earnings and more projected in coming years, stakeholders say that natural gas utilities see a strong financial outlook ahead. As DTE Gas President Joi Harris put it, the world is “moving toward a new place in terms of how it consumes and produces energy.”
“We believe the future of natural gas is bright for that reason,” she said. “The dispatchable nature of natural gas makes it an excellent enabler for renewables. We’re doubling down to make sure we have a reliable system that can support demand for natural gas as it continues to grow, and we are working in collaboration with our partners on the electric side to explore different technologies that can also help to further reduce the carbon emissions from use of natural gas.”
Natural gas might not compare to tech in splashy earnings, but the current “sweet period” of 6% to 8% earnings per share, or EPS, growth per year for utilities “could go on for decades”—and even increase, said Kelley.
“This is definitely a tortoise-and-hare story, and we actually like it when it just continues to plod along like a tortoise, because we like consistency,” he said.
DTE Energy is one of many utilities experiencing growth, and in the state of Michigan, where about 80% of homes are heated by natural gas, “we don’t see that changing,” said Harris. That steady and growing customer base continues to demand sustainability in its energy options. “We certainly want to make sure that we’re well positioned and being responsive to the needs of our customers and what they’re looking for in terms of reducing their carbon footprint,” said Harris.
DTE has responded with strategies that include CleanVision Natural Gas Balance, which allows natural gas customers to offset their carbon emissions through reforestation and the use of renewable natural gas. The product line, launched in 2021, is nearing 6,000 customers, and DTE is queueing it up for commercial customers.
Although the natural gas sector continues to trade at a discount compared to electric, its elevated earnings growth remains “pronounced,” and RNG as a pathway to decarbonization is one of the drivers, said Julien Dumoulin-Smith, analyst with Bank of America.
RNG is not a silver bullet, he added, but it “enables the sector to acknowledge a decarbonization trend.” He warned, however, that a “halo” around RNG—due to its use in transportation to decarbonize compressed natural gas vehicles—has inspired the robust pricing, and the gas utility space continues to “need an answer to decarbonization.”
“How do you continue to see this RNG blending adoption curve work?” he posited. “What is that palatable price curve?”
Along one pathway, corporate strategies are agile and evolving in relation to RNG as a pass-through versus RNG developed and blended by gas utilities, said Dumoulin-Smith. This application of “coherent logic to vertical integration” can supplement earnings growth.
“Companies are remarkably open to reevaluating the strategic limits in the scope of their business,” he said. “Historically, it’s not in the gas LDC space to overly expose on upstream gas production, but RNG could prove the exception to the rule.”
Investors might not see RNG as a pure driver of value, but it gets their attention as an element in energy diversification and the increasing electrification of cars, said L. Joshua Wein, vice president and portfolio manager at Hennessy Funds. “It can’t all be solar. It can’t all be wind,” he said. “It can’t all be pure-play natural gas, but it is nice to be able to put on the renewable tag.”
For example, DTE Vantage, a division of DTE, focuses strategically on decarbonization and continues to grow. In its fourth-quarter 2021 earnings call, officials cited higher RNG earnings as a primary driver in DTE Vantage’s operating earnings rising from $150 million in 2020 to $176 million in 2021. RNG projects are underway in South Dakota, Wisconsin and New York, while a Michigan landfill gas project is being converted to RNG. During the earnings call, officials noted the strong market growth is supported by the federal Renewable Fuel Standard and California’s Low Carbon Fuel Standard, as well as future demand expected from additional states pursuing low-carbon fuel standards.
“We’re continuing to look for those high-value opportunities, but at the same time, we’re very conscious about affordability,” said Harris. “We have to also make sure that we are not investing at a pace that our customers can’t afford. We are taking a very measured pace and examining not only what investors are looking for but what our customers need in the form of rates.”
In addition, DTE’s hydrogen storage pilot, now within its latest rate case, proposes an 11-megawatt electrolyzer on top of DTE’s new Blue Water Energy Center to reduce carbon emissions exponentially and create hydrogen for introduction into the natural gas stream. “Hydrogen is still a bit expensive right now, and this is proof of concept for us,” said Harris.
Meanwhile, Duke Energy’s examination of hydrogen—for power generation, blending into pipelines, heavy transportation and hydrogen fuel cells—is part of its collaborative efforts through such institutions as Gas Technology Institute and Electric Policy Research Institute to test and scale up hydrogen as a clean energy solution. Hydrogen’s potential includes fueling combustion turbines and powering heavy vehicles, said Sasha Weintraub, senior vice president and chief commercial officer of natural gas business unit, Duke Energy Corp. “This is a pooling of companies across the industry, pooling their dollars and expertise to fund and move forward some key pilots,” he said. “We all learn from some of these key projects.”
Within many of these strategies, industrial and residential customers can opt into RNG blending and other decarbonization plans, but as states adopt their own decarbonization goals, regulators and legislators are also being asked to buy into the ratesetting and investment-recovery implications of the transition, said Dumoulin-Smith.
“To what extent are the regulators going to approve the trajectory of buying that natural gas as blended in across all rates?” he said. “Whether it’s 1%, 2%, 5% or 10%, these are going to be fairly small numbers, but enabling that pathway on a state-by-state basis is going to be an interesting question to watch.”
Duke Energy has developed a five-year plan to lead in the RNG space, investing as an active minority owner of SustainRNG to build dairy RNG systems. The projects not only help decarbonize the agriculture sector and provide revenue for farmers, but they also are expected to provide offsets for Duke Energy’s stated goal of net zero methane emissions by 2030.
Partnering helps build capabilities and launch commercial, nonregulated projects in a timely fashion, said Weintraub. As Duke Energy seeks legislative approval to incorporate sustainability projects into rate-based delivery of natural gas, partnering also helps the utility build skill sets for when projects enter the regulated realm.
Customer-focused programs are also important. Efforts such as DTE Energy’s CleanVision, which includes voluntary programs for electric and natural gas customers to reduce their greenhouse gas emissions through renewable energy sources and offsets, meet customers “where their interests are,” Harris said.
Such programs also assure investors increasingly interested in “seeing how companies are living up to those sustainability commitments they have made and [how they are] being overt in sharing those details about how those commitments are coming to fruition,” said Harris. “That work is continuing in earnest, and there is an interest to pay a modest premium to make sure that folks are, in fact, reducing their carbon footprint.”
Decarbonization efforts “all seem to be catching investors’ attention,” said Weintraub. “The natural gas system is part of the clean energy future, and you start seeing analysts pay attention to what exactly is the opportunity to help decarbonize these natural gas systems.”
Keeping an ear tuned to customer demand enables progress toward emissions-reductions targets, and so does looking across the entire value chain, said Harris. That includes sustainably sourcing natural gas and customer services, encouraging and supporting customers—especially the economically vulnerable—to be energy efficient, and continuing main renewals and maintenance strategies to reduce leak potential.
Alignment of all elements within a sustainability vision builds investor confidence. Pipeline modernization investments have long been bread and butter to investors seeking assurances of safety and reliability. Now, these investments are also emerging as a key element of decarbonization pathways.
From a financial standpoint, gas utilities emerged relatively unscathed from the southern deep freeze of 2021, with underlying costs largely recoverable through amortization or securitization into bills, said Dumoulin-Smith. In fact, reliability and resiliency in an age of climate-driven catastrophes is a plus for natural gas in financial markets.
For DTE Energy, more than half of a $3 billion capital investment planned for the next five years targets main renewal for safety, reliability and emissions reductions. “It certainly ensures these pipelines are going to continue to operate safely for decades and decades to come,” said Harris. “That’s the best kind of investment to make. It also helps us achieve the earnings gxrowth that we articulate to investors, and it aligns with the interests of regulators and our customers who want to make sure that they have that reliable service as well. You can see how this all comes together and generates value for all stakeholders.”
Duke Energy’s goal of net zero methane emissions by 2030 is staked, in part, on satellite-detection technology being developed in partnership with Accenture and Microsoft to find leaks “that are smaller than our handheld devices can detect,” said Weintraub. And, in February 2022, Duke Energy announced it was expanding its clean energy plan to encompass Scope 2 and some Scope 3 emissions in its 2050 net zero goals. That expansion incorporates both upstream methane and carbon emissions related to purchased gas and downstream carbon emissions from end-use customers.
In the words of Duke Energy Chief Sustainability Officer Katherine Neebe, Duke Energy’s cumulative efforts will “deliver long-term value for our stakeholders.”
As sustainability trends accelerated, logic might have dictated that natural gas conversions and new hookups would slow down.
“Well, guess what?” said Kelley. “Industrywide, there were 900,000 new residential customers added in 2020. That’s the best rate in about 15 years.”
At the height of COVID-19 pandemic restrictions, conversions were put on hold because field staff couldn’t go into homes. As conditions eased, the lid came off, and the conversion trend resumed, said Dumoulin-Smith. Such residential growth can also support growth in the industrial and commercial rate base, he said.
In fact, regulated utilities are not emphasizing RNG and other forays into decarbonization at the expense of rate-based growth, said Dumoulin-Smith. He cited ONE Gas, where “accelerating customer growth trends in interconnects is not isolated and speaks to an overall still-robust backdrop of rate base-oriented investments in the LDC itself.”
The predictability of natural gas as an industry where earnings rise no matter the crisis du jour positioned the sector to ride out the pandemic, said Kelley.
“There aren’t many industries that will tell you their five-year earnings per share projections, and that’s a huge factor that lets you sleep at night,” he said. “So much of the rest of the market has taken turns coming back hard after the pandemic, but utilities didn’t fall as hard.”
Mergers and acquisitions have been an industry driver since the early 2010s, said Kelley, “albeit at a slower pace in the most recent three.” Of the 17 deals announced since 2016 for companies within the Hennessy Gas Utility Fund, four involved the acquisition of utility companies by private equity, said Kelley.
That particular slice of M&A got a jolt in February 2022 with the blockbuster announcement that Infrastructure Investments Fund had acquired South Jersey Industries, with an enterprise value of $8.1 billion—“by far the largest private equity deal we’ve seen in our fund to date," Kelley said. When news of the proposed deal landed, SJI stocks soared 47% premarket.
Private equity injects capital into an industry that needs abundant investments to achieve stated decarbonization goals. SJI President and CEO Mike Renna acknowledged that his board determined that “now is the time to join forces with IIF,” as lowcarbon and renewable-energy trends accelerate.
“Together we will be well positioned to execute on SJI’s clean energy and decarbonization initiatives in support of the environmental goals of our state and region,” he said in the announcement of the acquisition.
Kelley expects more private equity to enter the space, agreeing that more capital and more investments “could mean higher potential growth of the industry.” Factors stoking interest include the scarcity of pure-play natural gas utilities and, on the electric utility side, the transformation of the electric grid “to meet everincreasing energy demands.”
“We believe this is indicative of ongoing—and growing—interest by private equity firms in what they see as an undervalued industry with long-term growth forecasts and potential for continued transformation,” he said.
In general, regulatory regimes and a reliable customer base position utilities to “protect their ability to make money over time,” said the Hennessy Fund’s Wein. Challenges remain, including a dearth of interstate pipelines to move natural gas from flourishing gas plays, such as Marcellus, to areas of greatest need, such as New England. Investors are anxious to see the renewable future materialize immediately, but tortoise-like natural gas remains in a strong defensive position, with strong and growing dividends and a “solid, growing EPS.”
“Overall, we’re excited about the space and think that there is going to be a lot more investor interest in it going forward,” Wein said.
Sharing technologies and being transparent about initiatives and goals help support the sector’s financial health, said Duke Energy’s Weintraub. Natural gas creates opportunities when it participates in discussions of decarbonization, alternate fuels, creating local jobs and revenue, and cleaning up other sectors such as agriculture, wastewater and waste management.
“It’s fun to see when we’re all trying to solve what we all find is really important to us, which is cleaning up the environment,” he said. “Putting into action these steps and these initiatives is really engaging for everyone in the industry. These are exciting times.”
