As some gas utilities invest in RNG production projects, others may be sellers

Renewable natural gas asset values are leaving utility operators with a question: buy, sell or hold?

At the start of 2024, utility companies continued to invest in facilities that produce the alternative fuel. The activity showed that renewable natural gas (RNG) deals among deep-pocketed investors and energy giants have not dissuaded utilities from expanding into RNG production.

But the strong asset valuations that threatened to sideline cost-conscious utilities are also fueling speculation that some early investors will consider selling their RNG production assets. The twin headwinds of inflation and rising interest rates have also forced gas utilities to scrutinize capital spending, raising questions about RNG investment plans.

The RNG market continued to grow in 2023, supported by US and California renewable fuel standards, DTE Energy Co. Chairman and CEO Jerry Norcia said during a Feb. 8 earnings conference call. The number of operational RNG facilities in North America reached 300 in July 2023, up from 30 in 2011, according to the advocacy group RNG Coalition. RNG prices also strengthened in the back half of 2023, DTE CFO David Ruud told analysts in November 2023.

For gas utility owners, investment in RNG production provides a path to achieving methane emission reductions. RNG facilities capture and utilize methane that farms, landfills and other waste sources would otherwise vent into the atmosphere.

On Feb. 1, Black Hills Corp. became the latest gas utility operator to announce an investment in RNG production infrastructure. Acquiring a landfill RNG facility in Iowa provided a growth opportunity along with the ability to deliver sustainability and economic benefits to the company's service territory, said Katie Fleming, chief sustainability officer and director of strategic planning and communications for Black Hills' utility business.

"We're taking a three-pronged approach to our natural gas sustainability strategy — to operate a net-zero emissions distribution system, help customers reduce their footprint through energy efficiency and voluntary programs and to advance lower-carbon fuels," Fleming told S&P Global Commodity Insights in an email.

Black Hills joins buyers' club

Black Hills Energy Renewable Resources LLC (BHERR) struck a deal with Dubuque Gas Producers LLC to acquire RNG production infrastructure and rights at the Dubuque Metropolitan Area Solid Waste Agency's landfill in Iowa for an undisclosed price.

The facility started operations in 2021 and injects RNG into the gas grid operated by Black Hills Iowa Gas Utility Co LLC. A third party purchases the fuel, as well as credits representing its environmental benefits, on a long-term contract.

The facility produced 125,000 MMBtu of RNG in 2023 — enough to heat more than 1,800 homes a year — and has the potential to more than double its output, Todd Jacobs, senior vice president for growth and strategy at Black Hills Corp., told Commodity Insights.

Black Hills formed BHERR in 2022 to evaluate RNG infrastructure investment opportunities, focusing on projects with long-term offtake agreements, stable revenue streams and investment returns equal to or better than those in its utility business.

Jacobs previously said BHERR could leverage Black Hills' experience linking up its own utility infrastructure with RNG facilities to build interconnections and biogas purification hubs for other companies. Black Hills planned to complete four interconnections in 2024, bringing its total to 10.

"The way that I like to characterize this is that it's really a confluence of opportunity with our geography. We live and operate in very much agriculture-rich areas," Jacobs said during a Feb. 8 conference call. "There's a lot of interest from other utilities and other producers within our service territory for these types of assets."

Gas utility investments continued in 2023

These nonregulated projects allow Black Hills to participate in a "more lucrative" part of the RNG value chain, Jacobs said. Other gas utility operators are also chasing that opportunity.

In 2022, Chesapeake Utilities Corp. purchased a company that makes RNG from poultry waste and began construction on a Florida RNG production facility in 2023.

Northwest Natural Holding Co.'s first RNG supply investment through its nonregulated subsidiary recently entered the commissioning phase. Its Northwest Natural Gas Co. utility also received approval to invest in two RNG facilities through an Oregon regulatory framework.

UGI Corp. also continued to form RNG production partnerships and bring facilities online in 2023. However, mounting problems in the company's propane business prompted a strategic review and cost-cutting measures.

Analysts ask whether UGI will hit pause

Some analysts have speculated that UGI will pare back its plan to invest $1.25 billion in renewable gas ventures. The company had committed more than $500 million as of May 2023, mostly for RNG investments.

"We do not expect UGI to expand the scope of its renewables investments beyond the $500 million committed capital in the near-term," Mizuho Securities USA analyst Gabe Moreen said in a Nov. 17, 2023, research note.

Renewable fuels are part of UGI's "three R's" strategy, along with generating reliable earnings and rebalancing its business mix toward its gas segments. The company has not revised its long-term strategy, but the strategic review is not yet complete, UGI CFO Sean O'Brien told analysts during a Feb. 1 call.

Interim CEO Mario Longhi said the company is "taking actions that realign cost base to the underlying business" and "allocating capital to segments that have a solid track record of providing attractive returns."

Sellers' market

As Dominion Energy Inc.'s business review nears completion, analysts have speculated that the company could sell its stakes in RNG production facilities at dairy and swine farms.

For years, analysts have regularly quizzed DTE about the potential to sell its unregulated DTE Biomass Energy Inc. unit, which does business as DTE Vantage and holds a portfolio of RNG production facilities. In response, Norcia has consistently said the portfolio yields strong returns, generates cash flow that funds utility operations and supports DTE's emission reduction target.

In November 2023, energy financing news site PeakLoad reported that DTE was readying the RNG assets for sale, according to Guggenheim Partners. The assets could support a $2 billion or more enterprise value transaction, Guggenheim said in a Jan. 22 research note.

A sale is not "imminent at this time," Norcia recently told analysts. DTE is happy with the assets but is always looking for opportunities to create shareholder value through portfolio optimization, he said.

DTE currently does not have incremental cash needs in its capital plan, Norcia said. The company would use proceeds from any sale to offset debt issuances or buy back stock, he said.

RNG project returns in flux

In 2023, DTE Vantage placed three RNG facilities into service and posted operating earnings of $153 million, up $60 million from 2022, Ruud said.

As competition for RNG assets heats up, DTE has seen unlevered, pretax rates of return for RNG projects slip from the high teens to low double digits, company leaders said. Returns remain strong for RNG projects that convert equipment previously used to collect and combust biogas for on-site power generation, Ruud said.

The Inflation Reduction Act's Section 48 investment tax credit (ITC) for clean energy technologies could support RNG project returns, Norcia said. However, the US Treasury Department's recent guidance for the ITC was not consistent with congressional intent, he said.

The Treasury's guidance said the ITC does not apply to cleaning and conditioning equipment, which RNG producers use to upgrade biogas into pipeline-quality fuel. DTE is not overly concerned by the guidance, but it is participating in the public comment period, Norcia said.