We all know the US tax code is complicated. ALPS Advisors, manager of the Alerian MLP ETF (AMLP), has been tripped up by the tax complexities inherent in their fund structure. As a result they’ve been forced to make an embarrassing NAV adjustment to AMLP for taxes, depressing the fund’s NAV by almost 4%. It must be frustrating for recent buyers, since it shifted the fund to a 2.7% monthly loss, 3.9% behind its index.

AMLP is that rare ‘40 Act fund that pays corporate tax. Under the 1940 Investment Company Act, mutual funds and ETFs, which are corporations, can qualify to be RICs (Regulated Investment Companies) and therefore be exempt from corporate tax if they meet certain rules. These include being fully invested in securities, meeting certain diversification thresholds and so on. Almost all such funds qualify. Investing more than 25% of your assets in Master Limited Partnerships (MLPs) fails the test to be a RIC.

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AMLP holds MLPs because in 2010 when it was launched, midstream energy infrastructure businesses were mostly MLPs, not corporations. AMLP provides a way for retail investors who don’t want K1s to invest in MLPs – but at the cost of lower returns because AMLP first pays corporate taxes on its realized returns before making distributions to its investors. We’ve written about this in the past (see  AMLP’s Tax Bondage and Uncle Sam Helps You Short AMLP).

An MLP-dedicated portfolio is out of touch with today’s sector, since many MLPs have converted to be corporations. The pool of money willing to invest directly in MLPs is limited to K1-tolerant US taxpayers – older, wealthy Americans. US equities are overwhelmingly held by institutions such as pension funds, endowments, foundations and sovereign wealth funds. These investors are mostly exempt from US taxes, so they avoid MLPs because it would create a tax liability for them. Only two of the ten biggest North American pipeline businesses are MLPs – the rest are corporations.

Several years ago the Federal Energy Regulatory Commission (FERC) announced a change in how their expenses were calculated that was adverse to natural gas pipeline MLPs. Taxes owed by their investors used to be included in the operating costs on which MLPs based their tariffs. FERC’s new rule would have lowered revenues, so natural gas pipelines soon converted to corporations to sidestep the issue.

It’s another example of the tax complexity that comes with MLPs. Although FERC later modified their stance, today’s MLPs tend to be (i) more liquids/less natural gas oriented, (ii) smaller, and (iii) more levered. The pipeline sector and MLPs are no longer synonymous.

AMLP has stuck with MLPs despite their shrinking relevance. If they considered diversifying into corporations this would put downward pressure on their current holdings, depressing their NAV and alarming investors. They’d need to obtain shareholder approval for this change of strategy and doing so would signal to the market an impending seller of MLPs. Many investors use AMLP to achieve pipeline exposure and, in our experience, few consider either the dwindling number of MLPs or the tax drag on returns. If AMLP was created today it would include pipeline corporations, in order to reflect the entire industry. It is an anachronism.

It now appears that AMLP investors must consider tax uncertainty on top of the haircut this imposes on returns. In their press release ALPS Advisors blames the NAV reduction on tax legislation passed in 2017, as well as the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which was passed in March 2020. The problem is not recent.

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AMLP’s tax liability is updated daily, which suggests some certainty around its calculation. It looks as if ALPS had to modify their interpretation of the tax code, resulting in the sudden 3.9% NAV reduction. It must be complicated. Going forward, investors can no longer rely on the published tax liability. The press release warns that, “the daily estimate of the Fund’s deferred tax liability used to calculate the Fund’s NAV could vary significantly from the Fund’s actual tax liability.”

In other words, if ALPS gets their tax math wrong again, investors might face another big NAV adjustment. Because AMLP is a tax-paying entity and the tax code is fiendishly complicated, you can’t rely on the NAV being accurate.

Over the past five years, AMLP has significantly lagged the midstream energy infrastructure sector, because MLPs have lagged corporations and been more likely to cut their distributions. Investor inertia has presented little reason for any changes but lagging performance and now uncertain tax expense leave little here for the discerning investor.

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Midstream is up 27% for the year as of Tuesday, but investors are showing no irrational exuberance. The North American pipeline sector retains its MLP moniker because MLPs used to be the dominant business structure. Even though it’s now two thirds corporations, the ‘40 Act funds who specialize in the sector are still called MLP funds.

Investors have been exiting MLP funds for several years. JP Morgan calculates that 2016 was the last calendar year that saw inflows. The shale bust led to distribution cuts and saw several big MLPs convert to corporations. They did this in search of a broader investor base but often created a poor tax outcome for their MLP holders. The archetypal K-1 tolerant, US taxable, income seeking investor (ie rich old American) left in disgust. The Covid collapse in March 2020 was, for some, the last straw.

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Fund flows are a notoriously poor predictor of performance. Look at the ARK Innovation ETF, where inflows were synchronized with its peak in early 2021. Within a year it had achieved the ignominy of earning a negative return on the average dollar invested (see ARKK’s Investors Have In Aggregate Lost Money).

The history of MLP fund outflows coincides with a generally declining Alerian MLP Index (AMZ), but that is misleading because AMZ omits pipeline corporations which are held by the more diversified funds. Since September 2018 (the beginning of the fund flow chart) the broad and therefore more representative American Energy Independence Index (AEITR) has returned 10.8% pa.

The fundamentally bullish case for the sector is familiar to regular readers. However, the positive return despite persistent retail selling of MLP funds is another reason for optimism. If prices are rising when investors are turning away, it suggests that even a cessation of outflows could provide a further boost.

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Morgan Stanley calculates that for the first nine months of this year midstream companies repurchased over $3.1BN in stock. This more than offset the selling of MLP funds by retail investors. What could be more bullish than the less informed selling to the better informed?

Investors like the link to PPI inherent in pipeline tariffs. It allows the companies to raise prices in line with inflation, expectations for which have remained surprisingly quiescent. The ten year CPI implied by treasury yields minus TIPs is a remarkable 2.28%. Since the next year will be well over the Fed’s 2% target, investors seem very comfortable that inflation will be back at pre-pandemic levels soon after. The University of Michigan survey provides a slightly different view, with CPI for the year ahead expected to be 5% and 2.9% over the long run.

More consumers report hearing about inflation hurting business conditions, and 43% report that rising prices are eroding their own living standards, up from 20% a year ago. John Williams, president of the Federal Reserve Bank of New York, warned that the unemployment rate could reach 5% as the Fed cools the economy, which would mean around 2.5 million extra unemployed.

With the unemployment rate at 3.7% and inflation just under 8%, the Employment Cost Index (ECI) is rising at 5%. This still leaves many workers worse off in real terms. Greater awareness of inflation as shown in the Michigan survey suggests it will figure more in pay demands as well as spending patterns where half of consumers report cutting back.

Four railroad unions have rejected a 24% pay increase over four years, threatening a strike that could cripple the movement of freight across the US. Congress may force them back to work. The US has a history of legislating against the disruption caused by strikes. In 2005 the New York City transit system shut down for a couple of days over a pay dispute. Under the law, the union leader was sentenced to ten days in prison and the union fined $2.5 million. Workers can strike but not if it causes substantial economic harm, which seems right.

By contrast, in the UK workers on the London underground schedule one day strikes every couple of weeks. An email update sent to travelers in early November breezily advised that there are “lots of public transport options” but added, “There are also some planned strikes taking place over the weekend and into next week.”  There is no equivalent legislation that prevents a small group from inconveniencing millions, a significant omission from UK labor law reflecting the country’s liberal leanings.

It’s one reason why UK inflation tends to run higher than in the US.

Upcoming ECI releases will be interesting because pay raises tend to come around year end. Consequently, the December and March ECI seasonal adjustments correct for this and lower the index. The seasonal factors are based on pay increases in a world of 2% inflation. With pay raises running at 5% and the job market robust, it would seem that the ECI could reflect higher than normal pay raises because the seasonal adjustments will be inadequate. Inflation will appear more entrenched, requiring a higher rate cycle peak.

The December ECI is some way off – the September report will be released on December 15^th. Inflation won’t return to 2% until workers accept reduced compensation. There’s plenty of reasons to think this won’t happen soon.

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Long term energy forecasts are nowadays subject to a partisan test by many readers based on whether or not they project a rapid energy transition. The biggest oil and gas producers such as Exxon Mobil and Shell understand that the media interprets their published long run energy forecasts as reflecting their capex criteria. The result is a set of projections leavened with cheerleading for renewable energy, leaving the reader to separate the two.

The International Energy Agency (IEA) recently published their 2022 World Energy Outlook, and for the first time it projects a peak in natural gas consumption around 2030. The shift is caused by the loss of Russian exports to Europe, which has driven prices for LNG higher. The EU will import over 1.7 Trillion Cubic Feet (TCF) of additional LNG this year. This has caused many regions, including the EU, to turn to rely more on coal, as a workable alternative to high natural gas prices. But over the next decade, the IEA has increased its forecast of solar and wind power generation too.

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The IEA’s base case is the Stated Policies Scenario (STEPS) which assumes current policies continue. Other scenarios envisage new policies, including a set consistent with achieving zero emissions by 2050. The world isn’t even consistent with STEPS, although it remains the most plausible of the IEA’s three scenarios. Including more extreme outcomes allows the IEA to be an energy transition champion if not an unbiased forecaster.

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The 2022 Outlook includes many useful facts: this year fossil fuel producers have enjoyed a $2TN jump in net income (a “windfall”) versus 2021; governments have committed over $500BN in tax breaks and energy subsidies to households, hence the trend towards taxing windfall profits in Europe. Permitting and construction of overhead electricity transmission lines can take up to 13 years, with developed countries often the slowest. 75 million people who recently gained access to electricity are likely to lose it this year.

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How likely is the IEA STEPS to be right?

The US Energy Information Administration (EIA) sees consumption of all energy sources increasing. They see renewables output more than doubling over three decades and gaining market share. Rising energy consumption to support higher living standards in the developing world is the dominant theme. The EIA sees global energy consumption rising by over 40%, a 1.2% annual rate of increase. This is slower than the 1.9% annual rate of increase the world experienced in the decade (2009-19) leading up to Covid.

By contrast, the IEA STEPS outlook based on existing policies projects a growth rate collapsing to under 0.3% per annum. There is no basis in history to support this. It implies a much longer path to the rising living standards that are the aspiration of developing countries. Their other scenarios assume almost no growth and an actual decline.

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In 2020 the world’s ten year growth rate in energy consumption dipped to 1% pa for the first time in several decades because of Covid. Last year’s 5.8% annual increase brought the ten year growth rate back up to 1.3%, and it’s likely to edge higher again after this year. Forecasts are becoming less neutral and more aspirational, a form of political correctness at large organizations that requires more skeptical reading. In BP’s projections of global energy consumption, their three scenarios are called Accelerated, Net Zero and New Momentum. Their projected annual growth rates are 0.3%, 0.1% and 0.6% respectively.

The EIA, an agency of the US Department of Energy, provides the most plausible growth rate of the three. Accepting even the most realistic forecasts of the IEA or BP suggests billions of poor people acquiescing to constrained improvement in living standards.

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Meanwhile Shell sees a bright future for LNG.

The chart showing a sharp drop in EU wind turbine orders illustrates some of the challenges facing that industry. Russia’s invasion could have been a big boost for wind (watch Why Aren’t Renewables Stocks Soaring?), but companies are struggling to make a profit.

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The Economist magazine is projecting an increase in deaths this coming winter, with even a mild winter causing a seasonally adjusted rise. Such are the consequences of Europe’s failing energy strategy.

Lastly, Tellurian CEO Sharif Souki is the subject of a WSJ article that examines his failure to repeat the success he enjoyed at Cheniere (see US Natural-Gas Pioneer Struggles in His Second Act). Souki is a visionary, but he’s been handsomely paid for not delivering. We highlighted this “pay for performance in advance” in a recent video (see What’s Next For Tellurian?).

Souki admitted recently that his mistake had been to retain the price risk on shipped LNG. He’s bullish on prices, but lenders don’t share his enthusiasm for the risk. Conventional LNG projects charge a liquefaction fee that largely leavers the price risk with the buyers and sellers.

Although Tellurian has been forced to adjust its business model, Souki’s expectation for continued growth in energy demand from emerging economies looks realistic to us. Forecasters such as the IEA might benefit from considering it.

The COP27 ended with an agreement by rich countries to make increased payments to poor ones, but a commitment to phase out all fossil fuels failed to gather unanimous support. The holdouts included Saudi Arabia and Russia, who supply substantial volumes of oil and gas to willing buyers but don’t rank highly on the list of global emitters. Developing countries were also reluctant to make such a pledge, because they’re trying to raise living standards which requires more energy.

The EU and several OECD nations regarded the missing phase-out of fossil fuels as a failure. Climate change negotiations remain hobbled by two incongruities: the first is that developing nations who are most exposed to rising sea levels are less enthusiastic about steps to prevent this than the rich world.

The second is that suppliers of reliable energy are constantly pressured to reduce output while consumers face little incentive to curb demand. Rich countries could adopt policies that force their citizens to stop buying fossil fuels, but it would be too disruptive.

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Unable to persuade voters that they should reject anything made with reliable energy, policymakers are left with forcing supply scarcity. The ESG movement and climate extremists have caused reduced capex which has raised prices, but there’s little sign of a demand response. Instead, they’ve made energy the best performing sector in the S&P500.

Some observers regarded COP27 as a failure. But the uneven support for phasing out fossil fuels forced the first incongruity noted above into the open. Namibia’s Maggy Shino said, “Africa wants to send a message that we are going to develop all of our energy resources for the benefit of our people because our issue is energy poverty.”

The Inflation Reduction Act (IRA) that President Biden signed on August 16^th improved the viability of carbon capture via increaseed 45Q tax credits. Energy executives have figured out that more CO2 buried underground means reduced emissions and less pressure to phase out natural gas. 3Q earnings calls were sprinkled with references to carbon. It was mentioned 25 times on Occidental’s call, where they reported, “we broke ground on the world’s largest direct air capture plant in Ector County, Texas.”

Exxon Mobil plans to share more details about their “low-carbon solutions business” in December.

Among pipeline companies, Kinder Morgan’s CEO Steve Kean said the IRA, “has made more sources of CO2 economic for capture.”

Energy Transfer plans to sequester (ie bury) CO2 emissions from its planned Lake Charles LNG export facility.

Enbridge CEO Al Monaco said the IRA, “is providing a real catalyst for low-carbon investments.”

Jim Teague, Enterprise Products’ Partners co-CEO, said, “Asia continues to make no bones about their long-term appetite for our energy. We at Enterprise have been emphatic that it’s going to take all of the above in order to meet the world’s growing energy needs. That’s why in addition to traditional midstream services, we’re also focused on investments in lower carbon projects like carbon capture and sequestration and providing blue ammonia into export markets.”

Midstream energy infrastructure has an important role to play in the energy transition.

Demonstrating Asia’s willingness to make long term natural gas commitments, Qatar  signed a 27 year deal with China’s Sinopec for 4 million tonnes per annum, Qatar is playing in their first World Cup and became the only host nation in history to lose its opening game. Having watched it, betting on three straight losses seems safe. But on the world’s LNG stage they are top three (with the US and Australia).

EU climate policy chief Frans Timmermans thinks compared with coal and oil, natural gas, “is a different situation for which I have some understanding, especially if you combine that with infrastructure that is prefitted to also carry gases with other densities, such as green hydrogen or green ammonia in the future.”

European buyers continue to shun long term LNG contracts, preferring to buy as needed on the spot market at prevailing prices. The coming northern hemisphere winter is a swing factor for global LNG prices over the next several months. But over the next three years, Japan’s trade ministry warned that competition for supplies will intensify, with no new contracts available before 2026.

Many investors often note the correlation between midstream and crude oil. This month the sharp drop in oil has not been reflected in the pipeline sector which is roughly flat MTD. We think the continued growth in free cash flow and decreasing leverage are allowing a decoupling from commodity prices. If so, investors will welcome it.

2022 should have been a great year for renewables. The prices of fossil fuels, which they are supposed to replace, have jumped. Russia’s invasion of Ukraine has heightened the importance of energy security, which solar panels and windmills offer because most countries can find places to build them. And global Green House Gas emissions (GHGs) have rebounded following the dip caused by the pandemic. So why aren’t renewables stocks riding high?

One reason could be that some of them had benefited from the long rally in tech stocks. Investors in both sectors are typically relying on high growth rates which means years of waiting for a reasonable free cash flow yield. Rising interest rates put a higher discount rate on those delayed future earnings.

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A more likely answer is that investors are becoming more realistic about the profitability of renewables. Germany’s north coast is windy, but they and others scrambling to replace Russian natural gas did not bid up the price of windmills. Instead, they hoovered up every available Floating Storage and Regasification Unit (FSRU) on the planet. The onshore pier, pipelines and electricity lines for the first one were completed last week in a brief 194 days in Wilhelmshaven on the North Sea. They’re also planning to build onshore import terminals for LNG, which have greater capacity than FSRUs.

European LNG prices famously reached ten times the US price earlier in the summer before dropping back to around 5X now. European storage is full in preparation for winter. Dozens of LNG tankers are idling offshore waiting for better prices before they unload their cargoes. Many analysts expect it’ll be harder to replenish stocks for next winter, since Russian gas was flowing west through Nord Stream 1 for the first half of this year.

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Coal prices have soared as developing countries have been deterred from competing with Europe’s new appetite for LNG. Among non-OECD (ie developing) countries coal provides 46% of their power, versus only 19% in the rich world. And developing countries are where energy demand is growing.

China burns half the world’s coal and relies on it for 63% of their electricity.   They’ve even justified new coal plants as necessary for energy security (what’s Chinese for chutzpah?). Egypt is making government buildings and shopping malls turn their air conditioning up to 77° F, thereby reducing domestic demand for natural gas so they can export more.

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Coal and gas together provide 59% of the world’s electricity, and both are much more expensive than a year ago. It’s as if the world had agreed on carbon taxes to improve the economics of renewables. There are numerous articles stating that solar and wind are cheaper than reliable energy, most of which pre-date the run-up in coal and gas. Renewables stocks should be soaring.

But they’re not. Danish wind turbine manufacturer Vestas expects a profit margin this year of minus 5% and recently reported a bigger 3Q loss than expected. They are optimistic that they can boost prices over the long run.

The CEO of Siemens Energy reminded viewers on CNBC that, “renewables like wind roughly, roughly, need 10 times the material [compared to] what conventional technologies need.” Current fiscal year EBITDA is down 42% and the company isn’t planning to pay a dividend.

UK solar operator Toucan Energy has gone bankrupt, with debts including £655 million ($779 million) to Thurrock Council, the local government where it operates. Neighboring London averages 1,481 hours of sunshine a year, which is 17% (Tampa, FL is 33%). 48% of UK electricity comes from natural gas. Although solar is 7%, UK solar farms can expect 83% or more downtime. Combined cycle natural gas power plants are typically down 5% of the time for maintenance. That’s why Toucan borrowed money from a local government rather than return-oriented investors.

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The five biggest renewables ETFs are beating the S&P500 but lagging the American Energy Independence Index (AEITR). The global economy is rebounding from Covid, apart from China. Relying on foreign countries for energy is suddenly riskier. Fossil-fuel inputs for almost 60% of the world’s electricity have jumped in price. All these factors should have made renewables a hot sector.

Instead, a weary realism has cooled belief in a rapid energy transition. Developing countries are looking for very large payments from the rich world to help them invest in cleaner energies. This challenges the claims of those who argue that solar and wind are already the cheapest way to generate electricity.

The International Energy Agency (IEA) forecasts 0.5% annual production growth in natural gas through 2030 in their Stated Policies Scenario (STEPS). This is the most plausible one because it doesn’t assume every government’s climate pledges will be fulfilled. In their 2022 World Energy Outlook the IEA expects unconventional gas production (ie shale, overwhelmingly US) to grow at 2% annually. They estimate 750 million people don’t have access to electricity, and 2.4 billion don’t have access to clean cooking (meaning they cook using fuelwood, charcoal, tree leaves, crop residues or animal dung). Getting these families onto natural gas would improve their lives and leave the planet better off as well.

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Bitcoin could be poised for another ascent. Bulls will be encouraged that Jim Cramer advised holders to sell following the collapse of FTX. Few readers would have been surprised when this blog first expressed crypto-skepticism in December 2017. Its return since then is 1.7% pa, substantially behind the market and, naturally, midstream energy infrastructure.

But annualized returns are too pedestrian to be the metric of choice for crypto-traders. They prefer “X”, as in “I made 3X on crypto so far this year.” For them, red is the new black.

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Bitcoin is too volatile to be a store of value. Exchanges are routinely hacked. And the government can seize it. So what’s the point of it? You don’t have to short bitcoin to be unconvinced – avoiding it is sufficient. It has always looked like a modern Dutch tulip bulb craze. Not everything that changes in value is an investment or needs to be traded. Many investors in FTX were proponents of decentralized finance (“defi”), valuing the freedom to operate outside existing regulatory structures. Now as many as a million creditors are relying on regulators and national justice systems to salvage value for them.

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The long term bull case for bitcoin sees it assuming the role of a widely-held currency, with a yield curve reflecting interest rate expectations set in the absence of a central bank. For now the US$ is not threatened with a loss of dominance. Fed funds futures project a cycle peak of just under 5%, sooner and higher than a few weeks ago. Like the FOMC, the market expects rates to begin decreasing a few months later. Fed chair Jay Powell did suggest rates could peak at a higher level than previously expected, but that was before the benign CPI number.

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Investors sometimes ask us about the exposure of pipeline companies to rising interest rates. The chart from Wells Fargo is informative and shows the preponderance of fixed rate debt across the sector. Wells Fargo estimates that a 1% increase in short term rates would reduce free cash flow by a similar percentage. With around half the industry’s EBITDA subject to inflation-linked tariffs, elevated PPI and interest rates is preferable short of causing a recession.

The COP27 is notable for more realism (see Energy Pragmatism Is Beating Extremism) and the presence of traditional energy companies. EQT is the biggest producer of natural gas in the US. Their CEO Toby Rice has been vocal in making the case for natural gas as a substitute for coal. “The most important thing is for people to see America’s largest natural gas producer here at COP27 as a symbol that we’re going to be a leader in energy transition,” said Rice on the sidelines of the conference.

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Coal power plants produced a fifth of global greenhouse gas emissions in 2021, more than any other single source, according to the International Energy Agency. China consumes half the world’s coal. Their representatives at COP27 offered the novel argument that Russia’s invasion of Ukraine justifies this. China is building coal burning power plants roughly equal to what the US has operating, but this is apparently to improve energy security and does not represent a shift in emissions policies. Do residents of California or Germany, where expensive electricity comes with high renewables penetration, grasp this? Should we believe it?

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The White House has been frustrated that US E&P companies haven’t responded to higher prices by increasing drilling. Few are surprised given the hostile posture the Administration has towards the energy industry. It’s imperceptible on the chart but Drilled Uncompleted wells (“DUCs”) increased for the first time in over two years. The steady decline in DUCs has long frustrated Joe Biden, who has excoriated companies for not producing more oil in between promising no more fracking.

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Meanwhile, natural gas production continues to move higher. The US Energy Information Administration noted that natural gas is providing 38% of US electricity, up from 37% last year. In recent months the power sector has taken record amounts, consuming about a third of total US output. The EIA projects a slight drop next year, although that was once their 2022 forecast as well.  Along with renewables, growth is at the expense of coal.

The industrial sector and exports of Liquefied Natural Gas (LNG) have both been growing in recent years. There’s little doubt that LNG will continue to rise, providing energy security and a cleaner alternative to coal for its buyers. Crypto investors probably regard pipelines as boring, but tangible assets have their place too.

As the world’s leaders meet in Egypt at the COP27 climate change conference, there are reasons for optimism among those who yearn for a pragmatic approach to reducing global Green House Gas emissions (GHGs).

The Economist magazine front covers over the past couple of years provide an evolving perspective from one publication that likes to think of itself as a thought leader. In 2020 clean energy was expected to remake geopolitics; the energy shock of 2021 was well underway before Russia invaded Ukraine. Notwithstanding the White House narrative, high gas and gasoline prices are not solely Putin’s doing.

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Today there’s a growing recognition that the extremist approach championed by left-wingers and the Sierra Club is an abject failure. The purist solution of having the world transition rapidly to solar and wind is being shown to be a technical and commercial impossibility. Developing nations, responsible for all the growth in global energy consumption, and thereby emissions, aspire to western living standards more than they worry about climate change.

The loss of Russian natural gas exports to the EU did not cause a dash for more windmills. Instead, Germany has snapped up all the available floating storage and regassification units available worldwide to import Liquefied Natural Gas (LNG). The construction of permanent onshore facilities with greater capacity is underway.

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The rich world’s desire for lower GHG emissions hasn’t been matched by promised cash payments to help developing nations upgrade their energy infrastructure. Since the 2015 Paris agreement OECD nations have failed every year to deliver $100BN in promised climate finance. It shouldn’t be a surprise; US politicians have rightly concluded there are few votes in writing big checks to China and India where official policy is to maintain GHG growth at least until 2030.

As Namibia’s petroleum commissioner, Maggy Shino, said, “If you are going to tell us to leave our resources in the ground, then you must be prepared to offer sufficient compensation, but I don’t think anyone has yet come out to make such an offer.”  Speaking on the sidelines of the COP27 in Egypt, Saudi Arabia’s energy minister Prince Abdulaziz bin Salman said: “The world is hoping to crucify us.

Reliable energy is well represented at this year’s conference, with a record 636 lobbyists registered to attend. This is a positive development, because the industry best positioned to help guide the energy transition is the one that provides 80% of the world’s energy today. Nowadays, The Economist talks of adapting to climate change as much as mitigation. An increasingly pragmatic assessment will lead to increased use of natural gas at the expense of coal, the dominant fuel for many poorer countries because it’s easily burned for power generation. Growth in demand to support rising living standards also means that coal plants in developing countries are younger and have a longer remaining useful life.

3Q22 earnings for pipelines included strong natural gas results. Last week, TC Energy’s natural gas segment was largely responsible for their beating expectations. They raised full year EBITDA guidance to C$9.76BN. Although the midstream sector’s footprint is almost entirely in US and Canada, TC Energy has partnered with Mexico’s Comisión Federal de Electricidad to build the $4.5BN Southeast Gateway pipeline along the Gulf of Mexico coastline. It will move 1.3 Billion Cubic Feet per Day, helping increase Mexico’s use of natural gas.

Mexico also has ambitious plans to become an export hub for LNG, the supply for which will be US since Mexico produces almost no natural gas of its own. Six of eight proposed export terminals are located on Mexico’s Pacific coast where they would offer sharply reduced travel time to Asia compared with Cheniere’s terminals in Louisiana and Texas. Opposition to proposed LNG export terminals in California and Oregon spurred renewed interest in Mexico. Pembina dropped plans to build Jordan Cove in Oregon following local opposition.

The two-day market rally following Thursday’s better than expected CPI report took the S&P500 6.5% higher. Equity buyers eagerly await anything that suggests the Fed may moderate its tightening cycle. FOMC members were quick to welcome the news, showing that they also would like the data to allow a policy shift.

However, inflation remains a long way from the Fed’s target. The most recent Employment Cost Index is increasing at a 5% annualized rate. Persuading workers to accept 2% raises is critical to getting inflation back to that level, although this means millions of people accepting a drop in real living standards. The pipeline sector may offer a way to protect against inflation that remains stubbornly high.

Recent 3Q22 earnings reports for pipeline companies have been confirming the predictable nature of their business models. Dividend hikes have been common. Growth capex generally remains cautious.

Cheniere’s $2.8BN in EBITDA was close to consensus, and they reaffirmed their full year 2022 guidance of $11.25BN having revised it higher three times this year. They paid down $1.3BN in debt. The Stage 3 expansion of the Corpus Christi LNG export facility is on track with first shipments expected in three years. Eventually more US natural gas will be available to buyers in Europe and Asia, but construction takes longer than popularly believed.

Cheniere also noted that Asian buyers continue to negotiate 20-year contracts while European buyers are not. Countries like Germany are relying on being able to buy what they need in the spot market to avoid long term commitments and maintain their goal of reducing fossil fuel use. It’s another example of the EU pursuing green ambitions while developing countries prioritize growth, which relies on increased energy consumption.

Morgan Stanley believes Cheniere is on track to deliver at least $25 per share in Distributable Cash Flow within several years, a >14% yield based on the current stock price.

Williams reaffirmed their previous EBITDA guidance of $6.1-6.4BN with bias towards the upside. They’re also planning to invest in a Carbon Capture and Sequestration (CCS) facility in the Haynesville. The poorly named Inflation Reduction Act raised the 45Q tax credits for CCS, and Williams is one of several companies planning to take advantage. They raised their dividend by 3.7%.

Energy Transfer missed expectations in part because of a one-time $128MM legal expense related to a prior class action suit and 130MM hedging loss caused by difference in timing recognition between inventory and hedge instrument. Setting these two items apart, their results were in line with consensus. They are targeting Debt:EBITDA leverage of 4.0 by the end of next year – still a little higher than peers which we estimate will be around 3.5X by then. Management now expects to make a Final Investment Decision (FID) on their Lake Charles LNG export facility during 1Q23. 2022 EBITDA guidance was raised for the third time this year, now $12.8-13.0BN.

Enbridge, North America’s biggest pipeline company by market cap ($80BN), reported 3Q EBITDA of $3,758MM, 4% ahead of expectations. They raised their dividend by 3%. Enbridge has a C$17BN (US$ 12.75BN) backlog of growth projects, up from C$13BN the prior quarter. This includes C$3.6BN to expand the southern segment of their British Columbia gas pipeline system. This is a response to strong demand from LNG customers presumably in Asia. New England and California are impeding natural gas supply to their citizens, while Canada is preparing to increase exports.

Interestingly, Enbridge’s Renewable Power Generation segment reported $113MM, 32% ahead of JPMorgan’s estimate.

Enterprise Products Partners reported $2,258MM, meeting expectations, and raised their distribution 5.6%.

Plains All American reported $623MM vs expectations of $562MM. They raised their distribution by 23% and expect 10% growth going forward.

Results like these should continue to attract investors because of steady and growing cash flow generation. Meanwhile, President Biden reaffirmed that he is against any oil drilling just days after criticizing oil companies for not producing more oil. Even Democrats must agree the White House has no visible energy strategy.

The Financial Times published an interview with EQT CEO Toby Rice in which he said, “Sending US LNG to China and India is going to be the biggest decarbonizing thing we can do as a country,” Rice is promoting coal to gas switching as the most effective way to curb CO2 emissions. We believe this represents a big opportunity for US natural gas investors.

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Finally, the US Energy Information Administration (EIA) reported that capacity of Combined Cycle Gas Turbines (CCGT) will reach 24% of total US power generation by year’s end. Last year CCGT generated 32% of our electricity, ahead of coal (22%) and nuclear (19%). CCGT’s share of actual power generation is bigger than their share of capacity because solar and wind typically operate at only 20-35% of their capacity. It’s not always sunny and windy.

Around a quarter of US coal-burning power capacity is scheduled to be retired by 2029, continuing a trend that has been the main source of falling CO2 emissions over the past couple of decades.

Midstream energy infrastructure is well placed to support the continued growth in global demand for US natural gas.

Fed chair Jay Powell and the American worker do not have an alignment of interests. In his remarks, following another 0.75% rate hike, Powell said the FOMC is, “acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation.” He always says that, so as to remind that some must sacrifice their jobs due to the Fed’s pursuit of higher unemployment. This will cool the labor market, and inflation, for the rest of us.

The Fed’s inability to engineer a million or two lost jobs renders Powell’s warnings anodyne, because so far the tightening cycle hasn’t claimed any casualties. Reducing inflation requires taming wage growth. The US Employment Cost Index (ECI) for all civilian workers is increasing at 5.0%, the highest since 1984.

This is marginally below the Personal Consumption Expenditures (PCE) deflator which is increasing at 6.2%. For now, the American worker is accepting a 1% drop in real purchasing power. It probably feels worse. CPI inflation is 8.2%. PCE is a more accurate measure because its weights update dynamically, but CPI is more widely used, including for the social security cost of living adjustment which will be 8.7% next year.

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It’s unclear why anyone should accept a pay raise below inflation. Why should firefighters, teachers or indeed any worker whose annual income doesn’t include a healthy dose of variable compensation accept reduced purchasing power? Workers didn’t cause inflation. Supply disruptions due to Covid lockdowns, the excessive $1.9TN Democrat stimulus early last year and the Fed’s ponderous restoration of monetary normalcy all played a part. Action and inaction by government agencies are to blame, with reduced real living standards the result. The White House hasn’t articulated the case for restraint in pay negotiations. It’s not an easy one to make. But as long as pay raises are running at 5%, restoring the Fed’s 2% inflation target will be hard.

Powell noted that, “the labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies still very high, and wage growth elevated.” This empowers union negotiators to demand more, and they are.

For example, President Biden recently approved a 4.6% raise for Federal employees, more than two times the Fed‘s inflation target.

San Antonio is raising pay for city workers by around 7%, although some will receive raises of up to 20%.

NJ is increasing the minimum wage from $13 an hour to $14.13 (8.7%).

Teachers in many states across the country are receiving their biggest raise in decades. For example, in New Mexico base salaries are going up by 20%.

Railroad workers are threatening to strike, even though the Presidential Emergency Board, which is trying to mediate between the union and the railroad companies, recommended a 24% increase over the next two years.

Europe, as is often the case, is worse. Workers on London’s subway system (“the tube”) have scheduled a series of strikes over a 3% proposed pay raise and pension cuts. Transport For London, which oversees the city’s public transport, sent out an email one day last week that breezily reminded that there are “lots of public transport options” if you have weekend travel plans but went on to warn of “some planned strikes taking place.”

In France, demonstrators have clashed with police as they protest about inflation.

It’s easy to understand why workers left worse off by rising prices are fighting back. The US job market remains very tight. Unless you work at Twitter, it’s reasonable to expect your pay to at least keep up with the general price level. Unions are negotiating higher pay on behalf of their members. But employers are also often having to raise salaries to compete.

This is making it harder for the Fed to bring inflation back down. Unless inflation starts to fall rapidly and soon, it’s likely to strengthen the conviction of workers determined to maintain living standards.

The Fed needs job market softness now, in order to temper the trend towards higher wage increases. Jay Powell has been equivocal in his warnings, but on Wednesday he allowed that, “we may ultimately move to higher levels than we thought at the time of the September meeting.” When asked about the window for a soft landing, he said, “I would say the path has narrowed over the course of the last year.”

While it’s impossible to be confident about the rate cycle peak, continued low inflation expectations present the Fed an ever-present exit ramp. But for now, rates look set to keep rising. Friday’s strong employment report didn’t help. The dynamics of wage negotiations are adding to upside risk for rates.

New England’s largest utility, Eversource, is worried about a looming shortage of natural gas. CEO Joseph Nolan has publicly asked the White House to make plans for emergency supplies in the event of a severe cold spell this winter.

North America has abundant supplies and export volumes will grow. Europe is gearing up to increase its imports of Liquefied Natural Gas (LNG). Germany expects to begin taking deliveries at its first Floating Storage Regasification Unit (FSRU) in Lubmin by the end of the year. Britain has just officially banned Russian LNG although in practice this happened in February when Ukraine was invaded. 1.2 million tonnes of LNG (58 Billion Cubic Feet, equivalent to around 60% of US daily production) is in ships offshore Europe awaiting delivery to the few import facilities available (mostly in Spain).

Prices have slumped recently, with the US Henry Hub benchmark at $5, having briefly reached $10 during the summer. The world is not short of natural gas, although global prices remain several multiples of the US. Why is Eversource worried? Why aren’t there enough windmills in Massachusetts to plug the gap?

In 2016 Kinder Morgan abandoned its proposed North East Direct pipeline that was intended to link Boston with the enormous reserves in Pennsylvania’s Marcellus shale. Opposition from environmental extremists was led by Senators Elizabeth Warren and Bernie Sanders. Since then New England has suffered from inadequate pipeline capacity linking it to cheap, domestic reserves. Democrat opposition to reliable energy rarely confronts demand, relying instead on the misplaced conviction that solar and wind will provide cheap power along with well-paid union jobs.

As a result, in order to keep the lights on companies like Eversource have resorted to seaborne imports of LNG, the only place in America compelled to do so. Now that Europe no longer buys from Russia, there’s new competition for supplies. The Jones Act, which restricts trade between US ports to US-owned, built and crewed vessels, forces Boston to import LNG from places such as Trinidad and Tobago instead of Louisiana or Texas. In the past they’ve even bought from Russia.

Energy policies that resemble anything New Englanders have adopted should be firmly opposed by those of us who value reliable energy at a reasonable price. The virtue signaling that leaders in Massachusetts embrace has had no discernible impact on China, consumer of half the world’s coal where Green House Gas (GHG) emissions (28% of global total) remain on an upward trajectory. US GHGs have been falling for over a decade, mostly through painlessly using more natural gas (New England take note) and less coal. Should China follow through on its commitments to manage peak GHGs in 2030, masochistic energy policies in Boston will have simply enabled a later enactment of such pledges. And should developing countries’ GHGs (and therefore global) keep rising, climate extremists will have achieved nothing at great expense.

The cancellation of the PennEast pipeline last year that was supposed to bring cheap Pennsylvanian gas to New Jersey was celebrated by climate extremists and Governor Phil Murphy. It is an example of New England energy policies polluting New Jersey. It’s why people with money and limited family ties are sensibly moving south. New Jersey would be better off if the Democrats moved north.

The energy sector has benefitted from the more extreme policy prescriptions of the Democrats and the ESG movement (watch ESG is a scam). The American Energy Independence Index (AEITR) continues to make up ground on the S&P500, with their five year trailing returns now almost the same. We think circumstances continue to support outperformance of North American midstream energy infrastructure.

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Some places embrace pragmatic energy policies. Poland is building its second nuclear power plant, eventually helping replace Russian gas and reducing reliance on coal. This is a climate-friendly and sensible decision.

In the US the Tennessee Valley Authority (TVA) is planning to add 20 small modular nuclear reactors by 2050. TVA president Jeff Lyash thinks several hundred similar reactors will be needed across the US to deliver carbon-free power. Nuclear power is reliable and has a small footprint, the antithesis of solar and wind.

I have an erudite friend whose text messages send me to Dictionary.com so I can understand them. We’ll call him The Scouser, whose command of the English language belies this moniker. He recently lamented the peripeteia currently endured by English Premier League club Liverpool, who languish at midtable in a sharp reversal of fortune compared with last season. This blog is dedicated to helping inflict an overdue peripeteia on misguided climate extremists. Their policy prescriptions underpin today’s energy crisis.