To be an investor in the energy sector nowadays requires a view on the politics of climate change. Exxon Mobil’s (XOM) investor day slides go straight there in the Overview, noting the continued demand growth expected of non-OECD countries and its impact on emissions. The debate over global warming can be summed up thus:  OECD countries seek reduced emissions, while developing countries want higher living standards. The world’s energy-related CO2 output will move on the interplay between these conflicting goals.

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It’s as if the company is warily watching the climate extremists who believe they shouldn’t exist, while investing heavily to meet the demand growth they anticipate. The industry has sharply cut near term growth capex because of Covid. XOM plans a 30% reduction, which they nonetheless described as mostly deferrals, not cancellations. Although they lowered their long term growth capex guidance, they still expect to spend $25-28BN per year (prior guidance was $30-35BN). They see their future in oil and gas.

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Over the past five years, Cash Flow From Operating Activities (CFO) has averaged $29.6BN. XOM is roughly sinking every dollar they generate back into the ground. They still regard themselves as a growth company.

The presidential election is as vital to energy companies as to any sector. Trump’s 2016 victory was hailed by energy executives, who eagerly anticipated deregulation and pro-fossil fuel policies. The last four years have been a bust, as exuberant spending led to overproduction that Covid brutally exposed.

XOM has lost more than half its value since the 2016 presidential election. The company is expected to post a loss this year – the glut of oil and gas that has long weighed on prices has been exacerbated by the pandemic. But the potential for public policy to shift away from fossil fuels has further depressed its cash flow multiple – typically, multiples peak at market lows because the denominator is very low. But XOM’s price to cash flow multiple is at the low end of the past decade’s range.

The presidential cycle is too short to drive XOM’s capital allocation decisions. Nonetheless, they must contemplate the impact of a Biden victory. Future returns are likely to turn on the interplay between green policies that constrain fossil fuel output and the reduced supply that today’s curtailed spending will cause. Although XOM has trimmed its own long term capex guidance, the only way this level makes sense is if they expect industry-wide reductions to be greater.

Democrat policies that seek to lower fossil fuel consumption tend to focus on curtailing supply – it’s easier to control the few hundred companies involved in oil and gas production than to change the behavior of hundreds of millions of people.

XOM isn’t allocating capital based on the election – but it’s also safe to assume that a Biden victory won’t cause those plans to be altered much either. Since Democrat policies will constrain fossil fuel supply, it’s likely that energy prices will rise. A carbon tax would add further upward pressure. Energy prices are low in America, with plenty of room to rise without causing much outcry.

Higher prices support a green agenda, because they make renewables more competitive. Perversely, this could also usher in a period of improved profitability for the energy sector. XOM’s long term capex plans imply that governments and reduced industry capex will be more successful in constraining supply than demand, leaving higher prices as the main catalyst for changed consumer behavior.

On XOM’s 2Q investor call, SVP Neil Chapman noted that around 70% of its investor base is retail. So it’s not surprising that a quick tour of Seeking Alpha’s website reveals dozens of recent XOM articles targeting the self-directed investor. Many of these offer views on the likelihood of a dividend cut – with its shares yielding over 9%, there are many skeptics. It’s clearly at risk. At just under $15BN, the annual dividend is unlikely to be covered by free cash flow until at least 2023, according to a model from JPMorgan. Like MLPs during the exuberance of the Shale Revolution, XOM is investing in the future and borrowing to pay its dividend.

The most likely way for XOM to sustain its dividend is through higher crude oil prices. Their investors may not appreciate this, but a President Biden could be their path to better returns.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

The contrast between the pricing of debt and equity issued by pipeline companies is probably the topic that most engages clients in our discussions. In a recent piece on the equity risk premium (see Stocks Are Still A Better Bet Than Bonds) we used the example of Enterprise Products Partners (EPD). Because EPD’s common units yield 3X its long term debt, an investor with the flexibility to move from one asset class to another could achieve a bond-like return by investing a small portion of her capital in the equity.

In short, it seems implausible for the market to be so enthusiastic about a company’s long term debt while at the same time pricing its equity as if prospects are dire. Nonetheless, this fairly describes the current state of the public markets for midstream energy infrastructure securities.

Bond yields are low everywhere, partly the result of inflexible investment mandates by a significant portion of the global investor base. We have touched on this issue before (see Blinded By The Bonds and Real Returns On Bonds Are Gone). The persistence of negative real yields on sovereign debt, and indeed negative nominal yields, such as German ten year government bonds at -0.50%, can hardly reflect a widespread fear of deflation. Fiscal discipline is no contest for fighting the pandemic, and the Federal Reserve has even modified its inflation targeting to allow an overshoot of 2%. The only logical conclusion is that a great many institutional investors own bonds not because they want to – but because they have to.

This situation has been years in the making. Rates fell to previously inconceivable levels during the 2009 financial crisis, and have remained there ever since.

The comparison of Energy Transfer (ET) debt and equity over the past eighteen months offers a striking example of investors’ divergent views.

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ET issued new ten year bonds in early January 2019, with a yield of 5.25%. The chart above shows the path followed by this debt and ET’s common units from that issue date. The two securities tracked one another for a few months before the bonds began to modestly outperform.

During the pandemic, debt and equity both fell sharply. The bonds fell less, reflecting their senior position in the capital structure. But the most striking feature of the chart is that the bonds have almost completely recovered and trade well above par, while the equity remains 50% lower than January 2019.

ET has a poor reputation for corporate governance, something we have noted (see Will Energy Transfer Act with Integrity?). Kelcy Warren’s bare-knuckle approach to business has made many enemies. But the company didn’t suddenly adopt its culture.

Legal challenges with the Dakota Access Pipeline (DAPL) are a potential headwind, but DAPL is around 3.5% of ET’s EBITDA so even a complete shutdown shouldn’t seriously impact the company (see Pipeline Opponents Help Free Cash Flow).

If the company’s prospects are as poor as implied by the weakness in its equity price, its debt has no business trading with a 4% yield. Conversely, if its balance sheet is as solid as this yield implies, the equity is mispriced.

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Just as bond investors seem to buy yield-less government bonds without regard to value, equity investors in this sector seem to sell with equal disregard for the outlook. MLP funds have labored under outflows virtually all year. In conversations with investors, the biggest source of frustration is that prices don’t reflect fundamentals, and are often under pressure. The consequent fund outflows are, for now, drawing more selling. Nobody worries about pipeline stocks being overpriced (a preposterous notion). They do ask when the stocks will go up.

The answer is, when the current cohort of frustrated sellers is done. It could be any day.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Growth isn’t always good. The Shale Revolution led to enormous growth in U.S. oil and gas output, but abundance pressured prices and, for investors in U.S. exploration and production, it’s been a bust. Midstream energy infrastructure joined in the race for growth projects – but not every investment was accretive. Some, like Plains All American (PAGP), have seen their stock price lose 90% of its value since 2014. It’s the result of serial bad capital allocation decisions. The drop in Permian crude output caused by Covid will leave PAGP with excess pipeline capacity in the region.

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Energy investors have become so wary of growth capital expenditures that they now cheer when a company reduces future spending. Enterprise Products Partners (EPD) has managed their business better than most over the past few years. Their investment in new infrastructure plus acquisitions peaked in 2014, and had already resumed its downward trend last year before the pandemic caused an industry-wide reassessment.

EPD last week canceled their planned Midland to Echo 4 (M2E4) pipeline carrying crude from the Permian to storage facilities on the Gulf of Mexico. Although much of the 450,000 barrels per day of capacity was already committed, EPD was able to get its customers to agree to extend the term of their agreements while reducing near term volume commitments. The crude oil originally intended for M2E4 will now move on other parts of EPD’s pipeline network.

Excess pipeline capacity out of west Texas is the most visible consequence of Covid on U.S. oil output. EPD’s move helps them but doesn’t solve the problem for other pipeline operators. “The Permian will still be significantly overbuilt” warned Ethan Bellamy, managing director of midstream strategy at East Daley Capital Advisors.

On Wednesday morning when the news was announced, EPD’s stock opened strongly and outperformed the American Energy Independence Index (AEITR) by 2% on the day. EPD estimates its growth capex will be $800MM lower over the next couple of years as a result, continuing the trend of recent years.

Lower growth spending means more free cash flow. CEO Jim Teague commented that, “The capital savings from the cancellation of M2E4 will accelerate Enterprise toward being discretionary free cash flow positive, which would give us the flexibility to reduce debt and return additional capital to our partners, including through buybacks.”

This is welcome news, and represents the new normal in the pipeline business.

We expect free cash flow for the industry to more than double this year. From our calls with investors, there’s substantial interest in today’s attractive yields, especially following 2Q earnings. EPD stands out with a distribution yield 3X their 30 year debt. As the industry continues to generate more cash, equity buyers will start to appreciate the long term stability of the best run businesses, as bond buyers already do.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance. We are also invested in PAGP and EPD via the SMAs and mutual fund we manage.

Long-time MLP investors need little reminding that the sector is out of favor. The Alerian MLP ETF (AMLP), with its tax-inefficient structure (see MLP Funds Made for Uncle Sam) has been shedding clients for years (see AMLP’s Shrinking Investor Base). Its focus on MLPs while they dwindle in number means it omits most of the biggest pipeline companies, as they’re corporations. AMLP’s distributions are down by a third (see Why Are MLP Payouts So Confusing?).

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AMLP is designed to provide passive exposure to the Alerian MLP Infrastructure Index (AMZIX). It turns out that pipeline companies haven’t done nearly as badly as this index. The focus on MLPs has always excluded corporations – for many years, when MLPs were controlled by a General Partner (GP), Incentive Distribution Rights (IDR) allowed generous payments from the limited partners in AMZIX to the GP’s. Because AMZIX excluded corporations, it left out many of the GPs who were receiving IDRs payments. Although this model has largely disappeared, the exclusion of most GPs meant that AMZIX included the inferior side of the GP-LP equation. And there remain a handful of MLPs that still labor under the burden of making IDR payments to their GP — all unfortunately included in AMZIX. These include MLPs Cheniere Energy Partners (CQP, controlled by Cheinere Energy Corp, LNG) and TC Pipelines (TCP, controlled by TC Energy, TRP). Avoiding MLPs that owe IDR payments to a parent would have helped AMZIX perform better.

The GP-LP relationship has always looked more like the one between a hedge fund manager and its hedge fund. Hedge fund managers and MLP GPs both fared much better than investors in MLPs and hedge fund (see MLPs and Hedge Funds Are More Alike Than You Think).

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Canadian pipeline companies are among the best run in North America. In recent years they have been acquiring MLPs, rolling them up into the corporate parent. For example, Enbridge acquired U.S. pipeline company Spectra Energy, which included Spectra Energy Partners, its MLP, in 2016. Transcanada (TRP) bought Columbia Pipeline Group the same year, and later rolled up their MLP. All these acquisitions led to the assets leaving AMZIX, because they were no longer housed in MLPs. Excluded from AMZIX but still significant was when Pembina (PBA) bought Veresen in 2017 and also acquired Kinder Morgan Canada after it has sold its Trans Mountain Express pipeline expansion to the Canadian Federal government.

In early 2018, the Federal Energy Regulatory Commission (FERC) surprised investors with a tax ruling that prevented MLPs from including investors’ imputed tax liability in setting natural gas pipeline tariffs. Although FERC later walked back this hasty ruling, the damage was done and natural gas pipelines are largely housed in corporations, where FERC’s tax ruling has no effect.

The general shift from MLPs to corporations as the desired corporate form, so as to access a broader set of investors, has taken place throughout this time. The result is that AMZIX doesn’t reflect the North American pipeline industry (see MLPs No Longer Represent Pipelines). It has the last three big pipeline companies that maintain their MLP status, and a bunch of small gathering and processing names that are more risky. It also has an overweight to crude oil and refined products pipelines, with a corresponding underweight to natural gas pipelines.

AMZIX has wound up with a form of adverse selection – seemingly always on the wrong side of the trade. Holding MLPs that paid IDRs to GPs, rather than GPs themselves; gradually becoming more concentrated as MLPs were rolled up into corporations; and drifting away from natural gas pipelines, leaving them with commensurately more crude oil risk at a time when transportation demand faces a lot of uncertainty.

The American Energy Independence Index (AEITR) was always designed to reflect the better side of the historic GP-LP relationship, and to be broadly representative of the North American pipeline industry. MLPs, as defined by AMZIX and its associated investment product AMLP, have had a miserable decade. But the broad North American pipeline industry as defined by AEITR has done substantially better over multiple timeframes, because of the construction advantages noted above. For almost the past decade it’s performed 14% p.a. better

When an investor complains about lousy MLP performance, they’re right, but they’re also revealing that they’ve had too much exposure to the wrong index.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Last week the Centers for Disease Control (CDC) told state health officials to prepare for vaccine distribution as soon as November 1. “My fellow Americans, our long national nightmare is over.” was first spoken by President Gerald Ford following Nixon’s resignation under threat of impeachment in 1974. But it could equally apply to Covid in 2020.

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The pain has been unevenly distributed. Since March, stocks have defiantly marched higher in the face of relentlessly bad news. Hundreds of thousands of lives have been lost, and billions turned upside down. Yet people have adapted, and technology stocks such as Apple (AAPL) and Amazon (AMZN) have benefited enormously from the shift to socially distanced living. Tesla (TSLA) has shown that stock splits are bullish, even if caused by prior huge gains (see Tech Stocks Have Energy).

The market’s gains have reflected the distasteful reality that the economic impact of Covid is driven by our efforts at mitigation. Public understanding of the actual numbers reveals huge misconceptions (see Covid Exposes Innumeracy) about its lethality and who is really at risk. Recently, the CDC quietly added the following to Table 3 of its Covid website (Conditions contributing to deaths involving coronavirus disease): “For 6% of the deaths, COVID-19 was the only cause mentioned.” In other words, 94% of Covid victims had a pre-existing condition (a “co-morbidity”) which may have contributed to their outcome. It’s still tragic for each person, but as we learn more the seeming randomness of Covid becomes less so.

For an interesting perspective on mitigation efforts elsewhere, see Brazil – Not the Disaster We’ve Been Led to Believe.

Last week’s sharp market reversal around the CDC’s announcement was probably no coincidence. U.S. hospitalizations are down by a third from their recent second peak. Fatalities never reached the levels of early April, and in former hotspots like New York and New Jersey, hospitalizations are down by 95% from the peak.

A vaccine will accelerate the progress towards herd immunity that seems to be already underway. The possibility that the near future may see a modified return of our former lifestyles has hurt technology stocks but breathed new life into stocks like Carnival Corp (CCL). A resumption of cruising might be the final confirmation that we’re post-Covid, that the hospitality business no longer faces quite the same existential threat.

Few will be surprised that the outperformance of energy stocks caught our attention. The least liked and therefore most undervalued sector doesn’t suffer like AAPL from the loss of momentum investors, because there were none. The rubber band between liked and hated sectors is stretched taught. If the imminence of a vaccine has triggered a great unwind, pipeline stocks have substantial upside.

Relative valuations are provoking comparisons with past episodes that ended poorly, such as the late 1990s tech bubble. Tesla (TSLA) has risen 75% since announcing its 5:1 split on August 11^th. Apple (AAPL), and their 4:1 split caused Exxon Mobil (XOM) to be dumped out for the Dow (see The Dow’s Odd Construction).

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There are plenty of articles comparing growth with value. For an energy flavor, consider the comparison with pipeline company Enterprise Products Partners (EPD). As recently as early last year, like AAPL, it traded at under 10X cash flow. Their paths soon diverged, and this year’s Covid-inspired tech rally has led us to the surreal moment at which EPD would need to increase in price by 4.5X, or AAPL drop by 78%, in order for their cash flow multiples to be synchronized once again. AAPL’s net income over the past five years has varied between $46BN and $59BN, with $56BN expected this year. A reduced sharecount due to buybacks makes the EPS figures look better but, unsurprisingly with $50BN+ in anual profit, AAPL is no longer a high growth company.

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Technology has been hot to be sure, but in spite of what a cursory glance might suggest, the energy sector has not been completely abandoned. Investors who purchased EPD’s 5.1% 2045 maturity bonds issued in February 2014 have been handsomely rewarded – at least by the extremely modest standards which bond buyers have long accepted. At the time, the cash flow yield on EPD’s stock was modestly higher than the bond yield, which probably convinced some that the bonds, with their fixed coupons and no participation in EPD’s future cash flow growth, weren’t cheap enough.

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Those original investors have received their 5.1% coupon and enjoyed some modest price appreciation, since their bonds are now priced at around 120. This is in spite of making their purchase less than six months before energy stocks peaked. Since then, the Shale Revolution has been ruthlessly crushed, leaving energy stocks in disorderly retreat and sweeping EPD down with the rest. Since few bond investors have the flexibility to leap down the capital structure no matter how compelling the opportunity, the holders of this debt with 25 years yet remaining must regard EPD’s equity as altogether divorced from reality.

The change in valuations has been stunningly swift, and when the relationship between EPD’s stock and almost every other non-energy equity security is reverting to the mean, it will have all seemed inevitable. Until then, we can simply gaze at charts like these and wonder how the CFA curriculum will one day turn this into a teachable moment.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Last week’s ejection of Exxon Mobil (XOM) from the Dow Jones Industrial Average looks like another indication of the declining relevance of energy stocks. XOM had been in the Dow since 1928, and until 2013 was the most valuable publicly listed company. Its market cap peaked with oil prices in 2014 at $446BN, and is now around $171BN.

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Pfizer (PFE) and Raytheon Technologies (RTX) were also dropped along with XOM, and these three were replaced by Salesforce (CRM), Amgen (AMGN) and Honeywell (HON).

Being dropped from an index is never good. For the much maligned energy sector, it’s tempting to regard this as the bell ringing at the market bottom – the sign that sentiment is so irretrievably poor that the only way from here is up. But the list of such past signals is already long.

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The quirky construction of the Dow is the cause of these changes. The Dow may be “venerable”, and still the most widely followed index, but nobody would create anything quite like it today.

This is because it’s a price-weighted index, rather than market-cap weighted like most indices. This means that the price of a stock determines its importance in moving the Dow. Apple (AAPL) is the highest weighted stock in the Dow by virtue of its price. Because of its impending 4:1 split, its weighting is about to drop by around three quarters – for market cap weighted indices such as the S&P500, a stock split has no impact on the weights of the components.

If Berkshire A (BRK-A) was in the Dow, at $326K per share it would dominate the index.

Perhaps when Charles Dow and Edward Jones first published their eponymous average in 1896, calculating the average daily price of twelve stocks without a calculator was already enough work for two financial reporters. But their simple approach remains with us today.

The tables below illustrate the shortcomings. Perhaps the biggest is that a price-weighted index doesn’t reflect market cap weighted moves in its components. This makes it less representative. From next week moves in AAPL’s value will have much less impact on the index. An investor wishing to track the Dow Jones has to sell most of her AAPL’s shares, even though it’s still in the index. Tracking the Dow is more difficult and costly because it requires frequent rebalancing. That’s why there’s far more money invested in products linked to the S&P500, and they have much lower tracking error.  Market-cap weighted indices by definition reflect the experience of all the money invested in their components, and are more easily tracked by portfolios invested in them.

One result is that although the recent rebalancing reflects the biases of the committee that oversees the Dow Jones, the smaller size of Dow Jones-linked funds limited the rebalancing trades by investors tracking the index.

Energy investors can console themselves that XOM’s ignominious ejection is due to AAPL’s meteoric rise and subsequent split. Several big companies have had a sporadic relationship with the Dow. General Electric (GE) has been spurned three times, most recently in 2018. Since then, GE has lost almost half its value. Given valuations, energy investors are likely to do much better.

Labor Day weekend heralds the traditional end of summer in America. School starts shortly thereafter. For the past several months, school districts across the country have been wrestling with modified in-person versus fully online classes.

It’s the most consequential set of decisions of the pandemic. 50 million students attend school from kindergarten through 12^th grade. In March, schools abruptly switched to online learning. Few will be surprised that it failed students and piled stress on teachers as well as working parents.  Children are collateral damage, “…many students are struggling and falling far behind where they should be” reported the head of the Los Angeles Unified School District (see The Results Are In for Remote Learning: It Didn’t Work).

The effectiveness of lockdowns is increasingly being questioned – New York City’s was imposed by Mayor de Blasio on March 20^th, and infections continued rising for another three weeks. Deaths peaked after four weeks. By early May, two thirds of hospital admissions were from people who had been sheltering at home, in compliance with the lockdown.

Moreover, cases continued to fall and have stayed low after some restrictions were eased, suggesting that the spread had reached its break point without government intervention. We may slow infections temporarily, but ultimately the virus moves through the community.

Lockdowns have turned out to be a “blunt and economically costly tool” according to a recent article. Sweden’s modest restrictions were widely criticized, but its fatality rate is lower than the UK, which imposed tougher controls. Sweden’s Nordic neighbors have done better, but that’s partly due to Sweden’s more expansive definition of a Covid death.

The UK is seeing a 40% jump in non-Covid deaths, suggesting people are delaying seeking medical care. The government has pleaded with citizens to “protect” the National Health Service, by not getting sick. We haven’t yet started to count the cost of mitigation.

It turns out there are such enormous gaps between public perception and reality that statistics ought to be a core requirement for a high school diploma.

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Two surveys illustrate: one from Kekst CNC polled 1,000 adults in each of five different countries. The average rate of infection estimated by U.S. respondents was 20% — 66 million people, or 20X the number of CDC-confirmed cases at the time. Serology tests that look for the presence of Covid anti-bodies show that the actual infection rate is many times higher than the number of positive tests, so this result might imply the respondents have a more sophisticated understanding.

Their estimate of deaths shows otherwise, with an average response of 9% of the population. If 30 million Americans had died, rather than 180,000, that would suggest an Infection Fatality Rate (IFR) of 45%. Estimates put it at under 0.5% for all ages and perhaps 0.1% for those under 65.

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The Covid IFR is tragically high for the older population, those with co-morbidities, and worse if you’re old and have health problems. But here, another survey shows that people underestimate the proportion of deaths inflicted on older age groups. A Franklin Templeton-Gallup survey found that respondents estimated 58% of deaths were among people 55 and older, whereas it’s 92%. It also found that, “The misperception is greater for those who identify as Democrats, and for those who rely more on social media for information.”

Covid has been the top news story almost all year, feeding or fed by these misperceptions depending on your view. There’s no better example of the primacy of fear over facts than Andrew Cuomo’s upcoming book, American Crisis, which promises an inside view of his handling of the pandemic.

Cuomo’s oversight of the nation’s second worst fatality rate (topped only by New Jersey) is less recognized than his sober daily press conferences.

Dispatching infectious but stable patients back to nursing homes to free up hospital beds that were never needed was leadership that led to thousands of avoidable deaths. A skilled communicator of bad news can dodge accountability.

A poor understanding of the figures is about to infect the nation’s schools. Virtual classes are inferior for everyone, but the impact is most severe for younger children. There are over 35 million students in K-8^th grade. Their education will likely be compromised. 27 children aged 5-14 have died from Covid. These are all heartbreaking – as are the 2,793 children who have died from non-Covid causes over the same period.

Clearly teachers are more at risk, depending on age and health. A scared teacher won’t teach well, and there are legitimate cases for older teachers and those with compromised health to opt out. But with entire school districts planning for online instruction because of insufficient staff, our collective failure to understand the numbers has millions of young victims.

If you regularly visit The Covid Tracking Report, the Worldometer Coronavirus pages and Covid-19 Data from the CDC, you’ll find most mainstream news media of little use.

Instead, try Twitter where we’ve found some fact-based reporting, including by Alex Berenson, Florian Krammer, Kyle Lamb and a few others hidden behind pseudonyms such as the Ethical Skeptic and el gato malo.

We also found this quarterly letter from David Capital Partners insightful.

The reason stocks continue to march higher is because investors are collectively processing the data and overlooking the popular mood. The gulf between Wall Street and Main Street was never wider.

Californians have recently been enduring rotating blackouts – short term loss of power due to excessive demand. When the lights go out and the a/c units no longer hum, it’s always political. Oddly, both sides can agree that climate change is to blame. Liberals attribute the extended high temperatures in southern California to the gradual manmade warming that is afflicting the planet. Conservatives see a reliance on unreliable renewables as the cause – underlying the power supply shortfall was the loss of 100MW of output from a wind farm.

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Perhaps global warming is making it less windy. Environmental extremists will argue that fighting climate change is ever more urgent, while pragmatists will note that using more intermittent renewables is leaving consumers vulnerable to shortages.

What’s happening in California is important to all Americans, because it’s a preview of what an energy policy run by environmental extremists could look like if inflicted across the entire country.

For the past decade, California has been steadily pushing renewables’ share of power generation. For much of that time natural gas was easily the biggest source of electricity, since coal use stopped completely in 2015.

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But environmental extremists have been single-minded in their desire to run everything with solar panels and windmills. Although the state has not banned natural gas, it does allow cities and counties within the state to do so. Diablo Canyon, California’s last remaining nuclear power plant, will close its two reactors in 2024-25.

In 2018, California passed a law mandating 50% of its electricity to be from renewable sources by 2025, 60% by 2030 and 100% by 2045. There are no plans to build new nuclear capacity, so it looks like sun and wind will be the major source of power.

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America has been reducing its CO2 emissions, but oddly California has been lagging the rest of the country, with a slight worsening since 2011. This fact must sit uncomfortably with those thoughtful advocates of California as a leader in renewables. The problem, as anyone trying to drive around Los Angeles knows, is that transportation still relies heavily on fossil fuels. A couple of years ago when I was visiting clients with a salesperson for a couple of days, traffic estimates were critical to our meeting schedule. In fact, every meeting seemed to open with a brief chat about the 405. Automobiles and traffic jams generate a lot of California’s emissions.

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California’s renewables effort has focused on electricity, but that’s less than 14% of total energy consumption. This is why the popular image of green California isn’t reflected in reduced emissions.

The average retail price of electricity in California is 16.58 cents, versus 10.53 cents for the country as a whole. Unreliable power that costs 57% more than the average, along with a slower rate of emissions reduction, are not the hallmarks of a successful policy to combat climate change. This is where the drivers of Joe Biden’s energy policy are hoping to take us. The Biden-Sanders Unity Task Force has recommended, “…eliminating carbon pollution from power plants by 2035”. This is a decade ahead of California – because it’s going so well there.

California’s power blackouts are in part because the wind has inconveniently not been blowing when needed. This is why natural gas is such a good compliment to intermittent renewables – it’s always available. Many other U.S. states have embraced this, including Nextera (NEE), loved by environmentalists and investing in natural gas pipelines.

Energy density is another challenge that will lead to NIMBY problems.

An article in the Financial Times (see Green power needs to be dense power) compared the 950 acres required for a UK solar farm to produce 350 megawatts of power with the 80 acres to house a nuclear project with 3,200MW of output. Not only is this 9X the power output on under 9% of the land, but the solar plant is only expected to operate at 11% capacity, versus 90% for the nuclear. The power output per acre is 1,000 times lower for this solar installation compared with nuclear, a significant problem in densely populated Britain.

Any solar installation in the UK is a green extremist triumph in willful denial of the climate – but at least they’re still building nuclear plants, because they do want to keep the lights on.

California’s blackouts show what happens when climate extremists run energy policy. The silver lining for investors is that such policies lead to, and desire, high energy prices – both as a constraint on demand and also because it makes renewables less uncompetitive. Returns on energy investments tend to follow energy prices. Green policies that constrain supply need not be bad for the sector.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

As the world embraces more solar power, it turns out there are two competing visions – the traditional utility model of building solar farms for transmission to customers, and the distributed model where businesses and homes generate their own power using rooftop solar panels. One solution is likely to win, and today two highflying companies offer a sharply different way forward.

Nextera Energy (NEE), through its subsidiary Florida Power and Light (FPL), has 28 major solar plants generating almost 2 Gigawatts (GWs) of power, and plans to add 30 million solar panels (another 9 GW) over the next decade. 1 GW is conventionally believed capable of powering around 725,000 homes assuming constant load without peaks. Solar power is intermittent, but NEE is investing in battery storage too for when it’s not sunny in the sunshine state (such as at night and during hurricane season).

The FPL Manatee Energy Storage Center will have 409 megawatts of capacity (the equivalent of approximately 100 million iPhone batteries) when it begins operation late next year. NEE describes themselves as, “one of the world’s largest generators of clean, renewable wind energy, with the largest market share of North American wind capacity.” Solar was mentioned 27 times on NEE’s recent earnings call.

Tesla (TSLA) has a different vision that might well compete with NEE’s. TSLA’s $275BN market cap suggests that their electric vehicles will wipe out the traditional automakers. However, venture capitalist Chamath Palihapitiya believes that the bull story is built on TSLA’s energy business, which he notes is already profitable. TSLA offers residential customers solar panels with which to generate electricity, a battery (Powerwall) to store it, and software to manage the process. Palihapitiya believes part of TSLA’s upside lies in its ability to make every sunny home energy-independent.

It’s a compelling argument. While NEE is a leader in generating power from renewables, TSLA may lead to creative destruction of the wholesale-retail utility model that has existed almost as long as the commercial use of electricity. Solar is more likely than wind to adopt such a model – rooftop windmills seem implausible – and the sunny weather that solar farms rely on is also available to their residential customers. Utilities, with their high fixed costs and regulated pricing, are vulnerable to an erosion of their customer base, similar to the cord-cutting that has hurt cable TV providers.

My partner Henry Hoffman, author of this insightful NEE/TSLA comparison, recently invested in a home generator. Although Tropical Storm Isiasis makes this purchase look timely, his motivation was New York’s poorly conceived obsession with renewables. He chose the 22kW Generac natural gas generator.

Henry expects rolling brownouts will become more common as the NY metropolitan area struggles to meet power demand, a problem exacerbated by the pending shutdown of the 1GW Indian Point unit 3 nuclear facility next year.

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The solar devotee still needs TSLA’s Powerwall, which costs $7,167 per powerwall plus installation, to save that sunlight for the evening. Six powerwalls, costing $43K, would provide one day’s backup for a typical suburban home, on top of $22K for solar panels to charge the batteries. The solar purist would be carbon-free for $65K, plus the cost of installation.

Many homes in our neighborhood recently lost power, and the hum of generators seems more widespread than in the past. Solar panels,  plus a natural gas generator, offer the pragmatist green credentials, no intermittency, and more reliability than today’s fragile distribution infrastructure with its aboveground power lines strung from utility poles. A generator costs less than a fleet of powerwalls too.

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The way in which we’ll use the sun to generate power is not yet settled, and natural gas will continue to be the most important source. Enterprise Products Partners (EPD) delivers natural gas liquids (such as ethane) as a vital feedstock to the petrochemical industry. Regardless of the path energy markets take, plastics demand will keep rising, for which EPD is well positioned.

We are invested in EPD and all the components of the American Energy Independence Index via the ETF that seeks to track its performance.