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Renewable natural gas may benefit climate, but unlikely to solve declining demand for gas utilities

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In this quarter’s market update, Eaton Vance’s Core Bond team points to expected increases in volatility throughout 2020 as short-term sentiment swings on new developments. Both monetary and fiscal policy will provide a level of support to fixed-income markets, but will also cause distortions, leading to both opportunities and the possibility for value traps.
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By John MillerVP and ESG Senior Research Analyst, Calvert Research and Management and Leah Moehlig, CFAESG Senior Research Analyst, Calvert Research and Management

Washington - As U.S. gas utilities consider the growing demand risk for their core product in a decarbonizing world, investment and joint venture announcements in animal-waste-to-biogas, or renewable natural gas (RNG), have grown. While RNG offers a comparatively lower total greenhouse gas (GHG) footprint when benchmarked against traditional natural gas (gas), reliance on RNG is a risky proposition. Rather, a prudent energy transition strategy would include consideration of RNG as one of multiple measures in preparing for a reduced gas demand future, while simultaneously compelling upstream suppliers to cut operational emissions, and investing in upgrades to existing infrastructure and technology - not expanding networks.

Premium valuation at risk?

Historically, sales volumes of gas to US residential and commercial customers has been consistent and predictable. This predictability, and the expectation that future results will be equally consistent, has encouraged investors to assign higher asset valuations to the gas utility sector compared to electric peers.

Calvert Blog 10-1a

However, as the full GHG footprint of the gas value chain becomes evident, risks to this historical predictability have emerged. In 2018, fossil fuel consumption by residential and commercial end users -primarily gas - resulted in the production of 583.3 million metric tons (MMT) of carbon dioxide (CO2) equivalent emissions, or 8% of all US GHG emissions. Emissions from gas systems themselves adds a further 175 MMT CO2 equivalent.1

Simultaneous to this growing gas sustainability risk, the efficiency and cost effectiveness of electric alternatives - primarily heat pumps - has increased. When powered by renewable generation, these electrical alternatives can offer a lower cost, lower carbon intensity product, than that offered via traditional gas.

Animal waste to pipeline gas

The implementation of RNG projects have the potential to both reduce GHG emissions and minimize overall environmental impacts related to livestock waste. In the US, anaerobic digesters using animal manure have seen the most investment attention. In anaerobic digestion, microorganisms' breakdown the organic material feedstock in an oxygen deprived environment. The process generates methane and waste CO2. Once upgraded, the methane can be injected into a utility's gas pipeline.

Calvert Blog 10-1B

The climate argument for RNG rests on its conversion of animal waste -- which would otherwise emit methane from the farm -- to CO2 when the RNG is consumed. Over a 100-year horizon, methane carries 25 times the global warming potential of CO2.2

While ample feedstock exists to scale RNG, cost remains a major hurdle. At a time when traditional gas costs are hitting 20-year lows below $2.00/MMBtu, regional cost projections for animal waste RNG ranges from $18.4/MMBtu to $32.6/MMBtu.3 Federal programs, such as the Renewable Fuel Standard, and state-level initiatives, including California's Low Carbon Fuel Standard which carries a ~$70/MMBtu incentive for animal waste RNG are critical in incentivizing production and consumption.4

Preparing for lower gas demand

Prudent energy transition strategic planning for gas utilities calls for the real consideration of a lower gas demand future. While the timeline will vary, the relative economic advantages of electric alternatives make an eventual transition likely.

Animal waste derived RNG can certainly play a meaningful role in this future decarbonized state, but utility projections indicating growing, or even flat, long-term demand trends increase the risk of stranded investments in underutilized infrastructure. In addition to exploring RNG and other low carbon gasses, best-in-class energy transition planning should include pressure on gas suppliers to cut their operational emissions, while focusing capital allocation towards existing infrastructure upgrades and the deployment of technology and meter systems to boost efficiency.

Bottom line: Through Calvert's ESG investment research framework, centered on financial materiality, we have identified a series of best practices that leading gas utilities are taking to strategically plan for a lower demand, decarbonized future. These practices include exploring low and zero carbon alternative fuels, applying pressure on upstream suppliers, and capital spending on existing infrastructure upgrades and efficiency related technologies.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.