In my
last post, I finished off by introducing the two local natural gas distribution
companies (LDCs) here in New Hampshire that deliver natural gas to residential,
commercial, and industrial customers through their distribution networks. As a
reminder, I again present the map below which shows the service areas of these two LDCs.
Source: NHPUC
The first and largest of the NH LDCs, with
about 89,000 residential, commercial, and industrial customers as of 2012, is
EnergyNorth which does business under the Liberty Utilities umbrella. Liberty
Utilities has the franchise for the distribution of natural gas up the
Merrimack corridor to the Lakes region—where they tap into a branch of the
Tennessee Gas pipeline—and the tiny Berlin “island”, where they draw off the
Portland Natural Gas Transmission System Pipeline that crosses the northern
part of the state. EnergyNorth was, for many years, a standalone natural gas
distribution company, but has recently been through several ownership changes.
In 2000, it was acquired by Keyspan. In 2006, National Grid, a UK utility
company, acquired Keyspan. National Grid then sold EnergyNorth to Liberty
Utilities in 2012. Liberty Utilities is itself part of a much larger,
multifaceted energy company, Alqonquin Power and
Utilities Corporation. Alqonquin owns hydroelectric, wind, and solar
generating facilities, and well as water, natural gas, and electricity
distribution businesses in the US and Canada. Alqonquin Power and Utilities is
headquartered in Oakville, Ontario, and is listed on the Toronto Stock
Exchange. Liberty Utilities also has a smaller business distributing
electricity to about 43,000 customers in the west and south regions of NH.
The other natural gas LDC is Northern Utilities, which
operates under the Unitil name. This is a smaller natural gas and electricity
distribution company with operations in Maine, NH, and Massachusetts. In NH,
their gas distribution business is limited to the sea-coast area where they
draw of the Granite State Gas Transmission pipeline which runs up the coast to
Portland, Maine. In 2012, they had about 30,000 natural gas
customers. Northern Utilities Company has also been through many ownership
changes. It was purchased by Bay State Gas in 1979, which merged with NiSource in 1999. NiSource then
merged with the Columbia Energy Group in 2000 and, in 2008, Northern Utilities was
purchased by Unitil. Like Liberty Utilities, Unitil is also in the electricity
distribution business in NH. Unitil
is a publically traded corporation listed on the NYSE and is headquartered in
Hampton, NH.
There are two aspects to the business of the LDCs. The first
is creating and operating the natural gas distribution pipeline and the other
is providing the gas that the customer uses. This is the reason that NH natural
gas users are charged separately for natural gas distribution services and for
the natural gas commodity itself (see Jumping
Jack Gas for a typical breakout of a NH natural gas bill). Establishing and operating a gas distribution network
is a complicated, expensive, and highly
specialized business so these utilities have the sole right to distribute
natural gas in a specified area - a monopoly - on condition that it is done
cost-effectively, safely, and that the service is reliable. As a consequence of
the monopoly awarded to these companies, they are tightly regulated by the New
Hampshire Public Utilities Commission. (For a primer on public utilities, see What’s
It All About, Alfie?)
In NH, the natural gas business is partially
deregulated. Only the large industrial and commercial customers can choose
their natural gas supplier from competitive suppliers. Residential users have
no choice and are obligated to purchase their natural gas from their local distribution
company. The LDCs therefore distribute natural gas supplied by others in the
case of commercial industrial customers or supplied directly by themselves
directly for residential customers.
Operating a natural gas distribution company is a
challenging business. As we were reminded again by the gas explosion in New
York last month that killed eight people and leveled two buildings, handling,
transporting, and safely delivering a combustible fuel takes special technology
and unique precautions. When the pipelines leak and the leaks go undetected or
unreported, the consequences can be disastrous. The LDCs have a safety-first
approach and are very concerned about running a safe distribution system. They
react rapidly to reports of natural gas leaks. We, as citizens, also bear some
responsibility for natural gas safety and we should promptly report leaks when
we smell that distinctive natural gas smell. All excavation projects, including
simple home projects like planting trees and shrubs, should be first cleared by
a call to the Dig Safe hotline at 811 so that they can come out and mark where
your utility lines run. Nothing quite spoils a gardening or home construction
project like puncturing a natural gas line: you really don’t want to be that
guy who caused the whole neighborhood to evacuate on a Sunday morning!
Source: Flickr - Eugene Peretz
One of the prevailing safety issues is that the original gas
distribution piping was made of unprotected cast iron or bare steel buried
underground. After years of underground exposure, these pipelines slowly
corrode and, in areas where soil moisture is high or the conditions are highly
corrosive, corrosion can be severe and leaks can occur. The picture below shows
a piece of highly corroded pipe removed from a natural gas distribution network
in NH. The LDCs have active programs in place to replace steel pipe with newer
and safer high tech plastic piping, but this is an expensive endeavor with
costs of the order of $1.5 million per mile. Over the years, the utilities have
replaced a great deal of their networks with plastic distribution pipelines. The latest
pipeline report indicates that only 155 miles (8.2%) of the 1875 miles of
piping in NH is still made of iron. Compare this
to NYC, where 60% of distribution mains are
still made of cast iron or bare steel and where some of the lines are over 100
years old.
These LDCs are an important component of the business infrastructure for NH and, like all other businesses, they are looking to grow and to earn a return on their investment. However, they face some unique challenges. From my research and discussions with some of the LDCs and other folks who have been in the natural gas business for a long time, I got an improved understanding and appreciation for their business and challenges. Here are some of the interesting things I have learned:
- LDCs make their money from the distribution of natural gas and not from the sale of gas. The natural gas is passed through to their customers on a dollar-for-dollar basis. They are not allowed to mark up the price of natural gas that they purchase and resell. In the case of commercial and industrial customers, they simply transport gas provided by a competitive supplier.
- Because the LDCs are regulated utilities with a monopoly in their service area, any rate changes to their services need to be approved by the regulators at the NH Public Utilities Commission.
- In the rate-setting process, several factors are taken into account, the key one being the investment the LDCs have made in distribution equipment and facilities (pipelines, compressor stations, trucks, etc.) as well as the working capital used to operate their business. These investments are collectively known as the rate base. Expenses such as payroll, administration, and taxes are also taken into account. Because LDCs are for-profit business, they are allowed to earn a return on their distribution services, however, the rate of return is capped by the regulators, and is typically in the range of 9 to 10% on the equity invested.
- Rate-setting is a complicated business and rate cases presented by utilities are expensive and lengthy endeavors requiring a great deal of review and analysis by both the LDC and the regulators.
- Growing the natural gas distribution business is expensive and challenging. The reasons are complex, but an important aspect is that within the networks, the LDCs have already been very successful in signing up natural gas customers. In their service areas, which is considered to be within 100 ft of natural gas main, the LDCs have already signed up about 80% of potential customers. This significantly limits potential growth in their customer base from within their existing distribution network. Growth needs to come from expanding the network.
- At the same time as the natural gas utilities are trying to grow their businesses, there is a negative impact on natural gas usage due to energy-efficiency measures in homes and the “natural” turnover and replacement of aging heating units, such as dryers and stoves, to more efficient units.
As
public utilities, the LDCs are required to submit annual reports to the NH
Public Utilities Commission. These reports make for compelling reading. Here
are some interesting details that I gleaned from an examination of the 2012
annual reports (2013 reports are not yet available):
- These are capital-intensive business with profitabilities of the order of 5%.
- Revenues per customer are ~$900 per year and net income per customer is only about $50/year, which is not a great deal.
- The bulk of their costs are associated with the purchase of natural gas (about 60% of their overall expenses).
- Other costs include typical operations and maintenance costs, depreciation, administration and debt service expenses.
- The LDCs keep a small supply of liquefied natural gas at storage facilities on hand to assist with supply shortages. Some will even use propane when natural gas is in short supply and some LDCs have even purchased storage capacity at underground storage locations located in other parts of the US to ensure gas supply during periods of high demand.
A question often asked is why the natural gas utility cannot
provide natural gas to your home. The main reason is that there may not be a
natural gas main pipeline nearby. The service area for a natural gas company typically
lies within 100 ft of a mainline: anything further becomes too expensive. Expansion
of service area by the laying down of new distribution piping is expensive and
consideration must be given to the costs of pipeline extensions, housing
density, and the probability of signing up new customers. Moreover, regulators
are very sensitive to the “socialization” of expansion plans so they do not
want network expansion plans funded by rate increases for existing customers.
New pipelines, which cost about $1 million per mile, have to be paid by new
customers. As noted earlier, the income per natural gas customer per year is
low so capital recovery and return on investment requires a very long period. It
is for this reason that expansion in natural gas service areas is a slow,
measured, and carefully evaluated process.
In my next post, I will take a closer look at retail natural
gas pricing in New Hampshire, which turns out to be a fairly complicated
matter.
In the meantime, remember to turn off the lights before you
leave the room and call Dig Safe at 811 before starting to dig.
Mike Mooiman
Franklin Pierce University
mooimanm@franklinpierce.edu
[*Pipeline – A great 1960’s surf music instrumental by the
Chantays. I have always have loved the way this tune kicks off with that
distinctive riff. You just know there are good things to come. Here is Pipeline, covered by Stevie Ray Vaughn
and surf guitar god, Dick Dale.]
