UGI to Consider Pennsylvania Expansion With Philly Gas Works

UGI Corp. is among East Coast utility companies that may bid on municipally-owned Philadelphia Gas Works after city officials decided last week to put it on the market.

Philadelphia Mayor Michael Nutter is considering the sale after a study he commissioned found a divestiture would release the city from rising costs and financial risks associated with the 176-year-old utility. A potential buyer might value the gas works at $1.4 billion to $2 billion, depending on what was sold, merger advisory firm Lazard Ltd. said in its study. The city might clear as much as $496 million from a sale after costs, Lazard said.

“Pennsylvania utilities are a core business for us and we’d certainly take a look at it,” UGI Treasurer Hugh Gallagher said in a Feb. 17 telephone interview. “It sounds like it’s going to be a very complicated process. We’ll see if it makes sense.”

UGI, which the city hired to operate the gas works in 1961 before reclaiming management in 1972, is headquartered in King of Prussia, Pennsylvania, about 19 miles northwest of Philadelphia’s landmark city hall. The utility owner has twice expanded its Pennsylvania operations in the past six years, buying gas-distribution units of Southern Union Co. in 2006 for $580 million in cash, and PPL Corp. gas utilities for $268 million in 2008.

Seeking Financial Advisers

The city will solicit bids in March from financial advisers for a potential sale, Mayor Nutter said at a Feb. 13 press conference when the Lazard study was released. Any sale needs approval by the city council and state regulators and may take two years, he said.

UGI is one of a slate of nearby utilities that might glean savings and attractive returns from the largest, and oldest, municipal-owned gas works in the U.S., analysts said.

“This will pique a lot of interest if they actually go ahead with it,” Michael Gaugler, a New York-based analyst for Brean Murray Carret & Co. said in a telephone interview Feb. 14. “I can’t recall a municipal system of this size ever coming on the market.”

The utility serves more than 500,000 accounts, the most of any government-owned system, according to the American Public Gas Association in Washington. Philadelphia is the fifth-most-populous U.S. city.

Other Possible Bidders

Potential buyers also include nearby New Jersey Resources Corp., owner of gas distributors in central and northern New Jersey, and South Jersey Industries Inc., which distributes gas south and east of Philadelphia, said Gaugler and Chris Ellinghaus, a New York-based analyst for The Williams Capital Group LP. New Jersey Resources and South Jersey Industries don't comment on mergers or aquisitions, spokespersons for those companies said in e-mailed messages.

Nearby utilities could reduce costs by sharing systems and employees with the municipal gasworks, Paul Patterson, a New York-based analyst for Glenrock Associates LLC, said in an interview. Infrastructure investment funds might back a bid by a small utility like New Jersey Resources, which has a market cap of $3.1 billion, Gaugler said.

Pennsylvania’s Public Service Commission has encouraged privatization of the city gas works, saying its customer base can’t support vital safety improvements.

Philadelphia’s residential gas rates are the highest in the state, inflated by subsidies to the poor and elderly and the need to cover unpaid bills that rose to a total $103 million in 2010, Standard & Poor’s wrote in an Aug. 22 note to clients. Almost 20 percent of utility customers qualify for federal heating assistance.

Replacing Pipe

The new owner must replace as much as 1,500 miles (2,400 kilometers) of cast-iron pipe, a type implicated in fatal gas explosions in Philadelphia and Allentown, Pennsylvania, last year, James H. Cawley, a Pennsylvania Public Service Commissioner, said in an interview. The commission sets rates for Philadelphia Gas Works.

“It’s matter of public safety,” he said. “Cast iron is brittle. You’re going to have more leaks and you’re going to have more problems.”

It would take the city 85 years to finish the upgrades at the current rate of replacement, Cawley said. A buyer might borrow money to accelerate the fix, he said.

Mayor Nutter has placed several conditions on a potential sale. The successful buyer must agree to a rate freeze through August 2016, comply with a union contract that restricts layoffs, and continue discounts for the poor and elderly.

Unattractive Restrictions

“When you look at the restrictions they’re placing on a potential buyer, it becomes a lot less attractive,” Gaugler said. “You can’t fire anybody, you can’t raise rates, you can’t do this, this, this.”

Infrastructure investment funds and companies serving other parts of Pennsylvania and New Jersey may be potential bidders, Glenrock’s Patterson said.

An offer may also attract AGL Resources Inc., which became the largest owner of gas-only utilities with its December purchase of Nicor for about $2.5 billion, Gaugler said. WGL Holdings Inc., owner of Washington’s gas utility might look because it’s familiar with urban gas systems, he said.

Pepco Holdings Inc., which delivers power in Washington and gas in Delaware, also may consider a bid, Ellinghaus said.

At WGI Holdings, Ruben Rodriguez, a spokesman, didn't return a voicemail message seeking comment. Spokespersons for Pepco Holdings and AGL Holdings also had no immediate comment.

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