EXECUTIVE SUMMARY
- Given anti-natural gas rhetoric continues to grow from certain politicians and most environmentalists, we are updating our “at risk utilities” report from July 2020 and the good news for bondholders is there is very little exposure for bond investors outside of SoCalGas long bonds. Most gas utilities have very small maturities (3% of the LUAU index is pure-play gas companies) that are not index eligible. $3.1 bn, or 63% of total SoCalGas (under the Sempra umbrella of utilities and the largest gas LDC in the U.S.) bonds are 2030+ maturities where we do see some long-term ratings risk, especially if the agencies accelerate their ESG initiatives.
- On the equity side, the gas LDCs continue to trade at a significant discount to electric utilities (currently at 15.5x consensus 2022E P/E vs 19.5x, respectively) and this discount first emerged last summer right after now President Biden announced his clean energy plan. The current 4x discount is close to two full turns above the average since the beginning of 2020. This discount reflects the country heading towards a zero-carbon / “electrify-everything” future, and that gas utility earnings might have peaked and growth will be much more challenged going forward.
- For utilities, we view the pure-play gas distribution companies as the most at-risk from the continued push towards electrification vs the vertically integrated names (or names with a mix of electric and gas T&D operations) as certain states/cities (particularly along coastal states) have been steadfast on electrification and in some cases like in Berkley CA have been successful in banning gas hookups for newly constructed buildings. If we continue to see more of these types of natural gas bans, the risk is the gas LDCs will begin to see fewer deliveries to spread significant fixed costs over and this could lead to significant ratings/earnings risk. We provide a helpful visual in this report provided by S&P Capital IQ showing which states that have either adopted or are proposing these gas bans.
- The Bloomberg Barclays U.S. IG Utility index has a $570 billion market value with ~$17 billion (or 3%) coming from the pure-play gas LDC bonds which consist of the following handful of tickers: ATO, NFG, NJR, NWN, OGS, SJU, SR, and SWX. A significant portion of these gas LDC bonds are not index eligible with many outstanding bonds below the $300 million threshold but for the sake of this note we are including all of these bonds. In reality the percentage of pure-play gas LDCs is closer to just 1% when including only the index eligible notes.
- CreditSights views this anti-gas pushback as more of a medium to longer-term risk so we focus on the longer dated pure play LDC bonds in this note and found the widest names (average rating of A) trading at a bid OAS of +130 vs the regulated electric opco average for long bonds (average rating of A/A-) at +100, so investors are being compensated ~30 bps for taking on this longer-term gas LDC risk which we view as fairly priced. It is important to clarify that we are comparing the gas LDC names to the utility opcos and not the holdcos given most of the LDCs have very simplified cap structures (i.e. ATO, OGS) with minimal subsidiaries/less subordination risk, similar to the opcos. The average bond size for the LDCs is ~$300 million vs $500 million for the opcos so less liquidity could be a partial driver in this spread differential.
- We have a more cautious view on the pure-play gas LDCs from an ESG perspective relative to their electric peers due to this anti-gas sentiment and higher exposure to natural gas/lack of diversification away from it but this is not to say we would avoid the names altogether just on ESG concerns. We point out that just a few years ago gas LDCs were trading at premiums to electric utilities as investors viewed the subsector as a more attractive avenue for rate-base growth via gas pipeline replacement & safety programs.
- We continue to monitor/are highly cognizant of the current elevated natural gas price environment with the twelve-month natural gas strip price up over 65% YTD at $4.35/MMBtu (highest level since 2014) which in theory makes rate increases/rate-base growth opportunities more difficult and could lead to a near-term impact on customer bills but our primary concern for the gas LDCs remains an ESG one due to the reasons mentioned above. It is also worth pointing out that gas LDCs dealt with $5+ natural gas prices from 2002-12 and we never saw a credit rating impact as these are clearly a pass-through and with forward prices below this $5 range we are not overly concerned. Additionally, when gas prices spiked to $100+ from the TX storms this past February the regulators allowed for securitization and other bill smoothing mechanisms.
