Cash from Trash: Renewable Natural Gas
Published on March 28, 2024
Innovation and growth may not be the first words that come to investors’ minds when thinking about the waste management industry, but they should be.
Producing Cash from Trash: Renewable Natural Gas
Landfills often have a terrible reputation: smelly, polluting, and harmful to the planet. In reality, however, waste companies have proven to be strategic innovators as the regulatory framework in the U.S. has dramatically tightened over the past several decades, leading to stringent monitoring and containment practices that limit contaminants and control the siting of landfills. Recycling and composting have also expanded to account for roughly a third of the U.S. waste stream. Recent actions to ramp up production of renewable natural gas — whereby landfill owners convert landfill gas emitted by decaying landfill waste into a low-emission fuel for utilities and vehicles — further enhances the long-term sustainability of landfills while also creating a high margin, high return on capital revenue stream.
The (Strengthening) Case for Waste
We have written in the past about how attractive the North American waste industry is from an investing standpoint. Significant regulatory barriers to entry, stable demand, durable pricing power, and continued opportunity for tuck-in acquisitions have enabled prodigious and growing free cash flow generation with improving returns on capital. We think this healthy dynamic should persist for the foreseeable future.
Further enhancing the investment case for waste is an emerging opportunity to capture a high margin revenue stream that can also help reduce greenhouse gas emissions: renewable natural gas (RNG).
How RNG is Produced
Decaying municipal solid waste (i.e., garbage) in landfills generates copious amounts of harmful gases (landfill gas) comprised primarily of methane and carbon dioxide, in addition to other noxious particles. In the U.S., landfills are the third largest source of human-related methane emissions. Methane is a particularly potent greenhouse gas that traps heat in the atmosphere at 28x the rate of carbon dioxide; landfill gas can also cause unpleasant odors.
The Clean Air Act requires landfills above a certain size to build and maintain infrastructure to collect, monitor, and flare landfill gas. Flaring landfill gas typically destroys over 99% of the methane, thereby largely offsetting the most environmentally harmful component of landfill gas and neutralizing related odors.
However, rather than simply flaring the landfill gas, landfills can leverage their existing gas collection infrastructure, process it into RNG that removes the most pollutant elements of the gas through thermochemical processes like gasification, and sell the gas for use in vehicles and electric utilities. The resulting RNG is chemically identical to conventional natural gas and can be used in existing natural gas distribution networks.
Environmental Benefits of RNG
While flaring landfill gas significantly reduces the environmental harm of landfills, it may not seem obvious that processing the landfill gas into RNG has positive environmental ramifications. However, the impacts are meaningful.
RNG projects capture up to 90% of the methane emitted from landfills, depending on system design and effectiveness. The captured methane is destroyed (converted to water and the much less potent carbon dioxide) when the gas is burned to produce energy. And the use of RNG can help replace highly polluting fossil fuels like coal in electric utilities and diesel in trucks.
Economic Benefits of RNG
RNG qualifies as an advanced biofuel under the EPA’s Renewable Fuel Standard, which requires renewable fuel to be blended into transportation fuel in increasing amounts each year. This helps ensure sustained growth in demand for RNG and bolsters the market for related tax credits.
In the case of Waste Connections, the third largest waste management company in North America and a longtime holding in our core equity and income strategies, the company plans to deploy roughly $200 million of aggregate capital on RNG facilities through 2025. Waste Connections' management anticipates having roughly 12 RNG facilities in operation across its landfill portfolio generating as much as $200 million in pre-tax cash flow by 2026. As a result, management expects a very rapid payback of 2-3 years. Regulatory changes to the Renewable Fuel Standard could impact the price of RNG, so Waste Connections is taking various measures to hedge price volatility.
Importantly, capturing and processing landfill gas into RNG should help Waste Connections achieve two of its key ESG goals of driving a 40% increase in biogas recovery and achieving a 15% reduction in scope 1 and scope 2 emissions by 2035.
Benefits to the Environment and the Bottom Line
By processing landfill gas, companies like Waste Connections are helping reduce the impact of municipal solid waste (garbage) on the environment. Importantly, we believe the financial profile of RNG projects appears highly attractive, with significant cash flow generation and rapid payback. As a result, RNG should help make landfills more environmentally and financially sustainable long into the future.
Featuring
Nael Fakhry
Co-Chief Investment Officer – Core Equity
Prior to joining Osterweis Capital Management in 2011, Nael Fakhry worked as an Associate at American Securities, a private equity firm, and as an Analyst in the investment banking division of Morgan Stanley.
He is a principal of the firm and Co-Lead Portfolio Manager for the core equity, growth & income, quality cyclical growth, and flexible balanced strategies.
Mr. Fakhry graduated from Stanford University (B.A. in History, Phi Beta Kappa) and the University of California Berkeley, Walter A. Haas School of Business (M.B.A., C.J. White Scholar).
Related Insight
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Osterweis Fund Quarter-End Performance (as of 3/31/24)
| Fund | 1 MO | QTD | YTD | 1 YR | 3 YR | 5 YR | 7 YR | 10 YR | 15 YR | 20 YR |
INCEP (10/1/1993) |
|
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| OSTFX | 3.39% | 10.04% | 10.04% | 26.94% | 6.37% | 12.40% | 11.09% | 8.40% | 11.30% | 8.23% | 10.42% | |
| S&P 500 Index | 3.22 | 10.56 | 10.56 | 29.88 | 11.49 | 15.05 | 14.09 | 12.96 | 15.63 | 10.15 | 10.40 | |
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