Infrastructure Spending Drives Earnings Growth
Over the past decade, U.S. natural gas utility and pipeline companies have significantly increased investment in their infrastructure networks. We believe higher investment is a positive catalyst driving earnings growth for many natural gas distribution companies operating under rate of return (ROR) regulation.
The Infrastructure Network
The U.S. natural gas industry maintains a huge infrastructure network consisting of high pressure transmission pipelines, local distribution pipelines, storage facilities, processing plants, and liquefied natural gas (LNG) terminals.
Utility Regulation – A Return on Investment
Natural gas distribution companies operate under a rate of return (ROR) regulatory framework,which allows them to pass onto their customers, in the form of price increases, the cost of their investments, plus a rate of return typically between 8% and 11%. Effectively, the more a natural gas distribution company invests, the more it can earn.
Over the past 10 years, natural gas distribution companies have been investing significantly more than in previous decades, principally in their infrastructure network, laying the ground work for increasing earnings growth down the road. In fact, since 2006, total infrastructure spending by natural gas utility companies has risen almost 200%.
Spending on transmission pipelines (large diameter pipes that transport natural gas across the U.S.) has more than doubled while investment in local distribution pipelines (main and service lines that connect customers to their natural gas supply) has almost tripled from $5 billion to $13.4 billion.1
Spending has been driven by three major factors:
1. Pipeline safety and repairs. Increased investment on pipeline replacement and modernization began in earnest in 2011, following a series of serious pipeline incidents. New federal regulations prompted the local distribution companies to start major repair and rehabilitation programs and now 40 states have joined with the federal government to prioritize pipeline safety. For some companies, system integrity and replacement projects now account for over 70% of their total capital spending.
2. Significant growth in natural gas production. Growth in natural gas production over the past 10 years has pushed pipeline companies to increase the capacity of existing transmission pipelines by adding compressor stations along the line to boost pressure and by “looping” or adding another line along the same right of way.
Interstate transmission pipeline mileage has also been increasing, and miles of new pipeline were awaiting approval by the Federal Energy Regulatory Commission at the end of 2017. Local gas distribution companies have also been increasing the size and capacity of their distribution networks, extending the reach of service lines to add new households as customers. Over the last ten years, 171,000 miles of main distribution pipeline has been added in the U.S., an increase of 15% and just over 5 million residential users have been added, an increase of almost 8%. Today new residential gas customers are being added at the rate of about one per minute.2
3. Growth in Liquefied Natural Gas (LNG) exports. As a leading producer of LNG, Cheniere Energy has invested about $18 billion in their LNG terminal at Sabine Pass and expects to spend about $30 billion in total once a second LNG facility in Corpus Christi is completed.3 Dominion Energy also began exporting LNG earlier this year from its Cove Point facility. As of July 2018, there were nine approved and 13 additional proposed LNG export terminals in the U.S.2
Investment Drives Earnings Growth
The significant increase in capital spending by gas distribution companies is driving earnings growth today. Many gas distribution companies have been citing capital spending on infrastructure projects as a contributing factor driving reported earnings growth over the last twelve months. These companies include New Jersey Resources, Vectren, ONE Gas, and Atmos Energy, all of which are holdings of the Hennessy Gas Utility Fund.
1.American Gas Association
2. Federal Energy Regulatory Commission
3. U.S. Energy Information Administration
Investors should consider the investment objectives, risks, charges and expenses carefully before investing. This and other important information can be found in the Fund’s statutory and summary prospectuses, which can be obtained by calling 800-890-7118 or visiting hennessyfunds.com. Please read the prospectus carefully before investing.
Mutual fund investing involves risk. Principal loss is possible. A non-diversified fund, one that may concentrate its assets in fewer holdings than a diversified fund, is more exposed to individual stock volatility than a diversified fund. Investments in foreignsecurities may involve political, economic and currency risks, greater volatility and differences in accounting methods. Investmentsare focused in the natural gas distribution and transmission industry; sector funds may be subject to a higher degree of market risk.
Earnings growth is not representative of the Fund’s future performance.
As of 6/30/18, the Hennessy Gas Utility Fund held 4.79%, 4.96%, 1.36%, 1.81%, 2.11%, and 4.99% in net assets of Cheniere, Dominion Energy, New Jersey Resources, Vectren, ONE Gas and Atmos Energy, respectively. Fund holdings and sector allocations are subject to change and should not be considered recommendations to buy or sell any security.
The Hennessy Funds are distributed by Quasar Distributors, LLC.
© The Hennessy Funds
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