This Utility Could Save Big Bucks With This Natural Gas Strategy

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Electric and gas utility Consolidated Edison (NYSE: ED) has a monopoly on one of the greatest markets in the world: New York City and its surrounding suburbs. The population of this vibrant northeastern city is projected to reach 9 million by 2040, up from around 8.6 million in 2017. That may not sound like a huge change, but the Northeast as a whole has seen a steady decline, as people leave for warmer southern climates. But this good news for Con Ed is also a big problem, because the utility doesn't have enough natural gas to satisfy current demand for the fuel, let alone the increase in demand that will come with an expanding population. Below, we'll talk about a small test it's doing that could have big results in helping it deal with the issue.

How big of a problem are we talking about?

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Historically, coal was the primary source of electricity in the United States and an oil furnace was the most common way to heat a home. However, a mixture of low natural gas prices and the cheaper construction costs of natural gas power plants has led to natural gas catching up to and overtaking coal over the past decade. Low prices and the convenience of no longer having to call for oil deliveries have also led customers to switch from oil to gas for heat. There's an environmental angle to this shift as well, since natural gas is cleaner burning than coal or oil, but the financial component is probably the more important factor.

Cheaper and cleaner is a great combination. However, the infrastructure needed to supply the Northeast region with natural gas has lagged behind demand. Essentially, Con Ed can't get enough natural gas to satisfy demand. To be truthful, it's not a big issue on a day-to-day basis. The problem shows up on peak demand days, when heating needs spike due to extreme weather.

To put some numbers on that, during the 2004-2005 heating season Con Ed had to buy roughly 5% of its gas from third parties. That number jumped to 17% in the 2017-2018 heating season and is projected to rise to 22% by 2023. Looking at that another way, by 2024 Con Ed estimates that its natural gas capacity will only cover 78% of its peak demand use.

The key thing here is that natural gas is a commodity, and when demand spikes, so do prices. In other words, when Con Ed most needs natural gas is exactly the point when natural gas is most expensive. The issue is so troubling that the company has openly asked for suggestions to help deal with the problem. And, in early 2019, it announced that it was going to stop converting customers to natural gas heat (meaning more customers will continue to rely on dirtier oil heating systems). This is a growth issue, since every customer it turns away is a customer it doesn't get to add to its system.

The small test that could yield big results

One way that Con Ed is trying to deal with the issue is by borrowing a playbook from the electricity market: demand response. When demand peaks, certain customers agree to reduce their use of electricity (or in this case, natural gas). To motivate customers to do this, the utility compensates the customers for the reduction in use. It's more complex than just turning off the lights (or the furnace), since in some cases it can involve shifting use to lower demand periods. Use also has to be carefully tracked to ensure compliance. However, the basics are easy to grasp and you can see how it would help Con Ed with the natural gas demand issue if customers agreed to pull back at times of peak demand.

Having received approval from regulators, Con Ed is planning to spend roughly $5 million on a pilot program. A little under $600 million is earmarked for meters, with another $1.6 million to cover administrative costs. The rest, roughly $2.9 million, is for incentive payments.

A $5 million investment, to be honest, is chump change for a company like Con Ed, which plans to spend an average of $4 billion on capital projects in each of the next three years. But if the demand response test works out, it could have a huge impact on Con Ed and its customers.

This relatively small test alone, if it achieves the projected reductions, could meet roughly 1% of the natural gas shortfall by 2023. That sounds like a tiny figure, but Con Ed sold $2.4 billion worth of natural gas in 2018. If it can reduce demand during peak periods, the savings could be quite large for its customers and indirectly for Con Ed.

Con Ed largely passes on fuel costs to its customers on the electric and natural gas sides of its business. It gets paid for the delivery of these things across its system. So, on some level, Con Ed doesn't need to care about the cost of fuel. Unfortunately, customers see the bill and blame Con Ed, not fully understanding the structure of their relationship with the utility. But the bigger problem is longer-term in nature. If Con Ed doesn't start to do something like this now, it may not be able to get natural gas when it needs it most -- price may not be the only limiting factor. If it can't get gas, the company would have to resort to rationing it at the worst possible times. That's a disaster scenario for Con Ed and its customers.

It's basically a problem that Con Ed can't allow to happen, since one of the things that regulators monitor is its ability to provide uninterrupted service. So, if Con Ed can't find ways to solve the peak demand issue, it will likely need to take matters into its own hands and pay to build new pipeline capacity to carry natural gas into the New York region. That capacity, however, will sit idle on most days, since peak demand is intermittent and generally only occurs during the winter months. That's a hugely expensive proposition.

To give some idea of the cost, the Williams Companies-backed and recently opened Atlantic Sunrise pipeline (which brings gas from Pennsylvania to the Mid-Atlantic region) came with a price tag of roughly $3 billion...to build just 200 miles of pipes. That's roughly $15 million per mile. Then consider that pipeline capacity generally has to be paid for regardless of whether or not it's being used (known as a take-or-pay contract) to ensure that it's there when you need it. Con Ed would clearly rather not pay for something it only uses once in a while. No wonder the utility is looking for alternatives.

Keep watching this issue

This small test isn't likely to make or break Con Ed as an investment. However, the long-term implications are material. Con Ed faces a very real problem with regard to natural gas access. And since it is already turning customers away, the impact is starting to hit today. If this demand response test works, it could save Con Ed a lot of money down the line -- particularly if it can be expanded. How much is hard to tell, but savings for things like not having to support unused pipeline capacity or build new pipelines could add up to a huge number. Moreover, customer satisfaction from such a move could help build positive regulatory relationships for the company. If you own Con Ed, keep a close eye on its efforts to offset peak demand use, including things like this seemingly tiny demand response test. It could be bigger than it looks.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.