As U.S. gas utilities report billions of dollars in natural gas purchase costs during February's deep freeze, analysts and executives say the industry has never faced a cost recovery challenge quite like this.
The initial gas cost estimates are "astronomical and unprecedented" enough to complicate the funding and timing of any type of cost recovery, Mizuho Securities USA LLC analyst Gabriel Moreen said in a recent research note. While Mizuho was initially confident the impact on gas distributors would be limited, Moreen said the firm now sees potential for longer-term impacts. The cost recovery mechanism that policymakers ultimately approve will play a major role in determining the magnitude of those impacts, the analyst said.
Consensus is emerging among gas utility leaders and equity analysts that securitizing the costs would be the simplest and best solution for companies and ratepayers alike. Under this model, companies would issue bonds to finance storm-related gas purchase costs. Some state commissions have already authorized utilities to record those costs in a regulatory asset. They will later determine whether those recorded costs were reasonably incurred and accurate, before setting a schedule for recovering them.
One Gas Inc., which reported $2.2 billion in gas costs, is working with state policymakers and regulators to develop legislation allowing gas utilities to securitize the regulatory assets, Senior Vice President and Chief Commercial Officer Curtis Dinan said on a Feb. 26 conference call. He characterized the conversations as "very positive" but cautioned that the situation is unprecedented.
"Historically, you've seen [securitization] in different parts of the country primarily related to electric utilities that have dealt with different storm costs," Dinan said. "There hasn't been, that I'm aware of, situations that would apply to a gas utility similar to that until this most recent event."
Securitization seen as likely
The Public Utility Commission of Texas, which regulates electric utilities, can use securitization to address storm-related costs, but state law does not grant the same authority to the Railroad Commission of Texas, which oversees gas distributors, according to Moreen. However, the analyst noted that Texas legislators were responsive to calls to accommodate securitization in 2006 following Hurricane Rita and in 2009 following Hurricane Gustav.
Given the magnitude of the gas purchase costs, Moreen believes lawmakers will allow some degree of securitization. For context, in 2019, the Texas PUC allowed AEP Texas Inc. to securitize about $229 million in electric distribution system restoration costs after Hurricane Harvey, he noted. Atmos and One Gas face expenses that could be 10 times greater, he added.
By Moreen's calculations, Atmos' guidance for storm-related expenses exceeded its total gas costs over the past nine quarters, while One Gas' forecasted cost equaled nearly all of its purchase costs over the last 15 quarters.
On March 1, Atmos Energy Corp. narrowed its cost estimate from as much as $3.5 billion to a forecast $2.5 billion, making it more manageable to digest through liquidity, debt and an existing equity program. In a March 1 report, UBS Group AG equity analyst Aga Zmigrodzka expected investors to cheer the revision, and said a decision on securitization could be constructive for Atmos' recently downgraded credit ratings.
Atmos' disclosure that roughly 95% of the extraordinary costs were related to Texas operations could also be positive if the state moves swiftly to allow securitization. Similarly, CenterPoint Energy Inc. said $1.25 billion of its $2.5 billion in estimated gas purchase costs were linked to Texas operations.
Making due without securitization
If policymakers decide against securitization, they will face the challenge of establishing a cost recovery mechanism that does not substantially alter utilities' capital structure or leave them with more bad debt, Moreen said. Companies would likely try to avoid issuing new equity or using financing options that produce a long-term impact on their capital structure, he added.
Those options could lead to stock price dilution and lend the impression that regulators are allowing utilities to earn a return on equity linked to gas purchase costs. That could open a "can of worms," Moreen said. Regulators require utilities to pass on gas costs to customers at no markup.
Asked whether One Gas could simply roll forward its term loan, Dinan noted that One Gas must not only account for the astronomical gas purchase costs but also the cost of carrying that expense. Securitizing those costs would offer more clarity into recovery and would not require utilities to change how they capitalize their business, Dinan said.
Moreen did see a path for regulators to pursue a more traditional recovery approach while avoiding problematic outcomes. Regulators, who typically consider debt and equity levels in determining a utility's allowed return on equity, could let gas distributors deploy more debt without penalizing them in regards to allowed ROE, he said.
However, regulators would have to thread the needle to get the timing right. The magnitude of the excess gas costs may be a reason not to try to recover them too quickly, Moreen said. While accelerated cost recovery is ideal, it could cause companies' bad debt expense to blow out, since customers would face steeper monthly bills that they might be unable to pay, he noted. That would only add to unrecoverable past due amounts, which have crept higher during the COVID-19 pandemic.