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9 July 2020

Dominion sells off, as shockwaves shake US gas industry

As environment groups across the US get up this morning, nursing hangovers from celebrating the end of the Atlantic pipeline dream from dual proponents Dominion Energy and Duke Energy, there is a feeling in the air that some kind of threshold has been passed.

For Dominium it was not enough to simply change its mind on the pipeline, take a hit on its quarterly numbers and draw a line under the whole episode, but it went the whole hog and sold off its natural gas business to Berkshire Hathaway for just under $10 billion, of which some $5.7 billion is assumption of debt.

Unfortunately this puts the assets in a pot with almost limitless cash, so there is no saying what Berkshire Hathaway will get up to with the assets, but let’s leave that aside for a moment. The deal includes gas transmission, and storage assets and Dominion says it will go through a strategic repositioning toward ‘pure-play’ state-regulated, sustainability-focused utility operations. There is safety in running a regulated utility, but typically less profit. It says it has adopted comprehensive net zero targets and that this will result in more profit.

We have been telling people that natural gas is anything but natural for the past few years, and that it hurts your earnings and the only major issue is spending on capex in the early years of the transition to renewables.

Dominion CEO Thomas Farrell raised earnings guidance and growth prospects, but says it will be the largest spend on capex, but the move will create a stronger balance sheet. If it is that obvious to Farrell now, when did he suddenly see the light?

He is one of those who is widely respected, and his opinion will sway others. If you add to that the voice of Lynn Good, CEO over at Duke, and if she also changes her position on renewables as now seems likely, that’s two of the most dissenting voices in the entire USA, among the major utility groups, which will no longer be holding out for fossil fuel based strategies.

Without cheerleaders like this, the resistance to zero carbon strategies will likely evaporate, and investors will no longer get conflicting messages from each side of the fossil fuel argument. Oh there will likely continue to be support for natural gas, for some time to come, and both of these spokesmen may weigh in with vocal support, but if you are only talking the talk, and not walking the walk, then who will listen?

Make no mistake people like these are not swayed with rhetoric, but by hard-nosed financial truths. The state of gas, as viewed on the fast approaching horizon, is not going to make the pipeline profitable, nor is its existing natural gas plant business going to disappear overnight either.

In its 2020 IRP Dominion makes it clear that it is still on the lookout for sites and equipment for the construction of gas-fired turbines.

Currently through 2019 it generated 96% of the energy it used, and some 17.7% was from coal, 40.3% from natural gas, nuclear 16.1% and just 3.2% from renewables.

That’s all going to change we suspect. Currently the Dominion IRP is expecting to trigger extensions for four nuclear plants and add 265 MW of solar, 970 MW of gas peakers, and 2.5 GW of wind plus a 300 MW pumped storage facility.

However it has more than one plan, and Plan B, as it is referred to in the IRP includes keeping as much nuclear and gas as it can, but adding 31 GW of solar capacity, 5 GW of offshore wind capacity, and 5 GW of energy storage. Is this the version of the plan that Dominion is now working towards?

Or is it Plan C of its four plan IRP, which says it retires all company-owned carbon-emitting generation by 2045, but then adds another 1 GW of incremental solar and another 4.8 GW of energy storage over and above Plan B. It says that in this plan it would be required to build out the company’s transmission import capacity to 10.4 GW in order to support winter import needs, and spring and fall export needs.

Given that Farrell says that over the next 15 years Dominion will invest $55 billion in emissions reduction technologies it might be plan C. Of course we must also plan for gas distribution line replacement and renewable natural gas (whatever that turns out to be, but we suspect that it means steam reformed hydrogen for home heat). That means that in 15 years Dominion will no longer be a major customer for the gas unit it has sold Berkshire Hathaway, unless that also makes a U-turn into hydrogen.

All of this will let Dominion increase long-term earnings guidance by around 30% – which really does beg the question, why on earth was it not doing this in the first place and why has it been left to a court to block the Atlantic pipeline to force the CEO’s hand?

Warren Buffett, chairman of Berkshire Hathaway, said: “I admire Tom Farrell for his exceptional leadership across the energy industry as well as within Dominion Energy. We are very proud to be adding such a great portfolio of natural gas assets to our already strong energy business.”

Just how Hathaway has valued this business. If it is on the basis of a gradual wind-down over a 15 or 20 year period, extracting his returns from that, this is fine, but if he simply has miscalculated the period of time for which gas can be price competitive, and he thinks he can run these assets forever, then he will lose money on this deal.

Berkshire Hathaway already owns large-scale natural gas infrastructure, but also utility PacifiCorp, which itself has recently begun to invest in energy storage and more renewable energy, at the expense of gas.

Our money would go on Dominion also using gas for some time to come, but as it gets more comfortable with renewables, it will find less and less need and make retirements ahead of the 2045 deadline, we’re sure of that.

Dominion will retain a 50% passive interest in Cove Point, a bidirectional LNG facility in Maryland. What it is selling includes 7,700 miles of natural gas transmission pipelines and 900 billion cubic feet of gas storage

The $4 billion in cash that this will generate is likely to be used to repurchase around $3 billion of stock and leaves just $1 billion over to go towards capex.

The Dominion transition really equates to one of political acceptance. It is the Democrat dominated state legislature in its home Virginia that has adopted the 100% renewables by 2045 rule and imposed it on its regulated utilities.

The 600 mile pipeline project across West Virginia, Virginia and North Carolina was the answer to all the cost issues associated with gas, as far as Dominion was concerned, and once it hit just one too many legal obstacles, it had to redo its sums, and see that a change of plan was necessitated.

Costs of the pipeline had blossomed from an initial estimate of $5.1 billion to over $8 billion.

But the continual pressure on the Atlantic pipeline, despite support from the Supreme Court lately, which squashed one objection, will send reverberations through the entire gas world. If the US cannot build the Keystone pipeline with Canadian interests on the other side of the country, then selling the immense amount of “fracked” natural gas that US interests hold, for much higher prices in the markets of Japan, Korea and China, will be just outside its reach. In particular Russia will be the likely benefactor. But while that dream is already outside of the US reach, it is also likely that it will soon be outside of Russia’s also.

This week a leading green research agency Global Energy Monitor has pointed out that Japan’s hopes of building a far east LNG center, a kind of stopping off port on the way to all countries in the Asia Pacific rim, is foundering, short of cash, with banks unsure of whether it is worth the $20 billion plus it will cost (see separate story in this issue).

Singapore has already achieved something similar, and considers its energy security to be based on its LNG Terminal which replaced undersea pipelines from Malaysia and Indonesia. But the scale required for Japan is significantly higher.

China has also talked about limiting its dependence on natural gas going forwards.

This is all part of the train of clues which points to all not being right in the world of gas – the Atlantic pipeline, the double edged sword of the low price of gas, great if you are buying, but insufficient to support profitably those who are selling – the generic push towards clean energy and the recent understanding that especially fracked natural gas, comes with huge upstream, uncounted methane leaks, which make it no cleaner a fuel than the coal it replaced.

You can also see that the transmission connection queues at all the ISOs throughout the US, are slowly reducing the amount of connections which are assigned to gas electrical plants. Gas knows that it is sick, and the failure of Duke and Dominion to make the Atlantic pipeline work financially, is a major tipping point for the entire industry.