Oneok (OKE) is developing a habit of surprising the market with their acquisitions. Last year’s deal with Magellan Midstream (MMP) was roundly criticized, including by us, because of few obvious synergies and an unwelcome tax bill for MMP unitholders (see Oneok Does A Deal Nobody Needs).  

MMP’s refined products business didn’t look like a natural fit with OKE’s oil and gas pipeline network. For a while it looked as if shareholder approval might not be forthcoming, but OKE executives eventually got it across the line. Efficiencies from the combination have turned out to be more lucrative than expected, and strong operating performance has seen OKE return 46% over the past year.  

However, the tax bill was as bad as expected. Being a long term MLP investor means an increasing deferred tax liability, and the recapture of this took all the fun out of tax time. 

OKE has returned to the acquisition trail by purchasing a controlling interest in Enlink Midstream (ENLC) from Global Infrastructure Partners (GIP), with the intention to acquire the remaining publicly traded interests in ENLC via a tax-free transaction.  

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Once again, we own both stocks, and as with MMP had no reason to consider they might combine. We had been looking at ENLC more closely than usual in the past couple of weeks and found the relative value compared with Williams Companies (WMB) sufficiently appealing that we shifted some exposure towards it.    

Casting around for a blog topic, I summarized our thought process last week (see Deciding When To Sell). Once published, I waited for the relative valuation to explode back through our entry point, exposing our timing on the switch as inopportune while providing great mirth for the blog gods. 44 years of navigating markets is enough to ensure humility comes with every buy or sell decision.  

Thanks to OKE the opposite happened. I imagine they were attracted to the distributable cash flow yield, which was 15% prior to the news. They must have been drawn to the prospects for NGL pipeline tariff savings like us but went further and identified multiple points of synergy with their existing business.  

OKE paid $14.90 for GIP’s ENLC units. There’s an expectation that the remainder of the outstanding units will be purchased at the same price, but it probably depends on how events play out in the meantime. OKE may conclude that they paid a control premium and that the remaining units can be acquired at a lower price. In any event, ENLC’s value has been more properly recognized.  

The transaction is expected to close next quarter, and OKE’s acquisition of the remaining ENLC units during 1Q25.  

ENLC is an LLC that elects to be taxed as a corporation. So although investors don’t receive a K-1, it is a holding in the Alerian MLP ETF (AMLP). Like its MLP-dedicated peer funds, AMLP will once more have to hunt among the shrinking pool of MLPs for a replacement.  

Analysts responded favorably to the transaction. Wells Fargo’s Michael Blum raised his price target for OKE from $91 to $100 since the ENLC deal, along with the acquisition of Medallion, a private crude oil pipeline and storage business, “…transforms OKE into a vertically integrated competitor in the Permian.” 

It’s quite a deal when both the acquirer and target stock rise. Over the past month both have now handily outperformed the American Energy Independence Index (AEITR). Following the successful integration of MMP last year, there’s little skepticism among investors that OKE will be able to realize synergies this time around. 

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The brief but very sharp collapse in stocks during the early stages of the covid pandemic is increasingly a distant memory. Over the past five years midstream energy infrastructure has continued to outperform both the S&P500 and the energy sector itself. Capex fell in response to some cases of overinvestment in shale plays, although Americans continues to benefit via cheap energy and higher employment. Midstream companies have stronger balance sheets and with less to build they’ve been increasing cash returns to owners via buybacks and dividend hikes.  

Existing investors know this, and yet also understand how narrowly it’s appreciated by the larger market. The energy transition continues to deter many from committing capital to traditional energy because of fears of stranded assets. This overlooks the fact that the portion of the world’s primary energy provided by fossil fuels remains consistently around 83%. Increases in solar and wind are barely enough to satisfy additional energy demand. 

 As a result, energy businesses that generate reliable, growing cashflows have generated the best returns. The S&P Global Clean Energy Index has lagged the S&P500 by 8.5% pa over the past five years, and the AEITR by 10% pa. 

The pick-up in M&A activity illustrates greater comfort in the outlook.  

From where we sit, the energy transition is going well.  

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

Investors sometimes ask us what induces us to sell a security. It’s usually because relative valuation has made one stock more attractive than another. Williams Companies (WMB) is an example. The company holds a unique position in natural gas pipelines with its Transco network running along the eastern US. They have a heavily fee-based business, regularly meet or beat earnings expectations and have paid a dividend for half a century. They handle roughly a third of US natural gas.

However, their 2024 Distributable Cash Flow (DCF) yield is below 8%, the lowest of any of their peers. Over the past year they’ve returned 37%, roughly 7% ahead of the American Energy Independence Index (AEITR). WMB is a stable company, in our opinion richly priced.

So we’ve cut our position back and purchased more Enlink Midstream (ENLC). They’re not perfect substitutes – ENLC’s $6BN market cap is much smaller than WMB’s $55BN. But we like their exposure to natural gas and NGLs in Texas and Louisiana. Their leverage is a comfortable 3.3X Debt:EBITDA giving them an investment grade rating.

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Over the past five years ENLC has repurchased 10% of their stock. They have an interesting opportunity in Carbon Capture and Sequestration (CCS) since they serve many industrial companies throughout Louisiana’s industrial corridor. Their existing pipeline network allows them the opportunity to send CO2 generated by their customers back to the geological formations from where the natural gas was extracted.

There’s an elegant symmetry in taking carbon atoms originally sourced as CH4 (natural gas, methane) being returned home as CO2. Federal CCS tax credits under the misnamed Inflation Reduction Act help.

A further appeal is ENLC’s 15% DCF yield, among the highest in the sector and with potential upside from repricing of NGL contracts (see Long Term Energy Investors Are Happy).

ENLC has trailed the AEITR index with a 12% one year return. We concluded the valuation difference between WMB and ENLC was sufficient to switch some capital.

Sometimes less is more when it comes to regulatory approvals. Following a court ruling that partially suspended NextDecade’s (NEXT) permit for their LNG export facility (see Sierra Club Shoots Itself In The Foot) their stock fell sharply. Investors reassessed the odds of completing the Rio Grande terminal, even though construction continued after the ruling.

The Federal Energy Regulatory Commission (FERC) now has to revise their previously completed Environmental Impact Statement (EIS). NEXT was planning to include a CCS capability at Rio Grande. Now in an ironic twist, NEXT has withdrawn its CCS application from FERC, because they believe this will simplify regaining the permits they already had to build the LNG terminal.

The stock staged a modest recovery but will likely return to its pre-ruling levels only once the permit issue is resolved.

Climate extremists have been effective at constraining capex which in turn has helped drive up midstream free cash flow. But they’re opening themselves up to financial exposure along the way. Greenpeace was active in opposing Energy Transfer’s Dakota Access pipeline project, which substantially raised its cost.

Kelcy Warren’s company isn’t known for avoiding conflict. So they’re suing Greenpeace for $300 million, a sum the environmental group has said represents an existential threat. This is the group whose protesters illegally board ships and oil rigs to promote their dystopian views. They oppose natural gas, the biggest source of reduced CO2 emissions in the US.

If ET does prevail in court and a life-ending settlement is imposed on Greenpeace, they won’t be missed.

In another triumph for common sense, New Zealand is tempering its reliance on renewables (see New Zealand to push through law to reverse ban on oil and gas exploration). Electricity prices recently spiked to some of the highest among developed economies.

New Zealand’s previous center-left government imposed regulatory hurdles on LNG imports, something the current center-right government also wants to reverse.

Energy Minister Simeon Brown lamented that, “The lakes are low, the sun hasn’t been shining, the wind hasn’t been blowing, and we have an inadequate supply of natural gas to meet demand.” In other words, intermittent power supply that depends on co-operative weather has been, well, intermittent.

The climate extremists who speak loudest on policy promised New Zealand cheap, carbon-free energy. New Zealanders have received the opposite, with coal use for power generation increasing to meet the shortfall. New Zealanders each generate on average around 6 metric tonnes of CO2 annually, less than Germany which styles itself a leader on climate change.

Once the permit issue for NEXT is cleared up, they might have a new customer for their LNG.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

Rivian’s R1T truck has a special storage compartment for golf clubs. Nothing else so eloquently describes the conundrum facing the auto industry. America is not an obvious market for EVs. It’s a vast place, so we drive greater distances. Gasoline is cheaper than in other developed countries. And we like big cars – two thirds of US sales are light trucks and SUVs.

Progressively tighter standards on CO2 emissions are pushing auto makers to develop EVs in order to be able to keep selling cars. Given US consumer tastes, those cars need to be big. But the golf storage capabilities of the R1T surely address a very narrow sliver of the market. I can attest that the parking lots of country clubs are devoid of light trucks. And the guys at Home Depot loading their trucks with lumber to build a deck are not contemplating how that new wedge will get them reliably up and down from off the green.

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Moreover, golf clubs are generally politically conservative. Climate change is not a common topic on the tee box or in the bar afterwards.

The golfing light truck owner more worried about global warming than his short game is a niche market.

Nonetheless I know two, and like all my friends who own EVs they love them. But each also has a traditional car to complement their $60K Tesla or $100K Rivian. EV owners always have another car.

Seven years ago Ford fired then-CEO Mark Fields because the board felt he wasn’t moving the company aggressively enough into EVs. New management addressed the problem, and so now Ford is losing $BNs on EVs. They recently dropped plans to produce an EV SUV. The writedown could be as big as $1.9BN, and they expect to lose $5.5BN this year on EVs. While bigger gasoline-powered cars are more profitable to manufacture, the reverse is true with EVs. Batteries don’t scale easily. Ford has decided to slow their EV push.

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A survey several years ago showed that car journeys are overwhelmingly short, with fewer than 5% over 30 miles. I’ve never run a car business, but it looks to me as if the auto industry is squandering substantial sums trying to build a car that covers 100% of trips, instead of producing one that does almost all of them. Range anxiety kicks in at much more than 30 miles, so although the survey doesn’t offer that detail, an EV can probably suffice for 97-98% of an owner’s trips.

Since all the EV owners I know have a second car, instead of aspiring to build an EV that renders the long distance back-up unnecessary, why don’t manufacturers offer very cheap EVs for local trips? Consumers could keep the gas-powered car in the garage, brought out infrequently for that 200 mile journey to see grandma. Offer souped-up golf carts. Or take advantage of China’s substantial support of its domestic battery manufacturing to import their cheap EVs instead of imposing 100% tariffs.

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Developing countries are demanding $TNs in transfers to help them transition to low-emission energy systems. In a neat twist, by importing Chinese EVs they would be subsidizing our energy transition rather than the other way around. Transportation sector emissions would fall. The addressable market would extend beyond the virtue-signaling residents of blue counties, and golfing light truck owners.

Public policy doesn’t treat climate change as the existential threat policymakers claim it is. Otherwise, we would freely import Chinese EVs and solar panels. The Sierra Club would be calling for a Federal regulatory structure for nuclear power that enables a vast buildout. We’d be pushing our cheap natural gas on developing countries to displace coal.

The White House hails tighter emissions standards that will, “…create good-paying, union jobs leading the clean vehicle future.”

That’s fine but admit that the energy transition is outrageously expensive and competes with other priorities.

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Ford, like the rest of the auto industry, is finding energy transition profits elusive. Tesla is the notable exception. Windpower is generating billions in losses (see Windpower Faces A Tempest) . The S&P Clean Energy Index has performed miserably over the past five years, returning 6.9% pa compared with 16.4% pa for the American Energy Independence Index.

If you want to make a small fortune investing in the energy transition, start with a big one.

Midstream energy infrastructure companies can take the tax credit opportunities created by the Inflation Reduction Act while also generating reliable cashflows from their existing business. They can selectively invest in carbon capture or hydrogen hubs where Federal largesse is sufficient to tip the economics into profitability. But there’s no existential threat to their traditional business, because energy transitions have historically taken decades. This one will too.

Many investors like us are concluding that pipeline companies are among the best ways to participate in the energy transition.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

I traveled from San Diego to Portland, OR last week and enjoyed a delicious wine pairing dinner in nearby Oswego with a group of investors. Oregon is wine country, and its residents are knowledgeable about varietals and vintages. I met some people who cultivate vines as a hobby and enjoy producing enough to fill a few five gallon jugs.

Over six courses and wines we discussed investments. Although we hold US and Canadian midstream companies, energy is a global business and many of the upside opportunities come from demand growth in emerging economies.

The Energy Institute Statistical Review of World Energy, formerly published by BP, is a rich source of data on global energy production, consumption and trade. It can be helpful to understand the broad trends at work in considering the future. An enduring theme concerns the energy transition, which pits the desire of rich, mainly OECD countries to reduce emissions against the drive for higher living standards common across emerging countries.

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Per capita energy consumption and GDP are highly correlated. Billions of people want to live like Americans, and who can blame them? The Energy Institute (EI) estimates that 750 million people don’t have access to electricity to light their homes, refrigerate their food or run air conditioning. 2.6 billion people rely on wood, charcoal, coal or animal waste for heating and cooking. They want better.

In June Pakistan experienced a heatwave that sent thousands of people to hospital and killed hundreds.

Naturally it was blamed on climate change, as is every extreme weather event nowadays.  Poorer countries are more vulnerable to a warmer climate, and yet the rational policy choice for Pakistanis is to buy more air conditioning, meaning more energy consumption. Only 6% of their electricity comes from solar and wind. That’s the problem.

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Comparing the US and China neatly captures the changes between rich and developing countries. China’s primary energy consumption passed the US in 2009, eight years after they joined the World Trade Organization, and has never looked back. China’s population is 4X the US. That reaching this milestone took so long is a testament to the penalty decades of communism imposed on its people until its leaders embraced their unique form of capitalism without democracy.

China’s per capita energy consumption remains less than half the US, which is among the world’s highest. Canada, which considers itself a leader on climate change, undercuts this claim since the typical Canadian uses 30% more energy than her American neighbor to the south. It’s because Canada is cold, with a relatively dispersed population which means more long journeys, and some energy-intensive industries such as pulp and paper along with oil and gas production.

It’s notable that China’s per capita energy consumption is now the same as the EU, with each series moving in opposite directions. The calculation is simply energy used divided by population. As OECD countries outsource manufacturing to developing ones it can flatter their emissions. But Germany is also de-industrializing as companies flee restrictive energy policies with some of the world’s highest prices.

In the trade-off between emissions reduction and GDP growth, China and the EU have opposing priorities.

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China’s total Greenhouse Gas Emissions (GHGs) passed the US in 2004. Former White House Climate Czar John Kerry used to praise China’s efforts on climate change because of their enormous investments in solar and wind. These intermittent sources provide almost twice as much primary energy as in the US. But everything about China’s energy sector is huge. They burn 56% of the world’s coal, more than 11X the US.

China’s energy policies are better viewed from the standpoint of energy security rather than the energy transition. They are reducing their dependence on foreign-sourced crude oil, because when the inevitable conflict over Taiwan happens their imports will be vulnerable to western sanctions.

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An area that gets too little attention is the enormous growth in US production of Natural Gas Liquids (NGLs). Think ethane (used to manufacture plastics) or propane (used for crop drying and in your outdoor gas grill, and for restaurants in places like Naples, FL that are unserved by natural gas).

US NGL output has grown at 9.5% pa over the past decade. We now produce almost half (47%) the NGLs in the world, up from 29% a decade ago. We export around 1.7 Million Barrels per Day of propane. Japan and China are the two biggest markets, together taking around 40% of exports.

None of this would have happened without fracking and the shale revolution. This in turn was made possible by privately owned mineral rights, a uniquely American concept that allows landowner and driller to negotiate, regulated and taxed by the state. It’s brought us to energy independence.

Another reason why this is a great country.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

2Q midstream earnings have come in mostly at or ahead of expectations. Oneok had a strong quarter and are expected to raise full year EBITDA guidance in November. Targa Resources also beat analyst estimates and raised full year guidance. Cheniere beat expectations and once again raised full year guidance, something that is becoming a regular occurrence for them.

Evidence of the AI-driven boost to natural gas demand was evident in several reports. JPMorgan now expects data center power needs to increase natural gas demand by 4.6 Billion Cubic Feet per Day (BCF/D) by 2030.

Wells Fargo has looked closely at Enlink and believes that new pipeline capacity for Natural Gas Liquids (NGLs) coming online will allow them to negotiate substantially lower prices for shipping NGLs that their Marketing unit owns. Wells estimates that they could negotiate tariffs 50% lower than at present, adding $112MM of EBITDA (i.e. +17%) by 2028.

I spent some time last week at the annual LPL Focus Conference in San Diego. Two years ago it was held in Denver, and many attendees complained about the walk from the hotel to the convention center which passed by numerous homeless drug addicts and struck many as unsafe. There were apparently some instances of assault and robbery. Next year the conference will once again be in San Diego, and I suspect Denver will no longer be on the circuit.

The area around the San Diego marina where the conference was held is very nice, with a pleasant jogging trail. My Uber driver was a happy Tesla owner and reminded me that by 2035 no regular cars will be available for sale in California. She charges it on a regular 220V circuit every night which takes 10-12 hours. Her house is too old to accommodate higher voltage and the nearest public charging station is, oddly, 30 miles from home. This means after driving the car all day it’s unavailable to go out in the evening. Tesla drivers all seem to explain away the inconveniences they endure.

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It’s always a great pleasure to catch up with long-time clients and friends. LPL is a fast-growing firm, and attendance was reported at 9,000. The conference featured several motivational presentations along with senior executives reminding advisors how important they are to the firm’s success.

Advisors on the LPL platform routinely report that they’re happy with the support and the comparative freedom they enjoy to run their businesses as they see fit. You could feel the positive energy, capped with a rousing performance by Lionel Ritchie at the Rady Shell, an outdoor theatre on the San Diego marina. The enthusiastic crowd cheered whenever the singer said the LPL name.

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Advisors attending the conference left no doubt convinced that they’re partnered with the best firm in the business and believing they can continue to add clients.

Investor Ida Zhu runs a thriving business in Seattle. As an immigrant myself I always find their stories fascinating, typically full of hard work and ambition. Ida’s was no exception.

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Clients of Aaron Irving from Carlsbad, NM have similarly benefitted from his early insights about the pipeline sector. Aaron lives in the Delaware Basin, part of the Permian Shale play, so knows first hand from local friends and clients how the energy business is doing.

Pipeline investors are pleased. Performance has been good for several years. The industry has adopted a parsimonious approach to capex, which is boosting cashflow. Few seem worried about the election. One might think an investor base that is heavily Republican would be dismayed by the improving polling of Kamala Harris. Some attribute it to the honeymoon – the relief that Joe Biden finally acknowledged what everyone else knew.

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Others don’t think the party in power will make much difference to returns from energy, which tends to follow a cycle much longer than the four year electoral one. As we’ve noted before, returns under Biden have far exceeded those under Trump. The former is good for cashflow and the latter will make production easier. For many reasons, energy investors are more concerned with the continuation of financial discipline that has prevailed for the past five years than who’s in the White House.

This optimistic outlook is supported by the fundamentals. Data center power demand growth is no longer a forecast, but is making an impact now. Given the lead time needed to add generating capacity, typically 3-5 years according to Goldman Sachs, electricity prices are set to keep rising. Last year they rose 6.2%, outpacing inflation.

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The push towards renewables is exacerbating things because solar and windpower lead to more excess capacity. Since these weather-dependent sources typically run 20-35% of the time, more dispatchable power is needed as backup. It lowers the utilization of the whole system. The oft-repeated claim that solar and wind are the cheapest form of energy is at odds with the reality of rising prices as their deployment continues.

Data center demand is also slowing the retirement of coal-burning power plants. This all supports the case for more natural gas. Cost, reliability and coal displacement are among the reasons for JPMorgan’s forecast of 4.6 BCF/D demand growth over the next six years. The outlook for infrastructure supporting reliable energy remains good.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

US natural gas and its related infrastructure isn’t the only beneficiary of the AI-driven boom in power demand. Utility stocks have been rising, as investors assess growing power demand will boost earnings. The S&P Utilities Index is several per cent ahead of the S&P500 this year.

Operators of data centers well understand the challenges they face in obtaining reliable electricity. This is coming at a bad time for grid operators, who are already struggling to incorporate renewable sources into their power mix. Weather-dependent solar and wind operate 20-35% of the time. This requires increased redundancy across a grid as they add more dispatchable power (mainly natural gas) to compensate for when it’s not sunny or windy.

Some data centers are lining up their own sources of electricity. One example is a campus owned by Amazon Web Services (AWS) in Pennsylvania that will buy power from Talen Energy’s Susquehanna nuclear facility. But the AWS data center will retain access to the grid, run by PJM, the regional transmission organization.

Electricity markets are complicated. Exelon and American Electric Power (AEP), who operate within PJM’s region, have filed a formal protest with the Federal Energy Regulatory Commission (FERC). They are challenging Susquehanna’s application for a non-conforming Interconnection Service Agreement (ISA).

It’s not possible to assess the merits of this protest from public documents. But the filing does offer insight into issues that are likely to become common areas of dispute among industrial customers, power providers and regulators.

The infrastructure that delivers electricity (ie power lines, transmission stations etc) represents a significant fixed cost that is shared across customers approximately according to how much electricity they use. Residential solar panels are already challenging this model – California no longer credits homes that send excess power back to the grid at the same price they pay, because the economics no longer work.

The Exelon/AEP protest suggests that Susquehanna is trying to connect to the grid without fully paying for its costs. It asks why the nuclear facility will synchronize its power with the grid while still claiming to be separate from it. Data centers need extremely stable power with minimal harmonic distortions, so perhaps there are technical reasons Susquehanna needs to be “synchronized” with the grid.

The protest goes on to note that another unit at the facility had an unplanned outage last year, but apparently “no load was dropped” suggesting that grid power made up the shortfall.

Exelon/AEP are telling FERC that Susquehanna wants to “…operate as a free rider, making use of, and receiving the benefits of, a transmission system paid for by transmission ratepayers while not sharing in the costs.”

Susquehanna retorts that the protest is stifling innovation. As the competition for reliable power intensifies, such disputes will become more common.

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Meanwhile, PJM recently held an auction to provide their Regional Transmission Organization Reliability Requirement for the 2025-26 delivery year. Think of this as surge capacity to be available during a heatwave or when a substantial portion of its generating capacity is down. Unsurprisingly, solar and wind represented just 2% of the responses to the auction, since they produce power when they can, not necessarily when it’s needed. Natural gas was 48%.

PJM is estimating they’ll need 2% more surge capacity than in the prior year. The auction cleared at $269.92 per Megawatt-Day, more than 9X the prior year’s 28.92 figure. Moreover, their reserve margin shrank from 20.4% to 18.5%.

This is not good news for PJM customers. PJM attributed the price jump in part to the loss of 6.6 Gigawatts of generation capacity (mostly coal) that is retiring. Because it’s not being replaced at the same rate, there’s less power available.

The North American Electric Reliability Corporation has warned grids across the country that the energy transition as it’s currently being implemented is reducing reliability and increasing the risk of power cuts.

Solar and wind are especially useless at providing surge capacity because their operators can’t be certain how much they can produce. Natural gas was almost half because it’s “dispatchable”, meaning it can be delivered when needed. It’s another example of the inferior quality of solar and wind compared with traditional energy.

JPMorgan suggested that another reason for the price jump is that power providers are holding back, skipping the auction while they negotiate long term contracts with data centers.

The hunger for power to support AI is on a collision course with plans to decarbonize our electricity. Old forecasts of modest 1% annual demand growth driven by EVs is now turbo-charged to 5% or more. Globally, added renewables are unable to even meet the increase in primary energy consumption across developing countries. In the US the Exelon/AEP dispute with Susquehanna is only the first of many.

Energy investors will be learning more than they expected about the commercial intricacies of America’s electricity supply.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

Once again a liberal activist judge has succumbed to a far-left climate extremist group. On Tuesday DC Circuit Chief Judge Srinivasan, along with Circuit Judges Childs and Garcia sent parts of a previously granted permit from the Federal Energy Regulatory Commission (FERC) back for review.  

NextDecade’s (NEXT) Rio Grande LNG export terminal was one of the victims, although FERC was the respondent in the case. Today, obtaining any number of permits from a regulator is only the beginning of the approval process. Those permits then have to withstand legal challenges from judicial terrorists whose objective is to block infrastructure projects by increasing their cost and uncertainty of completion.  

We’re invested in NextDecade because we believe providing cheap US natural gas to developing countries around the world, allowing them to grow their energy consumption with less reliance on coal, will continue to be profitable. The Sierra Club and their weird partners wrongly believe that India and other Asian countries will use more solar and wind if they can’t buy US Liquefied Natural Gas (LNG). This is not supported by the facts.  

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Coal is the single biggest source of primary energy for the Asia Pacific region. 83% of the world’s coal is consumed there, of which China is 56%. It provides 47% of that region’s primary energy and 54% of China’s. Coal generates on average 2X the greenhouse gas emissions as natural gas per unit of power generation and also generates harmful local pollution.  

If you care about climate change, you want to reduce global coal consumption.  

The Sierra Club is not pursuing policies to reduce emissions. As well as opposing natural gas to displace coal they are against nuclear. They’re obstructive to the real work and are nothing more than a bunch of virtue signaling loony leftists. They are weird.  

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It’s unclear how this will play out. On the same day as the court ruling which affects Trains 1-3, NEXT filed an 8-K with the SEC disclosing an agreement with Bechtel to build  Train 4. The company hasn’t yet responded to the court ruling other than to say construction continues on the first phase. 

NEXT has some big customers lined up to buy its LNG, including Shell and Exxon Mobil. TotalEnergies is a strategic partner, with a stake in NEXT and an agreement to buy its LNG. The ruling requires FERC to issue a revised Environmental Impact Statement (EIS), in part because the environmental justice rights of some nearby residents are at risk of being compromised. Specifically, the court found that they, “…may experience significant visual impacts, as well as significant cumulative visual impacts.”  

The Rio Grande LNG terminal is being built alongside the ship channel in Brownsville, TX, so it’s this view that will be impacted. I don’t know what else you’d expect to see along the Brownsville Ship Channel other than energy infrastructure. It seems to me like buying a house near an airport and then complaining about the noise.  

There’s no indication from FERC how quickly they will respond to the ruling and how long a new EIS will take.  

Large holders of NEXT include York Capital Management, Blackrock and even Marc Lasry (co-founder of Avenue Capital, a distressed debt firm). Lasry is a well-known Democrat party fundraiser and has often drawn criticism from the weirdos at the Sierra Club for his investments. It’s an example of how fringe they are. 

On Friday Ukrainian troops captured a key gas transit point supplying Europe as part of their incursion into Russian territory. Ukraine released a video of their troops at Gazprom’s Sudzha gas measuring station. US LNG provided vital supplies to Europe following Russia’s invasion of Ukraine. They still rely somewhat on Russia, some of which passes through Sudzha. European energy officials will have been made acutely aware of how tenuous that remaining supply is. America can be a reliable source. 

Between the LNG buyers and investors there are some deep pockets who want to see the Rio Grande project through. We think that’s the most likely outcome, although the election adds some uncertainty. 

New energy projects are less likely, which raises the value of existing energy infrastructure. Democrats have unwittingly been good for energy investors by discouraging investment in new supply. A President Harris probably wouldn’t be a supporter of new LNG, although she might note that swing state Pennsylvania will likely provide its throughput.  

Under Kamala Harris, pipeline companies would have even less reason to boost capex, which will in turn drive up free cashflow.  

Alan Armstrong, Williams CEO, has commented that they see less competition than in the past for new business. Energy Transfer and Cheniere each raised full year EBITDA guidance again when they reported earnings last week. Sierra Club policies will further strengthen their dominant market positions.   

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

It looks like a big margin call started in Japan. The Japanese Yen has become a funding currency in recent years, a source of cheap financing with the proceeds reinvested in better returning assets – such as US$ listed AI stocks. Debtors benefit when the currency in which they’ve borrowed depreciates. The Yen offered low borrowing costs and a lower value – until it didn’t.

The proximate cause of the unwinding of this carry trade was the Bank of Japan’s modest 0.15% tightening last week. Friday’s weaker than expected US unemployment report was quickly interpreted as signaling a growth scare. The subsequent Friday-Monday sell off looks far more than is warranted by the data but has nonetheless triggered calls for a 0.50% cut in September, with another by December.

Perhaps big bank economists at JPMorgan and Goldman Sachs were sufficiently shocked by the carnage that they felt compelled to align their own revised forecasts with the market drama. Or maybe they expect the Fed will feel compelled to act on the market’s sudden swing from manic to depressive.

What hasn’t received much attention is that the market was far from cheap, a state that has steadily worsened during the year.

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S&P500 earnings forecasts for this year and next have been trending sideways and are barely changed from a year ago. Stocks have risen largely on multiple expansion. The Equity Risk Premium (ERP, defined here as the S&P500 earnings yield minus the ten year treasury yield) slipped to 0.1 on July 16, when stocks made another high.

This is the lowest in over two decades, and essentially means that an investor eschewing bonds in favor of stocks with virtually no yield pick-up was fully relying on earnings growth to compensate for the increased risk.

Put another way, with forecasts of long term equity returns in the 6-8% range, riskless treasury bills yielding 5.3% look competitive.

The subsequent drop in equity prices and bond yields has improved relative value somewhat, but stocks remain historically unattractive on this measure. The great unwinding of the carry trade came, as these things usually do, at an inconvenient valuation point.

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By now long-time readers are asking themselves when your blogger will explain what this means for energy stocks, especially midstream. Those long-time readers should know that the answer will soothe any concerns they might have about retaining pipeline stocks during a tempestuous market.

Start with leverage. Pipeline stocks have been paying down debt, such that large US c-corps and MLPs have Debt:EBITDA below 3.5X, in many cases on a path to 3.0X.

Dividends are comfortably within discretionary cashflow, covered by around 2X. 2Q earnings so far have been good. Targa Resources and Plains All American both raised FY guidance. Williams reaffirmed towards the high end of their 2024 range. Oneok reported good earnings. Two weeks ago Kinder Morgan provided an encouraging update on AI-driven natural gas demand.

It’s become normal for midstream earnings to meet or gently exceed expectations, and for Cheniere to do rather better.

Over the past decade US primary energy consumption has grown at 0.6% pa. Apart from during the pandemic and subsequent rebound, year-on-year changes are 1-2% or less. Commodity prices may gyrate wildly, but volumes are remarkably stable.

The outlook for natural gas demand continues to improve. The combination of AI and increased reliance on intermittent renewables means more natural gas – both because solar and wind can’t easily provide electricity with low harmonic distortions that delicate data center kit needs – but also because as unreliable power sources infiltrate the grid, assuring 24X7 supply relies ever more on dispatchable, traditional energy. Which is gas.

The unraveling of the Yen carry trade hasn’t changed any of this. Nor has midstream been a notable beneficiary of the leveraged speculator’s buying, meaning there’s little if anything to unwind.

Over the long run stocks are far more likely than bonds to preserve purchasing power. This is especially so if inflation eventually settles closer to 3% than the Fed’s 2% target. But the ERP relative valuation suggests little need for haste in committing cash. The exception is energy, where we believe the prospects are compelling.

As a reminder of the challenges in making money from renewables, Sunpower (SPWR), once a venerated solar power company with a $9BN market cap, filed for bankruptcy. Pipeline companies keep generating cash and are benefiting from energy transition subsidies from the Inflation Reduction Act.

If you have cash ready to commit, we think now is a good time to put some of it to work in midstream.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

US natural gas is the cheapest in the world. December TTF futures on the European benchmark are $13 per Million BTUs (MMBTUs). The Asian JKM benchmark is $12.50. The US Henry Hub December futures are at $3.15. Fracking has become ever more efficient, allowing production to continue even at prices that seem ruinous.  

Range Resources (RRC), a natural gas producer in the Marcellus and Utica shales in Pennsylvania, is expected to generate net income of over $400MM this year on a realized sale price of $2.60 for its natural gas. JPMorgan forecasts $750MM next year at $3.30. A few years ago such low prices would have been thought unsustainably low.  

Cheap natural gas has been a huge boon for America. It underpins our cheap electricity, although increasing reliance on solar and wind is offsetting (see Renewables Are Pushing US Electricity Prices Up). Gas-fired power generation recently hit a new record (see Cash Returns Drive Performance).  

Gas remains our biggest source of electricity, and by displacing coal plants has been the most important contributor to falling US CO2 emissions. Cheap, reliable energy has attracted foreign investment, creating jobs while western Europe cuts emissions by de-industrializing.  

Horizontal drilling and hydraulic fracturing (“Fracking”) unlocked enormous supplies of US oil and natural gas. Kamala Harris used to be against fracking, but like Joe Biden did before, has now changed her position given the importance of swing state Pennsylvania in November. 

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How long can gas stay this cheap? Investors Leigh Goehring and Adam Rozencwajg think the turn in prices is near. Their reasons begin with declining growth in production, coinciding with some large fields having produced half of their recoverable reserves. They think the Energy Information Administration’s (EIA) production forecast of 105 Billion Cubic Feet per Day (BCF/D) next year is too optimistic.  

The demand side starts with Liquefied Natural Gas (LNG). The price gap between US and foreign markets is easily sufficient to support LNG exports – currently running at 12-13 Billion Cubic Feet per Day but soon to rise as new export terminals become operational. They see an additional 5 BCF/D within three years. Other forecasts expect a doubling by 2030.  

AI data centers’ need for power will rely substantially on natural gas. This isn’t just because it’s reliable, not dependent on sunny weather. Electricity from solar and wind includes more harmonic distortions which can be unsuitable for the sensitive hardware use by AI models. There are technologies to reduce such distortions but they add cost.  

Power demand is already increasing. The Southern Company, which supplies electricity to Virginia, reported that demand from existing data centers was up 17% in 2Q24 compared with a year earlier.  

Natural gas bulls have endured plenty of false starts in recent years, other than the spike that followed Russia’s invasion of Ukraine two years ago. But circumstances may finally be aligning to push prices higher. It looks like an appealing bet.  

Complicating this outlook is the narrowing polling gap between Trump and Harris. Betting markets still favor Trump although his lead has halved. Energy markets have been attuned to the fluctuating outlook, with the S&P Global Clean Energy index a useful barometer for the odds of a Trump victory.  

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The spread in relative performance between the American Energy Independence Index (AEITR), or traditional energy, versus renewables, peaked just before Biden withdrew from the race. Since then it’s narrowed – it’s either the Harris Honeymoon or relief that it’s no longer a duel between two old men, depending on your perspective.  

Kamala Harris is left of Biden – chosen in part to secure the votes of progressives four years ago. So she’s not obviously good for energy investors. But as with Biden, the actual effect could be nuanced. Left wing energy policies tend to focus on constraining energy supply rather than demand, with the hope that renewables will benefit. It discourages new capex as we’ve seen under Biden (hug a climate protester).  

Republican policies favor deregulation, making it easier to produce oil and gas.  

One way to think of it is that Republicans are good for domestic output while Democrats are good for prices. Crude oil is a global market and forecasting how a President Trump might affect prices means assessing policy choices towards Iran and Russia. 

But natural gas exists as regional markets, so US prices will be driven by domestic considerations. Restricting supply will be hard, but limiting demand will be harder. Owning natural gas producers, such as RRC, may be a hedge on a Harris election win. If it happens, energy investors may feel they’ll need something to cheer them up.  

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund

One casualty of the shale revolution was the MLP financing model. The General Partner (GP) would typically direct its MLP to finance assets that were “dropped down” from the GP. MLP capex and M&A more than tripled from 2010 to 2015. Cash returns too often came up short of those promised, and investors lost confidence in many management teams’ ability to generate a Return On Invested Capital  (ROIC) above their Weighted Average Cost of Capital (WACC).

Stock prices fell, MLPs converted to c-corps with distribution cuts led by Kinder Morgan, and midstream capex fell by more than half. Many management teams responded with greater discipline on new spending, and cash returns on capex started to rise. In some cases the improvement was dramatic. Wells Fargo calculates that Williams Companies (WMB) generated a 20.0% ROIC over the past five years, almost double the 10.3% they earned during 2013-18 period.

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Targa Resources (TRGP) jumped from a miserable 6.2% to 20.1%. Former CEO Joe Bob Perkins used to call their capex opportunities “capital blessings”, to the frustration of sell-side analysts who didn’t feel very blessed. But the improved ROIC of recent years is behind the stock’s strong performance.

Industry capex remains well below the 2017-19 peak. The question for investors is whether a Trump victory will cause a resurgence in the optimism that led to higher spending and disappointing results.

One area where this is already happening is in more natural gas to support AI data centers. Wells Fargo estimates that WMB is investing $1.3B of capex into SESE at a 5x return, meaning when completed it’ll generate EBITDA of around $260MM annually, a 20% ROIC. Kinder Morgan (KMI) is investing $1.5BN into their SNG South System 4 expansion project at a 6X multiple (~18% ROIC). Both projects will help meet the increasing need for electricity from the AI boom.

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KMI missed expectations on earnings last week, but the stock nonetheless rose because of the SNG news. Investors looked ahead to the accretion from this and up to 5 Billion Cubic Feet per Day of growth opportunities. The irony is that KMI is among the worst allocators of capital in the sector. Wells Fargo calculates a five year trailing return of only 1.4%. The five years prior was 4.0%.

Several years ago we engaged KMI on this topic (see Kinder Morgan’s Slick Numeracy). Their chronic misallocation of capital dates back to when Kim Dang was CFO. She’s now the CEO, and when appointed last year promised to maintain “business as usual.” The stock’s positive response to AI power demand reflects a hope that Dang is a better judge of accretive projects than in the past.

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Over the past five years the market has favored companies with above average skill at deploying capital. KMI could benefit from the Targa Touch.

Proponents of windpower will be disappointed to have seen that wind output reached a 33-month low recently. Fortunately, natural gas made up the difference when hot weather boosted demand for air conditioning. Output from gas-fired power plants of 6.9 Terawatt Hours (TWhs) was, according to the Energy Information Administration “probably the most in history.”

The poor wind output is even more disappointing when you consider that we keep adding capacity. Last year wind generated 425 TWhs, down 2.1% from 2022. We have 147.5 Gigawatts of capacity which is theoretically capable of producing 1,292 TWhs annually (i.e. 147.5 X 365 X 24). So US wind operates at around 32% of capacity.

This is why it’s so misleading when progressives assert that renewables are cheap. They ignore the weather-dependent intermittency of solar and wind whose growth increases the need for excess capacity to compensate. It’s one reason why US electricity prices are rising even though the price of natural gas, which is the biggest source of power, remains low. Grids with more renewables need greater redundancy for when it’s not sunny or windy.

France gets about two thirds of its electricity from nuclear power. This is a constant reminder that carbon-free energy is available to other western governments able to design an approval process that allows predictable outcomes. Currently, constructing new nuclear exposes investors to the uncertainties of persistent legal challenges, making it hard to project IRR.

The CEO of France’s EDF recently complained about excessive subsidies for solar, which are distorting electricity markets by forcing EDF to buy solar power under the country’s complicated rules. They’re planning to add six new nuclear plants, although the recent French election has left political support unclear.

US energy policy is not perfect but has mostly avoided the distorting effects of blindly embracing renewables that is seen in many European countries.

We have three have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

Real Assets Fund