LONDON (Reuters) - More than 250,000 homes could be switched from heating with fuel oil to natural gas, cutting New England's heating oil consumption by 10 percent and providing a new market for U.S. gas producers, under ambitious plans published by Connecticut's Department for Energy and Environmental Protection (DEEP).
Even if the plan is successfully adopted and implemented, only half of Connecticut's households will be on gas. Hundreds of thousands of homes will be stuck on expensive fuel oil, especially in the more sparsely populated areas of the state.
But Connecticut's draft energy strategy highlights the wider potential for cheap gas to seize market share in parts of New England and the Mid-Atlantic states that have traditionally relied on fuel oil. Switching will depend on innovative financing mechanisms to help customers with the costs of new equipment and connections to gas systems.
Conversion is drawing attention from utilities and financial services companies. In New York City, private companies such as Dual Fuel Corporation are already offering to organize the work and even fully fund the conversion using shared cost savings.
Connecticut has limited natural gas infrastructure. Natural gas did not become widely available in the state until the 1960s. Even now, there are just three transmission and distribution systems and three utilities serving the heavily urbanized areas along the coast and the central industrial area.
Of the state's 1.4 million homes, just 482,000 (34 percent) use gas as their primary heating fuel. Gas use is much lower than in neighboring Massachusetts (47 percent) and Rhode Island (48 percent) and the country as a whole (51 percent).
About half of the state's homes rely on oil furnaces. Historically gas was more expensive, so using heating oil made sense. However, the fracking boom, coupled with the soaring price of oil and especially middle distillates such as heating oil and road diesel, have inverted the economics and made gas far cheaper.
"Conversion to natural gas promises a cheaper, cleaner and more reliable fuel for heating, power generation and perhaps transportation," according to DEEP's "Draft Comprehensive Energy Strategy", published on October 5.
Switching to gas would also cut CO2 emissions by 25 percent and lessen the state's exposure to volatile global oil prices.
But the strategy admits: "As things now stand, Connecticut is not well positioned to take advantage of the emerging natural gas opportunity."
The number of households converting to gas is increasing: Connecticut's gas companies will add 15,000 new customers this year, up from 9,000 in 2009. But the strategy aims to double or even quadruple the number of customers switching every year by overcoming obstacles.
At present, many households are put off by the high upfront costs of installing gas furnaces and the even steeper charges for connections. DEEP wants to raise awareness of the savings from switching fuels and offer new customers more help with connection costs.
Homeowners considering conversion face three sorts of costs: (1) installation of a new gas heater and removal and disposal of old heating equipment, including the fuel tank; (2) installation of a service line and metering system to connect to the gas main; and (3) extension of the gas main if the building is more than about 150 feet from an existing one.
Homeowners are always responsible for installing new equipment and safely removing and disposing of old oil furnaces, though they may be able to finance the replacement through a home equity loan or energy efficiency program.
The typical cost is $7,500, according to DEEP, and generates savings of $1,800 a year, implying a simple payback period of about four years (or longer if the homeowner takes out a loan).
For homes adjacent to an existing main ("on main"), the homeowner must also pay for the costs of installing a service line and meter. The typical cost is just over $4,000.
Homes more than about 150 feet away from an existing gas main ("off main"), must also pay for an extension of the main, which costs roughly $190 per foot, $1 million per mile, and can quickly become cripplingly expensive.
The local utility can offer some assistance towards service line, meter and mains extension costs. But to protect the interests of other customers and ensure existing customers do not subsidize the addition of new ones to the network, the utility must show it can recover the costs over a reasonable period, usually set at 15 or 20 years.
This "hurdle rate" test restricts the amount of money the utility can invest to about $5,000 per new residential customer - enough to cover service line and meter charges but not pay for extending the main.
If the revenues associated with the new customer are not sufficient, the new customer must pay the remainder up front through a contribution in aid of connection (CIAC).
For customers located on main, the contribution may be small. For off-main customers, it can quickly become enormous.
Connecticut's gas companies estimate there are around 177,000 customers currently on main who could potentially be persuaded to switch to gas.
The cost of converting them all would be around $2.6 billion. Homeowners themselves would need to invest $1.8 billion in new equipment. The utilities would incur service line and meter costs of about $800 million, but in most cases these would be covered by the hurdle rate calculation, so they could be recovered from existing ratepayers.
The main problem is persuading them to switch. Most heating equipment is replaced after it breaks down, often in winter when the priority is to replace it quickly, usually on a like-for-like basis rather than undertaking a complex, costly and time-consuming conversion to gas.
DEEP wants to encourage switching at other times and offer more attractive financing options for customers who are reluctant to meet the whole cost upfront.
It could include interest rate subsidies or financing through the customer's utility bill. "Because the payment is tied to gas service, this mechanism lowers the risk of non-payment" and thereby lowers the financing cost, according to DEEP.
Regulatory approval would be required for an on-bill program. But if it were permitted, the program could be capitalized by the utilities themselves, financial institutions or state bonds.
BUILDING MORE MAINS
Connecting all the potential on-main customers would still not bring Connecticut's gas use up to the 50 percent level in neighboring states. So the comprehensive plan envisages adding up to 89,000 off-main customers, which would be much more tricky because of the far higher costs of building out the network to them.
Connecting these off main customers could cost another $2.6 billion, and whether it is worth doing is more sensitive to assumptions about future gas and oil prices.
One option is to try to sign up groups of neighbors at the same time to share the costs of mains extension, perhaps by offering an incentive to off-main customers who sign binding commitments by a specific deadline.
Another is to sign up anchor customers such as schools, hospitals and large commercial and industrial premises, which can more easily realize the benefits of paying for the extension because of their higher gas usage. Then residential customers along the new route could be connected.
DEEP is also investigating innovative financing options. Payback periods used in hurdle rate calculations could be lengthened from 20 years to 25 years, enabling utilities to offer more financial assistance and reducing the contribution demanded from customers.
Utilities could also be allowed to take a portfolio view of mains extension programs.
At present the entire cost must be recovered from those customers who have made a firm commitment to switch. But if the utility were permitted to make an allowance for other customers on the route who could be expected to switch in future, it would significantly increase flexibility.
Connecting more off-main customers will require significant regulatory changes to permit companies to provide on-bill financing and other flexibility. It is therefore dependent on approval from regulators and the state legislature.
But if the state and others in the Northeast can employ more creative options, millions of homes, as well as small businesses, could be switched, slashing fuel oil consumption.
(John Kemp is a Reuters market analyst. The views expressed are his own)
(editing by Jane Baird)