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Gas utility M&A shakes up pipeline upgrade work, revenue streams

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Gas utility M&A shakes up pipeline upgrade work, revenue streams

Dealmaking in 2018 shook up an annual ranking of the natural gas utilities most actively repairing pipeline leaks, underscoring how companies view acquiring and replacing aging infrastructure as a viable path to rate expansion and revenue growth.

The 10 companies with the highest ratio of gas leak repairs to pipeline miles continue to be located mostly in the Northeast and mid-Atlantic, according to an analysis by S&P Global Market Intelligence. Safety concerns over obsolete pipeline materials and a number of deadly explosions in recent years have spurred utilities to fast track pipe replacement programs and accelerate deployment of leak detection technology.

One of the biggest changes to the annual ranking was the appearance of Elizabethtown Gas Co. in the top 10. The debut follows Southern Co.'s $1.7 billion sale of the Union, N.J.-headquartered utility and Maryland's Elkton Gas Co. to South Jersey Industries Inc., or SJI, in 2017.

The nearly 165-year-old company's arrival at number 4 also explains the absence of perennial top 10 finisher Pivotal Utility Holdings Inc. The Southern Co. subsidiary was essentially dismantled after SJI bought Pivotal's Elizabethtown and Elkton assets and NextEra Energy Inc. acquired its Florida City Gas business.

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New top 5 entrant extends robust replacement program through M&A

Elizabethtown Gas repaired 3,549 leaks in 2018, representing a repaired-leak ratio of 0.65 along nearly 5,500 miles of distribution mains and service lines. That was higher than any annual ratio attributable to Pivotal Utility Holdings going back to 2013, when S&P Global Market Intelligence first analyzed data from the U.S. Pipeline and Hazardous Materials Safety Administration for utilities with at least 5,000 miles of pipeline.

SJI had already been investing heavily in pipe replacement in its existing service territory in southern New Jersey when it struck the Elizabethtown Gas deal. Because of those investments, SJI expects to complete bare steel and iron pipe replacement in its legacy service territory, where it operates as South Jersey Gas Co., by 2021.

The acquisition gave SJI the opportunity to tee up continued revenue growth by replacing the iron pipes and unprotected steel lines that make up 8% and nearly 1%, respectively, of the Elizabethtown Gas system. That opportunity was particularly attractive to SJI because the assets were within a state where the utility already had experience executing an accelerated replacement program.

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"When [SJI] evaluated the acquisition they saw that Elizabethtown Gas still had a significant amount of replacement work needed," Christie McMullen, president of Elizabethtown Gas, said in an interview. "That really ... created an opportunity to take the best practices that are there at South Jersey Gas for infrastructure replacement processes, to apply that in a regulatory environment that they were familiar with operating in."

The New Jersey Board of Public Utilities in June authorized Elizabethtown Gas to replace 250 miles of pipeline and make other system upgrades at a cost of $300 million. SJI is negotiating with the board for a $65 million base rate increase to cover the cost of the improvements.

Despite its divestment from Elizabethtown Gas, Southern Co. is nevertheless represented on this year's list through its subsidiary Virginia Natural Gas Inc. The Virginia Beach-headquartered utility broke into the top 10 in 2018 with a leak-repair ratio of 0.43.

Virginia Natural Gas and Southern Co.'s Illinois subsidiary Nicor Gas both have rate riders that allow them to quickly recover capital expenditures from programs to replace cast iron, bare steel and older plastic infrastructure or expand gas distribution systems, the company noted in its 2018 annual report. Southern Co. expects to spend $408 million on these programs in 2019.

Climate activism impacting pipe upgrade attitudes

As utilities continue to aggressively tackle gas leaks, climate activists are focusing more squarely on sidelining natural gas, the cleanest burning fossil fuel but still a major contributor to global warming, and potentially crimping demand and eliminating some opportunities to repair infrastructure.

Bloomberg Philanthropies announced the Beyond Carbon campaign in March to build on its work reducing U.S. coal consumption and begin shrinking the role of oil and gas in the nation's energy mix.

Berkeley, Calif., adopted a ban on new natural gas hookups in July, and similar measures are being considered in other cities. Most of the statutes under consideration would impact the Golden State, but analysts said cities with ambitious climate goals and aging pipeline systems are also among the most likely to consider similar measures.

Local lawmakers in Massachusetts' Brookline, Cambridge and Lexington communities already plan to introduce Berkeley-style gas bans. Brookline and Lexington are serviced by National Grid PLC subsidiary Boston Gas Co., which had the sixth highest leak-repair ratio in 2018. About one-third of Boston Gas' system is still comprised of unprotected steel and iron pipe, leaving ample opportunity for revenue-boosting replacement.

There is also a push for building electrification underway in Philadelphia, where questions about the financial viability of Philadelphia Gas Works Co. have been swirling for years. The nation's largest municipal gas utility had the second-highest leak-repair ratio for the sixth year in a row, as it faces persistent pressure from state regulators to address a lengthy backlog of leaks.

Philadelphia Gas Works still has the lowest percentage of plastic pipeline and the highest percentage of iron and unprotected steel in its system among the top 10. Corrosion on its pipelines accounted for nearly 40% of leak repairs in the system.

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Across the top 10, corrosion and problems with equipment such as pipe fittings and valves continued to be the top causes of leaks, on average each accounting for about 30% of the leaks companies tackled. The percentage of equipment-related issues among the top 10 was up significantly from last year and just edged out corrosion as the most prevalent cause of leaks repaired in 2018.

Safety concerns keep leak detection on the front burner

Few industry analysts expect gas bans to spread like wildfire, and the Berkeley statute only impacts new buildings, leaving opportunities to replace pipelines that serve existing customers. Meanwhile, fatal explosions on distribution systems in major U.S. cities have kept pipeline safety top of mind among ratepayers and regulators.

Consolidated Edison Co. of New York Inc. once again topped the list, a position it has held since 2014 when a deadly blast in New York City's Harlem neighborhood prompted the company to shore up its gas leak detection efforts.

In 2018, the Consolidated Edison Inc. subsidiary reduced the percentage of unprotected bare steel to just under 19%, knocking a full percentage point off the 2017 total and keeping with the pace of the last several years. Iron pipes accounted for just over 13% of its system, down about half a percentage point year over year.

Overall, the ConEd utility's leak-repair ratio climbed to 1.62, one of the highest on record for its 12,351-mile system. ConEd's 2018 capital requirements for its gas operations surpassed $1 billion in 2018 and are projected top $1.1 billion in 2020. It plans to replace 100 miles of pipe per year in 2021, up from more than 90 miles in 2018 and 80 miles in 2017.

The list of companies with the lowest leak-repair ratios was once again dominated by companies with systems comprising entirely or mostly modern materials that are less likely to leak. Many of those are located in the Midwest and western U.S.

Portland, Ore.-based Northwest Natural Gas Co., which only transports gas through plastic and cathodically protected steel pipes, repaired just 804 leaks along its 23,824-mile system, posting the lowest ratio at 0.03. Companies among the bottom 10 with some of the highest percentages of leak-prone pipes, including West Texas Gas Inc. and New York State Electric & Gas Corp., continued to strip unprotected steel and iron mains and lines from their systems in 2018, driving the percentage of their pipeline mileage comprised of those materials into the low single digits.

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But recent regulatory reviews in New York show that there are still risks, even when using modern materials such as plastic. ConEd, along with National Grid subsidiary Brooklyn Union Gas Co. — which had the seventh highest leak-repair ratio in 2018 — face potential fines over allegations they failed to properly oversee the work of contractors who hired unqualified plastic pipe fusers to complete New York gas pipeline projects.

Rapid deployment of leak detection technology can also create challenges for gas utilities. Dallas-based Atmos Energy Corp. reported second-quarter operating costs rose faster than anticipated as the company hired additional workers to process leak detection data and dedicated more time to processing unfamiliar information streams. Like ConEd, Atmos ramped up spending on pipe replacement following a deadly 2018 blast in Dallas.