Investors tend to think of advancements in technology coupled with high-tech equipment when thinking about clean energy opportunities. Electric vehicles, solar panels, wind farms, and hydrogen and carbon sequestration are all hot topics for discussion when thinking about clean energy. What about landfill gas? There is an emerging trend developing to capture methane from organic waste, landfills and wastewater treatment plants to produce renewable natural gas (RNG).

RNG is getting more attention because it solves emissions problems with proven technologies and processes. RNG also helps companies meet their own respective emissions targets in several industries, such as utilities, and it can serve as a transportation fuel for commercial fleets. In addition, RNG can be relatively easily integrated into existing pipeline infrastructure to supply both utility and transportation demand. This ease of integration avoids the need for complicated or expensive processes for product adoption. 

RNG environmental benefits

Methane’s high potency as a greenhouse gas is widely publicized. According to the EPA website, municipal solid waste landfills are the third-largest human-generated source of methane emissions, contributing over 15% of emissions in the United States, in 2019. Organic materials emit methane gas naturally through the rotting process in the absence of oxygen. This problem will only continue and compound with the growth in landfill waste. According to the 2018 World Bank report “What a Waste: A Global snapshot of Solid Waste Management to 2050,” landfills are forecasted to grow from approximately 8 billion tons of waste in 2020 to exceed 12 billion tons of waste in 2050 in the United States. As more landfills emerge, emission problems will intensify. Organic materials generate more emissions when located deep in a landfill. 

RNG solution

RNG provides an effective solution to help companies and communities reduce greenhouse gas (GHG) emissions. RNG companies capture and utilize waste emissions from landfills to produce low-carbon fuel for the purpose of energy generation. This reduces the amount of emissions from landfills into the atmosphere. Depending on the system, a project is able to capture approximately 60%-90% of the methane emissions from the landfill. In the American Gas Foundation Renewable Sources of Natural Gas: Supply and Emissions Reduction Assessment published in December 2019, the ICF estimates RNG has the potential to reduce GHG emissions by 235 million metric tons by 2040.

Importantly, companies are capturing waste emissions right now with existing equipment, technology and proven production process. This is an environmental solution that does not depend upon new technologies or a dramatic reduction in production costs. Methane has been gathered from landfills, dairy operations and wastewater treatment plants for many years.  Landfill gas follows a predictable production trend. Even when a landfill stops accepting waste, the gas rate will gradually increase for 10 to 15 years, and then follow a predictably shallow decline. By accelerating spending programs on developing RNG projects, more RNG can be produced and concurrently reduce the amount of GHG emissions from landfills, which is a positive for the environment.

Potential RNG benefits do not stop there. The RNG industry could gain further traction by participating in the more popular developments with hydrogen and carbon sequestration. Landfill gas could be discussed in the same sentence with the high-profile hydrogen and carbon sequestration businesses. Specifically, RNG could be utilized to produce renewable hydrogen, either by supplying feedstock to a steam methane reformer, or by generating electricity to power an electrolyzer. Importantly, RNG is a feedstock for the production of green hydrogen, which is the most environmentally friendly grade of hydrogen. Lastly, landfill gas contains 40%-50% carbon dioxide in many cases. Depending on the RNG project, this carbon dioxide could be captured and sequestered to further reduce landfill emissions.

Growing customer demand due to ease of integration with existing infrastructure

RNG can be used to fuel transit fleets, power industry, and heat homes and businesses. RNG consumers benefit from the ability to integrate RNG technology into existing infrastructure, such as pipeline assets. For example, many utilities in northern states with cold weather conditions are looking to RNG as a supply source, considering the challenges with utilizing electric heat pumps during the winter. Specifically, the efficiency of electric heat pumps drops with colder weather. RNG is reliable, efficient and resilient to extreme weather conditions. This makes RNG an attractive option for residential customers and utilities, which avoid the need to scrap existing infrastructure and spend a significant amount of capital on developing new infrastructure.

In addition to utilities, RNG is a growing source of fuel in transportation. According to the Coalition for Renewable Natural Gas report in April 2021, RNG supplied 53% of all on-road fuel used in natural gas vehicles in 2020. On a gasoline gallon-equivalent basis, RNG use as a transportation fuel grew 25% on an annual basis and eliminated 3.5 million tons of carbon dioxide equivalent in 2020. More impressive, RNG use as a transportation fuel grew 267% over the past five years, according to the Coalition for Renewable Natural Gas report in April 2021.  

Evolution business model, attracts capital, drives emission reductions

Historically, RNG companies tended to operate with merchant (plant) business models. Profits primarily were generated by the monetization of Renewable Identification Numbers (RINs) and Low Carbon Fuel Standard (LCFS) credits. This made cash flows volatile and somewhat risky, which created a challenge for RNG companies to raise capital due to the volatility inherent in owning merchant plants.

The growth in environmental, social and governance trends and company mandates for greenhouse gas emission targets has contributed to a sharp rise in demand for RNG from dedicated buyers. For example, Fortis (ticker FTS CN) has published a target for RNG to supply 15% of their Canadian gas utility sales target in 2030. This represents an RNG gas procurement requirement of over 30 billion cubic feet per year. In the United States, Sempra Energy (ticker SRE) has a published target for SoCalGas to replace 20% of their traditional natural gas supply with RNG. According to the Sempra management team, RNG provides an opportunity to have a positive impact on the environment due to the problem that over 80% of methane emissions in California come from agriculture, dairies, wastewater treatment plants and other organic sources. 

This growth in demand has created an opportunity for RNG operators to secure fixed-price, long-term contracts with strong counterparty customers, including utilities, universities and other institutions that have set their own respective greenhouse gas emissions targets. This is significant. The ability to secure fixed-price, long-term contracts encourages more capital to flow into RNG companies and projects.

Many traditional and clean energy investors looking to participate in clean energy investments could see RNG as less risky due to contracted cash flows and predictability of supply with proven technologies and processes. There are far fewer execution risks in landfill RNG businesses than investments based on technological advancements or that require a dramatic reduction in cost structures. The RNG industry is at an inflection point to attract more capital.  An improvement in capital formation into the RNG industry should accelerate more spending, projects, production and environmental benefits.

RNG is an emerging industry with a growing number of companies seeking to participate

While renewable natural gas has not yet captured widespread media attention, there are many public and private companies seeking to develop RNG businesses. Over time, the RNG industry should grow as more companies participate in the business, and as capital is allocated to develop projects. A broad range of companies have announced RNG initiatives: major oil companies, including Total, Chevron and BP; midstream companies, including Enbridge, Kinder Morgan and Williams; demand markets (utilities), including Sempra Energy, CMS Energy, DTE and Dominion; and companies with large transportation fleets that utilize RNG as a source for their commercial fleets, such as Amazon and UPS. Private equity firms have also emerged as a source for RNG projects.

One example of an RNG project currently underway is Enbridge, a utility that plans to spend $42 million on an RNG plant in Niagara Falls, with a completion date in 2022. More recently, in April, ENB announced a joint venture with Walker Industries and Comcor Environmental to develop RNG projects throughout California. In the midstream industry, Williams is currently spending capital on RNG projects. Currently, Williams delivers RNG by partnering with energy companies in Washington, Idaho, Ohio and Texas to transport methane emissions captured from landfills and dairy farms. Williams’ Northwest Pipeline is interconnected with four RNG facilities, of which two were brought online in the past seven months. Looking ahead, the company plans to aggressively pursue additional RNG partnership opportunities.

While there have been many project announcements, it is important to remember that many of these early stage RNG projects are small-scale initiatives. To provide some indication on sizing of projects, the largest RNG project in the world is located at the Keystone Sanitary Landfill in Dunmore, Pennsylvania. This facility, which is owned by Archaea Energy, has a target to provide over 12,000 million British thermal units per day.

Europe is another potential market that may provide an opportunity, considering the current premium price for natural gas in the region. Recently, Montauk Renewables (ticker MNTK) secured a fixed-price contract with this is company name, Iogen RC Fuels, in Europe. While only a small contract, this is a good example of an RNG company broadening opportunities into Europe.

Risks

To be balanced and put into perspective, the RNG industry is, for the most part, still in the infancy stages. The primary risk with RNG businesses is dependence on government programs to provide a lift to economics. The removal of LCFS and RIN credits would be a negative to the industry. While we see less of a risk in the Biden administration, this is a long-term risk depending on which political party has control at the federal level. At the state level, we have noticed some local governments embrace the clean energy industry. For example, there are several states with proposals for LCFS programs, which would add to the list of states that have already implemented LCFS programs (California and Oregon). Another example is in California.

On June 1, the California Public Utilities Commission R. 13-02-008 Phase 4A Staff Proposal draft, recommend approval of a mandatory biomethane procurement program for California’s four large gas investor owned utilities to procure on behalf of their core customers.  “The preliminary medium term 2030 target for the gas IOUs (Investor Owned Utilities) should support CARB’s 4 million metric tons of carbon dioxide equivalent landfill emission reduction goal, which translates to total annual procurement of at least 75.5 million MMBtu (72.8 Bcf) of biomethane by 2030.  This procurement amount is equivalent to approximately 12.3 percent of total annual statewide gas IOU (Investor Owned Utility) core customers consumption in 2020.” Consequently, this is an example of a state proposal that provides an incentive for RNG projects at landfill sites.

Today, RNG production from dairy farms is getting a ton of attention. It is easy to see the appeal for RNG companies to participate in dairy farms. The carbon intensity scores are off the charts in negative territory, which provides a significant lift to RNG pricing from dairy farms. But there are risks to dairy farm RNG production. Specifically, there are risks with stability of supply (reference manure), lack of scalability (dairy farms produce a smaller amount of RNG compared to landfills) and dependance on farmers’ financial stability. In short, the RNG producer’s success is correlated to the farmer’s financial condition. If the farm goes into economic distress, that may create supply challenges. Having fewer farm animals reduces the supply of animal manure.

Lastly, the construction of anaerobic digestors does add both expenses (in the $5 million-$100 million range) and complexity. We have heard of several management teams that struggled with the execution on these projects. Anaerobic digestors require a constant supply of feedstock or risk disruptions that trigger maintenance issues. A critical driver for RNG producer profits is plant efficiency, and plant downtime and maintenance activities are a problem in dairy farms involved with RNG production. There have also been challenges with moisture concentrations in anaerobic digestors. Additionally, there is a higher probability that RNG produced from dairy farms requires transportation by trucks as compared to more efficient pipelines for landfill production, as dairy farms produce smaller amounts of RNG compared to landfill gas operations. This adds aggregation costs to a dairy farm’s cost structure.

The other challenge with RNG is the lack of scalability, especially with dairy farms, and high fragmentation of companies in the industry. We consider RNG to be a niche industry, which may deter some institutional funds from investing here. Lastly, it is important to remember that this is still a young industry. Many management teams have yet to demonstrate an operational track record, which opens the door to amateur mistakes, such as project delays, cost overruns and poor execution.

Adam Karpf is a portfolio manager for CIBC Private Wealth's Energy Infrastructure strategy. He has over 20 years of experience in the financial services industry and began his career as an analyst for Standard and Poor's. In 2018, Adam was also selected as a Board Advisor to the Tortoise Acquisition Corp. In 2020, Adam was also selected as a Board Advisor to the Tortoise Acquisition Corp II and Rice Acquisition Corp.