- Despite enthusiasm for the electrification of heating and industrial processes, gas local distribution companies (LDCs) are not about to go extinct, a panel of investment bankers said Wednesday at S&P Global's Power and Gas M&A Symposium. But they also said there could be a shift in how the sector is owned and capitalized.
- Gas utilities as a group lost 17.3% of their share value in 2020, according to S&P, and the panel acknowledged the fuel is not viewed favorably right now. However, "the death of the LDC has been way overstated," said Jeffrey Holzschuh, chairman of Morgan Stanley's global power and utility group.
- Part of the lower gas valuation is related to an increasing focus on environmental, social and corporate governance (ESG) issues, including decarbonization, the panel said. Banks are increasingly considering ESG issues before financing energy company deals, making carbon reduction strategies one key to accessing capital at affordable rates.
Electric companies ought to be evaluating any positions they hold in gas LDCs "because they trade a little differently now," said George Bilicic, vice chairman of investment banking and global head of power, energy, and infrastructure, at Lazard.
That could lead to an increase in corporate transactions, he said, particularly as Lazard expects concerns around the gas LDC business to continue.
The electric utility sector has done a "great job of working with Wall Street banks on ESG matters," Joseph Sauvage, vice chairman and global head of the power group at Citi, said during the virtual conversation, which focused on shareholder activism.
Sauvage pointed to an ESG reporting template developed by the American Gas Association and the Edison Electric Institute, with input from member companies and banks. The panel discussed broader ESG pressures on electric and gas utilities from stakeholders such as banks, in response to pressure from shareholders and regulators.
Sauvage said he would break the stakeholder side of ESG concerns into two components.
"The first is simply credit implications, in terms of changing business models, the acceleration of coal retirements, and questions about the longevity of the gas LDC business in certain spots," said Sauvage "The banks' regulators are focused on the credit quality of their portfolios."
The second part, and more interesting for the sector as a whole, said Sauvage, is "how the stakeholders of those big Wall Street banks are approaching ESG," including carbon intensity and commitment to the Paris climate accord.
Every bank with a large finance and capital-raising business has adopted, or is in the process of adopting, policies on oil and gas exploration, coal and carbon, said Sauvage. Many electric utilities have committed to 2050 carbon neutrality, and banks face similar pressure.
"Banks are going to be under tremendous pressure to hit net-zero carbon neutrality in 2050," said Sauvage. "For U.S. companies, the question will be how their own targets ... correspond to the pressure that the banks are seeing from their regulators, also shareholders and stakeholders."
The influence of stakeholders and shareholders in the utility business is a net positive for the sector, said George Bilicic, vice chairman of investment banking and global head of power, energy, and infrastructure, at Lazard.
Utilities are probably "underappreciated in terms of their skill" in responding to stakeholder concerns, said Bilicic. "It's an emerging area, but its an area of strength for the utility industry given the ratepayer interfacing nature of the sector and the need to work in communities."
The impact of banks and other groups on utility policy is a relatively new phenomena, Holzschuh observed. When conversations on carbon began 20 years ago, utilities were most impacted by environmental groups and other non-government organizations.
"Now it's become mainstream," said Holzschuh, with pressure coming from shareholders, regulators, activists, banks and other groups. "It's here to stay, and we need to figure out if we can quantify its impact on shareholder value going forward," he said.
The growing impact of carbon issues was a factor in gas utility valuations last year.
While the value of gas utilities took a hit last year, in part due to storylines surrounding carbon and bans on natural gas, Bilicic said the LDCs are "an enduring business."
"There isn't a technology or solution that, is in our judgement, practical to displace the gas LDC business," Bilicic said.
There are opportunities to "supplement" what gas LDCs have traditionally done, through renewable natural gas and possibly through hydrogen, Bilicic said. But "the idea this business is going away is not an idea that we would subscribe to."
Howeverm, gas LDC valuation levels have been effected because of the uncertainty in the business, said Bilicic. "And we'd expect that to continue," he said, pointing to continued criticism of the fuel, concerns about growth prospects in new construction utilizing natural gas and the ability to convert new customers.
This has raised doubts in some quarters about the future of gas companies. A study earlier this year completed by environmental consulting firm Energy Innovation and corporate social responsibility group As You Sow concluded investment into new gas infrastructure like pipelines and power plants is "incompatible" with long-term shareholder value.
Nevertheless, "there is the potential for this business to be more in the hands of private capital," Bilicic said. "If there is a lot of noise in public markets around this business, and taking into account the total market cap focused on gas LDCs, you could see private capital winding up owning these businesses because of their enduring nature and their cash flow profile."
Holzschuh agreed, noting that historically valuation multiples for LDCs "may have been higher" due to the hope that high rates of return on gas assets would continue to be authorized by regulators. With less than a dozen large, publicly traded gas utility companies in the space, "we do believe as well that's likely to be consolidated," he said.