Illustration by Stuart Briers
From an economic investment standpoint, in some areas, natural gas utilities have recently been steering against strong headwinds. Electrification is accelerating in some states. Inflation is driving up costs. High interest rates are making debt expensive.
But despite these challenges, the sector’s growth outlook in earnings per share remains steady at about 6%. As always, natural gas utilities that invest in their core infrastructure and good governance are the ones consistently projecting stability and confidence in the future.
“There is headline risk out there, but by and large, we are seeing an acknowledgment that natural gas infrastructure is going to be needed for a long time and, over time, can be part of the solution for decarbonization, reducing emissions and promoting energy efficiency,” said Sarah Akers, senior analyst, director equity research–utilities, Wells Fargo Securities LLC.
Headwinds in the economic climate have been strengthening since around mid-2022, according to Akers. As the costs of debt, equity and labor soar, the effects appear in gas utilities’ near-term earningsper-share growth.
“These costs are generally recoverable in customer rates but not on a real-time basis,” she said. “The utility has to file a rate case and ask for the rate increase tied to these higher costs.”
In this atmosphere, investors gravitate toward utilities capable of offsetting the headwinds, she said. For example, utilities might underpromise on returns and build cushions into their plans that keep earnings targets within range or assure targets through cost cutting.
The utilities better positioned to manage the headwinds include those that de-risked in advance, hedging their debt by locking in low interest rates in forward-looking equity agreements, she added. The utilities that didn’t hedge may now find themselves repricing low-cost debt that matures at a higher cost.
Natural gas utilities have not underperformed electric, Akers said, but they continue to underperform the overall market. In recent years, utility valuations have fallen as interest rates rise, creating a situation where bonds are more enticing to incomeoriented investors.
“With the rise in interest rates over the last couple of years, it’s been harder for utility dividend yields to compete, and so we’ve seen underperformance,” she said. “We’ve seen price-to-earnings multiples come down across the board for the utility space.”
Falling interest rates, as anticipated, should favorably impact valuations by easing competition with bonds while also bringing down the costs of borrowing in a capital-intensive sector.
“Higher interest rates have been a theme for the last couple of years, but if you go back, that was a tailwind,” Akers said. “You had very low inflation, and when utilities went in for rate cases, the focus was just on the infrastructure investment. Now you have the element of asking for a higher cost of capital as well.”
Spire Inc. affirmed its fiscal year 2024 earnings guidance as well as its long-term 5% to 7% net economic earnings per share growth target beyond 2024, driven by 7% to 8% utility rate-base growth. Amid 2023’s high inflationary environment, Spire executed its target to manage operations and maintenance expenses below inflation levels.
“We set this target for ourselves every year,” said Spire Treasurer Adam Woodard. While the trend lines of long-term interest rates are higher than they have been, he added, “they were unusually low two years ago. We’re probably getting back to a range of long-term interest rates that are within historical norms.”
In an inflationary climate, cost management and efficiencies executed without sacrificing safety and reliability take on added importance. The unavoidability of higher labor costs complicates those efforts, Akers noted, but gas utilities are leveraging technology and artificial intelligence to create efficiencies. For example, Spire is exploring and deploying technology to automate manual tasks, streamline scheduling and standardize supply chain practices.
At New Jersey Resources, New Jersey Natural Gas is the core subsidiary, comprising 60% of earnings, people, assets and investments. But complementary businesses—including solar, storage and transportation, energy services and appliance services—provide a protective diversification, said Patrick Migliaccio, NJNG senior vice president and chief operating officer.
Investors view strong relations with the workforce as an asset, said Migliaccio. NJNG’s constructive relationships with its union workforce, IBEW 1820, have resulted in fair and beneficial outcomes for both sides.
Akers noted that customer growth also offsets the headwinds, and even dual-fuel utilities pressing on with electrification plans acknowledge that certain parts of their territories could be difficult or cost-prohibitive to electrify.
NJNG’s growth picture is evident in a “healthy conversion market,” said Migliaccio. Bucking Northeast trends, NJNG’s service territory is experiencing a net migration of people, as post-pandemic remote workers move permanently to their shore vacation spots. When NJNG extended service for the first time into Sussex County in northern New Jersey, one new customer displayed a handwritten sign welcoming NJNG to the neighborhood, with the words, "Good-bye high oil prices" and "Praise the Lord."
“It made us feel really good about the work we do in the community,” said Migliaccio.
While higher costs have constrained the near-term outlook, long-term growth trends remain intact, said Akers. Utilities “still have a long runway” for infrastructure investment, focusing on pipe replacement and supporting rate-base growth of 7% to 9%.
Perhaps ironically, the storied gas utilities with older systems have a better infrastructure replacement story to tell than the relatively newer, more modern utilities, Akers noted. Gas utilities in states such as Texas and New Jersey benefit from the combination of pipe replacement and actual growth in customers.
At Spire, where the gas utility constitutes 90% of the business, metropolitan systems in Birmingham, Alabama; St. Louis; and Kansas City, Missouri, are reaching the sesquicentennial milestone of 150 years old. Natural gas utility investment drove Spire’s fiscal year 2024 capital expenditure spend of $765 million, and infrastructure modernization is propelling projected earnings growth of 5% to 7%, said Woodard. “Investors are attracted to our long-term, consistent capital growth plans,” he added.
NJNG’s newest rate case, filed in January 2024, stresses breadand-butter safety and reliability investment, including traditional infrastructure upgrades. Simultaneously, it also incorporates an ongoing enterprise-platform replacement to modernize customer service and dispatch operations, cybersecurity enhancements aligned with Transportation Security Administration directives, and rising labor costs, including a three-year union agreement forged to support adequate staffing.
“At the end of the day, we’ve got a well-telegraphed rate case that our investors and regulators expected,” Migliaccio said. “It helps support the continued earnings growth at NJNG, while from a customer and community stakeholder perspective, it continues to improve the safety and reliability of our system.”
Investors show interest in decarbonization plans and sustainable fuels, but the picture differs state by state, said Akers. Such plans are likeliest to capture investor attention when their efforts align with state decarbonization goals and policies, especially where cost recovery is concerned.
“Investors like to see gas utilities have a decarbonization strategy, but at this time, that is still secondary to having good fundamentals, including supportive regulatory treatment, state policy support in the infrastructure investment opportunity and a good balance sheet,” she said. “You have to take your cues from the state. Investors are very cognizant that they want the utilities to have a decarbonization strategy, but not one that gets out in front of their regulators.”
In the eyes of investors, pipeline replacement and energy efficiency programs align with decarbonization strategies for their power to reduce emissions, she added.
“Energy efficiency is something that the gas utilities can do just to reduce overall usage,” she said. “Many of the gas utilities have decoupling mechanisms in place where they’re not incented on usage, so if they can support energy efficiency programs, that doesn’t necessarily hurt the bottom line.”
Regulators have been “generally supportive” of capital investments to improve safety and reduce greenhouse gas emissions, Akers added. Investors know that some states could pull back on supporting fossil-fuel infrastructure while pushing electrification to achieve decarbonization targets. But there is also broad acknowledgement that the electrification of transportation and emergence of energy-hogging data centers will put a heavy strain on the electric system.
“There are a lot of demand drivers on the electric side, so there is a reality that we’re going to need this gas infrastructure as part of the energy delivery system,” she said. “By and large, we’re still seeing good support for gas infrastructure investment.”
For its investors, NJNG spotlights its energy efficiency programs, including a December 2023 filing seeking a $482.4 million investment in the next generation of its SAVEGREEN™ initiative, which offers energy efficiency rebates and financing. Investors count energy efficiency as good corporate citizenship, and institutional ownership increasingly values a focus on the environment, said Migliaccio. Meanwhile, customers incentivized to weatherize and upgrade equipment save money through reduced usage while cutting greenhouse gas emissions. “It is an important mechanism in the near term to drive real emissions reductions,” he said.
On the alternative-fuels side of the equation, investors are interested in ongoing research into hydrogen and in the U.S. Department of Energy’s hydrogen hubs initiative, but “it’s not viewed as a key part of the story, at least for the next five years,” Akers said. “In terms of alternative fuels, renewable natural gas is still getting more attention than hydrogen.”
NJNG was the first East Coast gas utility to blend hydrogen for delivery through its underground system—and then recovered $6 million in costs through its last rate case. “That was an important signal for investors and others that there was an openness in the state of New Jersey to consider hydrogen as part of the fuel mix and as part of the rate base,” said Migliaccio.
NJNG is also exploring RNG projects that manage landfill methane through capture and cleanup, using it to heat homes and displace geologic natural gas. These types of projects build a case for the natural gas distribution infrastructure and its underground pipe, which is safer from disruption than above-ground alternatives.
“By and large, investors understand our approach,” said Migliaccio. “The clean fuel strategy is one element that demonstrates in this environment and this clean energy transition that this infrastructure has a place in the future.”
New Jersey is managing a busy energy docket, with Gov. Phil Murphy’s aggressive clean-energy agenda, a Legislature and Board of Public Utilities focused on affordability and reliability, a pending “future of gas utilities” proceeding, and discussions on decarbonizing buildings. NJNG is engaged with and monitoring all avenues, pursuing public and policy stakeholder pathways “to arrive at what makes the most sense for New Jersey, which we think is to leverage the underground energy infrastructure that utilities, like NJNG, spent $17 billion on in the state of New Jersey,” said Migliaccio.
In times riddled with uncertainty, regulated natural gas utilities continue to represent a generally stable place for investors, said Akers.
“They want to hear about predictable, consistent performance that’s being driven by things like customer reliability and safety,” she said. “With a 5% to 7% growth trajectory, we’re looking to again execute on our plan and keep things very consistent and predictable and very transparent to investors, which we think will play well over time and continue to be appealing to investors.”
That kind of stability was evident at Spire in 2023 when CEO Suzanne Sitherwood retired and COO Steven L. Lindsey was promoted to continue the growth and transformation she had overseen.
“We’re focused on our core business and growing organically, and that creates a backdrop from a governance standpoint that this transition into new leadership isn’t signaling significant shifts in our approach to the business,” said Woodard.
Gas utilities, he added, might be “undervalued for what we bring to the table for investors.”
“We’re always engaged in talking to investors about that,” he said. “It’s hard for utilities to escape the backdrop of interest rates, but we do continue to see a lot of investor interest in the space, and we will look for that to continue.”