Addressing climate change has become an increasingly urgent topic of discussion globally, and many countries have moved to reduce their greenhouse gas emissions significantly. In the U.S., the president’s April 2021 announcement of a goal to reduce greenhouse gas emissions to half of 2005 levels by 2030 provides a direction for federal policy. Several states have taken more significant actions, including setting targets for emission reductions by 80% or more in New York, California, and Massachusetts within the next 30 years.
Emission reduction targets may have profound effects on a variety of industries, including transportation, manufacturing, power generation, and residential heating. While it is uncertain how and to what extent each sector will be affected, natural gas utilities could be impacted. Changes could range from modifying distribution systems to incorporate other fuels to the migration of gas customers to other energy sources. These changes will likely affect the price of natural gas delivery.
Modeling Price Impacts
Natural gas distribution companies in the U.S. are regulated monopolies for which prices are established by state jurisdictional utility commissions. One of the most significant factors in establishing a utility’s revenue requirement is depreciation expense (the return of capital). This represents allocating the capital costs of a company’s assets to each period of service over their useful lives. This blog examines three scenarios using different depreciation approaches in the context of state greenhouse gas emissions policies to assess the resultant financial impacts. Each assumes that such policies would result in a 50% reduction in gas demand by 2050 and a similar 50% reduction in the number of gas customers. We note that our analysis is not intended to suggest that such reductions in demand or customer counts are the most likely future state. However, the scenarios below illustrate the impact on gas delivery prices in the event of such outcomes.
Scenario 1: The recognition of the impact of emissions reduction on depreciation expense is delayed. A 45-year average remaining life, consistent with the company’s historical experience, is used initially and then gradually shortened each time a depreciation study is performed and estimates of service lives are updated. The straight-line method is used for depreciation — capital costs are allocated in equal amounts to each year of the service lives of the company’s assets.
Scenario 2: The average remaining life is shortened to 30 years to better align with 2050 carbon emissions targets. The straight-line method is used for depreciation.
Scenario 3: The average remaining life is shortened to 30 years, and the units of production method is used. This method allocates costs in proportion to consumption rather than equal amounts each year.
Long-Term Price Impacts
Figure 1 shows the annual depreciation expense on a per-customer basis through 2050. Due to capital replacements over time and the incremental costs that result from these replacements, depreciation expense increases for each scenario on a per-customer basis. However, both straight-line method scenarios (Scenarios 1 and 2) increase significantly over time, whereas the units of production scenario (Scenario 3) result in a more gradual per-customer increase each year.