Infrastructure Spending Drives Earnings Growth

Over the past decade, U.S. natural gas utility and pipeline companies have significantly increased investment in their infrastructure networks. We believe higher investment is a positive catalyst driving earnings growth for many natural gas distribution companies operating under rate of return (ROR) regulation.

 

February 2019

  • Ryan C. Kelley
    Ryan C. Kelley, CFA
    Portfolio Manager

Key Takeaways

  • Natural gas industry infrastructure investment has risen significantly over the past decade
  • Primary factors driving spending include safety and repairs, production growth and an increase in LNG exports
  • We believe this increased spending could help drive earnings growth of gas distribution companies

The Infrastructure Network

The U.S. natural gas industry maintains a huge infrastructure network consisting of high pressure transmission pipelines, local distribution pipelines, storage facilities, processing plants, and liquefied natural gas (LNG) terminals.

Utility Regulation – A Return on Investment

Natural gas distribution companies operate under a rate of return (ROR) regulatory framework, which allows them to pass onto their customers, in the form of price increases, the cost of their investments, plus a rate of return typically between 8% and 11%. Effectively, the more a natural gas distribution company invests, the more it can earn.

Over the past 10 years, natural gas distribution companies have been investing significantly more than in previous decades, principally in their infrastructure network, laying the groundwork for increasing earnings growth down the road. In fact, since 2007, total infrastructure spending by natural gas utility companies has risen over 150%.

Spending on transmission pipelines (large diameter pipes that transport natural gas across the U.S.) has more than doubled while investment in local distribution pipelines (main and service lines that connect customers to their natural gas supply) has more than tripled from $4.8 billion to $14.9 billion.1

Spending has been driven by three major factors:

1. Pipeline safety and repairs. Increased investment on pipeline replacement and modernization began in earnest in 2011, following a series of serious pipeline incidents. New federal regulations prompted the local distribution companies to start major repair and rehabilitation programs and now 40 states have joined with the federal government to prioritize pipeline safety. For some companies, system integrity and replacement projects now account for over 70% of their total capital spending.

2. Significant growth in natural gas production. Growth in natural gas production over the past 10 years has pushed pipeline companies to increase the capacity of existing transmission pipelines by adding compressor stations along the line to boostpressure and by “looping” or adding another line along the same right of way.

Interstate transmission pipeline mileage has also been increasing, and miles of new pipeline were awaiting approval by the Federal Energy Regulatory Commission at the end of 2017. Local gas distribution companies have also been increasing the size and capacity of their distribution networks, extending the reach of service lines to add new households as customers. Over the last ten years, 95,000 miles of main distribution pipeline has been added in the U.S., an increase of 8%, and about 1.6 million residential users have been added, an increase of almost 3%. Today new residential gas customers are being added at the rate of about one per minute.1

3. Growth in Liquefied Natural Gas (LNG) exports. As a leading producer of LNG, Cheniere Energy has invested over $20 billion over the last five years constructing their LNG terminals at Sabine Pass and Corpus Christi with five trains expected to be operational by year end 2019.2 Dominion Energy also began investing in LNG and exporting LNG in early 2018 from its Cove Point facility. Sempra Energy and Freeport LNG are also investing in LNG terminals and expect to start exportation in mid 2019. As of January 2019, there were ten approved and 18 additional proposed LNG export terminals in the U.S.3

Investment Drives Earnings Growth

The significant increase in capital spending by gas distribution companies is driving earnings growth today. Many gas distribution companies have been citing capital spending on infrastructure projects as a contributing factor driving reported earnings growth over the last twelve months. These companies include New Jersey Resources, Vectren, ONE Gas, and Atmos Energy, all of which are holdings of the Hennessy Gas Utility Fund.

1. American Gas Association

2.Bloomberg

3. U.S. Energy Information Administration