NextDecade (NEXT) has drawn plenty of investor questions over the past ten days. It began with their most recent 10Q, filed with the SEC on May 13^th. The phrase, “... there is substantial doubt about the Company’s ability to continue as a going concern.” wasn’t pleasant reading for many. How can a company that reached Final Investment Decision (FID) on trains 1-3 for its Rio Grande LNG export facility last year have any doubts about its survival?

Investors initially looked past the company’s reiteration that it has secured funding for Stage 1 (Trains 1-3). The “going concern” language referred to Stage 2 (Trains 4-5) which is not financed and hasn’t yet reached FID.

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The stock swung wildly over the two trading days (May 10-13), covering a range from $7.41 to $6.37. On Tuesday 14^th it recovered strongly, perhaps as investors reassessed.

Our opinion remains that the market is giving little if any credit for the economics of Stage 2. The costs of completing Trains 4-5 should be lower than 1-3 because the site will have already undergone its initial preparation. So we think it’s undervalued. However, the company disappointed investors when they reached Stage 1 FID last July because they wound up with only 21% of the economics.

My partner Henry and I often debate how to assess this. I think they negotiated poorly. Global Infrastructure Partners (GIP) and TotalEnergy outsmarted them. No doubt capital and offtake agreements are vital to the project. But if you’re acquiring the land, capital, infrastructure partner and customers it seems that should be worth more than a fifth of the resulting business. NEXT had led investors to expect a 30%+ share, so on this they disappointed.

The counter, as Henry points out, is that they’re in a much stronger position to negotiate over stage 2 where we expect them to achieve a higher share than Stage 1. Even though Stage 2 is two trains versus three in Stage 1, it’s plausible that Stage 2 could be more valuable.

The LNG permit pause, ill-advised though it is, has helped NEXT. This is because, crucially, they have permits for Stage 2 already. Energy Transfer, whose planned Lake Charles LNG project is currently hostage to the pause, has seen negotiations slow because of the uncertainty. Japan’s Minister of Economy, Trade and Industry Ken Saito has sought clarification since Japanese companies are among the potential customers.

NEXT is not impacted by this. As if to demonstrate, on Monday they announced a 20-year 1.9 million tons per annum offtake agreement for Train 4 (ie Stage 2) with ADNOC of the United Arab Emirates. ADNOC additionally acquired an 11.7% stake in Stage 1 through GIP.

NEXT’s 10Q reminded that they plan to resolve the going concern issue by, “obtaining sufficient funding through additional equity, equity-based or debt instruments.”

This deal didn’t raise any equity for NEXT, so the possibility of a secondary is still there. But it did provide welcome confirmation of Stage 1 economics for the current investors.

NEXT hopes to reach FID on Train 4 later this year.

Deals can get done before FID has been reached on a facility, as NEXT has shown repeatedly in recent years. Permit uncertainty is a more difficult hurdle to overcome.

The contrast with Tellurian (TELL) is stark. Former CEO Charif Souki pursued deals that let TELL retain natural gas price exposure, a risky approach that made it impossible to obtain financing. Agreements expired as TELL failed to make progress. Souki left a job that had already awarded him success bonuses even though he hadn’t been. He was better at negotiating payment for performance in advance than in making TELL successful (see What’s Next For Tellurian?).

In other news, JPMorgan reiterated their bullish outlook on Cheniere (CEI) with its 11% Distributable Cash Flow (DCF) yield and highly visible cashflows. One of my favorite charts is from Wells Fargo where they rank companies in the sector based on what percentage of EBITDA they need to reinvest as maintenance capex.

CEI is top on this metric. LNG terminals don’t require much spending to preserve their functionality.

Earnings for the sector generated few surprises other than CEI’s predictable beat of expectations. Midstream energy infrastructure businesses are generating steadily increasing cashflow. Yields betray that a substantial percentage of investors remain skeptical. Fund flows are modestly positive but there is no irrational exuberance evident. Energy is the best performing S&P sector for the past three years, but to us it still looks like we’re in the early innings.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Ominously for President Biden, opinion polls consistently show voters are unhappy with his economic stewardship. The surge in inflation in 2022 didn’t help, but after believing it to be transitory the Fed responded and it’s now back down. Wednesday’s 3.4% CPI figure isn’t yet at the Fed’s 2% target but is close enough that the difference shouldn’t be discernible for the typical consumer.

And yet 22% of voters identify inflation/prices as their most important issue, according to a recent Brookings poll. Inflation feels higher than 3.4% to many people.

Part of the reason is that inflation calculations assume a basket of goods and services of constant utility. This anodyne term means the Bureau of Labor Statistics (BLS) adjusts for quality improvements. A better iphone gives you more utility. More iphone for the same money is a price reduction under this construct.

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The chart shows the difference. Average smartphone prices are up 72% over the past five years. But adjusted for their enormous quality improvements, the BLS find that they’re down 54%. They’re called hedonic price adjustments.

This is an extreme example, but it illustrates the point. Household income isn’t up 72% over the past five years, and since it’s impossible to live without a smartphone they are commanding an increasing share of disposable income. We’re all benefitting from increased utility since today’s smartphones are better, but few of us recognize that increased utility or can figure out what to do with it.

It just means that what the BLS is measuring doesn’t correspond with how we experience the purchase of goods and services. We have written on this subject before (see  Why You Shouldn’t Expect A Return To 2% Inflation, Why It’s No Longer Enough To Beat Inflation and Why You Can’t Trust Reported Inflation Numbers).

The energy transition is inflationary. It’s taken a long time for this to become clear because Democrats have long clung to the shibboleth that moving towards renewables would create well paid union jobs while exploiting the fact that solar and wind are cheaper than natural gas.

It’s now clear this was never true.

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US electricity prices have moved sharply higher over the past two years, from 15.1 cents per Kilowatt Hour to 17.3 cents.

The trend over the past couple of decades has been for natural gas to displace coal, because it’s cheaper. Renewables have been gaining market share as a policy choice, often driving additional demand for natural gas to compensate for their intermittency.

Incidentally, the relative stability in annual electricity consumption of around four terawatt hours since 2000 is about to change as data centers for AI come online (see AI Boosts US Energy). This will also push natural gas demand higher over the next few years.

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More weather-dependent electricity requires increased spare capacity for when it’s not sunny or windy. This reduces the capacity utilization of the grid (see Renewables: More Capacity, Less Utilization and Management Stumbles; Getting Less From Our Power Sources).

The energy transition causes inflation directly through higher electricity prices. The Inflation Reduction Act, which does the opposite of its title, is a huge source of energy subsidies. It’s intended to reduce CO2 emissions and is likely to cost over $1TN in fiscal stimulus.

Paying more for energy in order to reduce emissions isn’t necessarily a bad thing. Democrats have opted not to argue that green costs more because it’s good for you. But achieving lower CO2 underpins public policy in OECD countries to varying degrees. An economist might say that this brings greater utility. Carbon-free electricity that costs more might even cost less following a hedonic quality adjustment from the BLS.

It’s tempting to predict that the BLS will apply their statistical magic to energy prices, ameliorating price increases to reflect greater utility (ie lower emissions). A Democrat White House would surely love this, although it’s too late to make an impact before the election. But it’s unlikely, because the value of reduced emissions is unknown, and it would too easily appear politically motivated.

But it could provide a reason for the Fed to relax their 2% inflation target. There’s not much point in spending $TNs to reduce emissions if monetary policy responds by increasing the cost of capital for the long-lived assets the energy transition requires. Several years ago the Fed acknowledged an asymmetric inflation target, in that they’ll now tolerate it above 2% for a while. There’s no chance the Fed would then seek <2% inflation to bring the average lower. So we should already anticipate inflation above 2% over the long run.

This will also ease the burden of our looming fiscal catastrophe. The baby-boomer driven climb up the CBO’s steep wall of indebtedness has already begun. Tight monetary policy is making it worse via higher interest expense on outstanding debt (Our Darkening Fiscal Outlook).

Prudence dictates that investors plan for the Fed to accept inflation generally above their 2% target. All we’re waiting for is to see how they justify it.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Costa Rica, a central American country of five million, has a proud history of strong environmental policies. Their electricity comes almost entirely from renewable sources. Hydro is 73%, with geothermal providing most of the rest. Solar and wind are minor. Over the past decade they have reduced oil from 12% to virtually zero.

Costa Rica’s success in moving to a power grid free of fossil fuels is hailed as an example to emulate by those who would have the rest of us forego reliable energy. A year ago Spain’s University of Navarra praised them for, “driving the global commitment to overcome hydrocarbons.”

The thinking goes that if relatively poor Costa Rica (per capita GDP $18K) can do this, rich countries like the US ($85K) or groups like the EU ($42K) should be able to with their greater resources.

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Except that Costa Rica introduced power cuts this week. The country is enduring a drought, which some blame on El Nino. Reservoir levels are low, and so is power from hydro. Customers have been told to expect daily outages of two to three hours.

Neighboring countries like Nicaragua or Panama that might normally provide electricity are struggling with the same problem, so don’t have any excess. Ecuador is also rationing electricity, and Bogota, Colombia’s capital, is rationing water.

If it rains normal service may resume within a week. It is their rainy season. Weather-dependent power can fail to deliver. The last time they had outages was in 2007.

There are virtually no oil or gas power plants able to pick up the slack. Their rejection of dispatchable energy is absolute. However, Costa Rica’s President Rodrigo Chaves is less enamored of past policies and has suggested they may wish to develop domestic natural gas reserves. Many of their political leaders believe they need to diversify their sources of energy.

Costa Rica generates 16 million tonnes of CO2 equivalent annually, around 0.04% of the world’s total. So it’s safe to say that any energy policy the country followed would have an inconsequential effect on global emissions. ClimateActionTracker rates countries based on their efforts and is a tough grader. They rate Costa Rica “Almost Sufficient”.

As to whether their example is inspiring similar selfless efforts by others, such an evaluation is inherently subjective. However, we’ll go out on a limb and postulate that China, where new coal plants are being added roughly every three weeks, is not inclined to follow Costa Rica’s lead.

Their citizens will suffer the consequences of undiversified energy sources without changing global emissions through deed or example. Nonetheless, it is by all accounts a wonderful place to visit, and if Costa Ricans find power outages an acceptable price to pay for a little virtue-signaling, their tourists will probably agree.

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Coal consumption for electricity generation continues to fall in the US, setting an example for developing countries to follow. It’s how we’re reducing emissions. Natural gas continues to replace coal in providing baseload power. Meanwhile net exports of coal were the highest in five years, providing further evidence that the Administration maintains an ambivalent posture on climate change.

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Earlier this week I had the great pleasure to catch up with long-time investors Ian Dietz and Paul Morse from Alliance Global Partners in New York, along with Justin Morcom, our Catalyst regional sales partner. There’s a steady drumbeat of unfortunate stories that contribute to some New Yorkers feeling less safe than before the pandemic. I found midtown Manhattan to be unthreateningly normal on a weekday lunchtime.

Clients are drawn to midstream energy infrastructure by the 6% yields, augmented by dividend growth (2-3%) and buybacks (1-2%) that in our opinion offer a reasonable prospect of a 9-11% pa total return. It’s safe to say that clients of Dietz and Morse have done well out of their advisors’ early insight into the sector’s potential.

We had much in common during our lunch, including a bullish outlook for the sector.

EV’s are seeing tepid US growth. Inadequate charging infrastructure and poor battery life are dissuading buyers who just want to reliably get from A to B.  Many would be surprised to learn that crude oil demand is on track to set another record this year of around 103 million barrels per day. Gasoline demand from developing countries and global aviation are two important drivers. Slowing EV demand is another.

As recently as last year the International Energy Agency was predicting that global gasoline demand had peaked in 2019, pre-pandemic. Like many of their forecasts, this one has been revised.

Natural gas demand growth adds to the positive outlook – over the next six years LNG exports will require an additional 12 Billion Cubic Feet per Day (BCF/D) as new terminals come online. Data centers could take another 6 BCF/D for increased electricity.

Midstream energy infrastructure is well positioned to keep providing more of what the world wants — reliable energy.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Energy Transfer (ET) is the pipeline company most often directly owned by the financial advisors we talk to. It seems perennially cheap, and that’s in part due to their controversial history of at times treating themselves better than their other unitholders. They’ve provided plenty of material for this blogger to note how management always seems to get the best deal.

When the GP-MLP structure prevailed, Energy Transfer Equity (ETE) controlled several MLPs. Investors in all of them suffered distribution cuts, except ETE which was coincidentally the preferred vehicle of then-CEO Kelcy Warren and other senior executives (see Energy Transfer: Cutting Your Payout, Not Mine). They did eventually cut their distribution in late 2020 under pressure from rating agencies but have since fully restored it plus some.

Eight years ago Energy Transfer was engaged in an ill-fated pursuit of Williams Companies (WMB). After reaching an agreement and concerned about the increased leverage embedded in the deal from the cash portion, Kelcy Warren had second thoughts. They issued a special class of convertible preferred securities just to ET insiders which diluted the value of the deal so it fell apart. An adverse tax opinion helped (see Will Energy Transfer Act with Integrity?). WMB sued and finally won $495MM in damages last year.

With the deal canceled, many expected the offending convertible preferreds to be canceled, since their purpose had been served (see Is Energy Transfer Quietly Fleecing its Investors?). Their terms allowed owners to reinvest dividends at the original issue price, an attractive feature that further diluted the rest of the shareholders.

A class action lawsuit followed. A client of ours was even asked to testify. It seemed obvious that the offending securities would be canceled by order of a Delaware judge. But the company prevailed by arguing that their issuance had preserved the distribution on the common equity for everyone else. The court victory didn’t mean they’d acted fairly. ET’s stock has long been weighed down by fears that management will put their own interests ahead of unitholders again.

The company never avoids a fight. Their construction of the Mariner East pipeline in Pennsylvania resulted in numerous regulatory infractions. ET eventually pleaded “no contest” to environmental and other charges, which under state law presumes they’re guilty.

In 2016 protesters tried to block completion of ET’s Dakota Access pipeline, needed to transport crude oil to Illinois. This was a case of opponents trying to overturn already approved permits, an all-too-common problem that is impeding many types of new infrastructure. Critics accused the company of taking a bare-knuckle approach to resolving the conflict. North Dakota is suing the Federal government for the $38MM cost of policing the protesters and subsequent clean up.

WMB wants to build a natural gas pipeline that will cross an existing one owned by ET in Louisiana, and the company has refused permission. Many think it’s simply an effort to impede competition. ET has cited safety concerns. WMB said last week they expect to prevail in court.

You get the picture. ET doesn’t back away from a fight. When the stock was languishing below $10, I wondered if they’d engineer a management buyout at some modest premium, capturing substantial value themselves from a too-cheap stock price their own actions had created. Were we incurring the downside risk but with only limited upside, like a put option?

At one time this curbed our enthusiasm for the stock.

I’d have bet they tried to take the company private, but even back then at ~$30BN equity value plus debt it would have been challenging to line up sufficient capital.

Kelcy Warren stepped back from the CEO role in 2021 but is still Chairman. Mackie McCrae and Tom Long now split the CEO-role. The management team knows how to run their business, and the stock has responded accordingly. Over the past year it’s returned 42%. 1Q24 EBITDA beat expectations by 5%. They raised FY 2024 guidance by $0.5BN and increased their dividend, both by around 3%. The self-dealing reputation earned by convertible preferreds is a receding sour memory, but they retain their “in your face” posture.

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ET still looks cheap to us. They’re guiding to $15BN of EBITDA this year with a market cap of $53BN.

Earnings for our portfolio companies were largely at or ahead of expectations. Data centers to support AI growth figured prominently in subsequent conference calls. With another 12 Billion Cubic Feet per Day (BCF/D) over the next six years for LNG and increased consumption of natural gas for domestic power generation, Citibank thinks this could require 20 BCF/D or more of domestic production by 2030.

NextDecade stock was strong last week. We continue to think the market isn’t pricing in trains 4 and 5, which are already permitted and therefore not subject to the recent pause on new LNG permits. We are hearing reports that Administration bureaucrats are finding other ways to frustrate new LNG exports. It’s bad energy policy and prevents Asian buyers from reducing coal use. But it’s good for NEXT because they still have some remaining export capacity to contract out. We understand negotiations are progressing well, with a go-ahead decision on train 4 possible next quarter.

Lastly, the White House confirmed its ambivalent approach to the energy transition by increasing tariffs on Chinese EVs. Achieving the widespread adoption Biden says he wants will require cheaper EVs, because recharging is inconvenient. Progressives must realize that he’s not genuinely concerned about climate change, just the political posturing it requires.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Earnings season for midstream energy infrastructure has been wonderfully devoid of excitement for many quarters. These companies just keep churning out more cash, typically within a few percent of expectations.

The exception is Cheniere (CEI), where earnings often come in substantially ahead of sell-side estimates. 1Q reported EBITDA beat by 12.5%. The company spent $1.2BN repurchasing stock and continued at about the same rate in April. They are moving towards self-financing their LNG terminal expansions and prioritizing debt paydown.

Cheniere’s stock has been a surprising laggard this year. It remains one of our highest conviction names. The most effective way the US can reduce global emissions is to export more natural gas to emerging economies, displacing coal the way it has in this country.

Cheniere is best positioned to profit from this opportunity.

Last week on my mid-west trip several investors asked me what risks the sector faces. The pandemic caused the worst sell-off any of us could have conceived, albeit a brief one.  A recession would inevitably depress prices along with the rest of the equity market. And yet, reduced leverage and capex along with greatly improved dividend coverage mean we’d enter any downturn in much better financial shape than in the past.

There’s always downside risk, but more robust balance sheets should offer greater resilience.

EBITDA at Plains came in 3.5% ahead of estimates, helped by higher tariffs on crude pipelines. Their stock has returned 50% over the past year.

TC Energy (TRP) beat expectations by 3.5% with all segments doing well led by natural gas pipelines. Their Coastal Gas Link (CGL) pipeline will soon be sending deliveries to LNG Canada in Kitimat, British Columbia for export to Asia. Like CEI, TRP has lagged the market although for different reasons – the size of their capex program continues to weigh on the stock.

However, the company did place $1BN of projects into service during 1Q24, most of which was CGL. They’re guiding to $8-8.5BN in capex this year. Along with Enbridge, the Canadians are bucking the trend towards lower spending on new projects. TRP is -2% YTD.

Williams Companies beat estimates by 8%. The stock has returned 14% YTD.

In their weekly research note Wells Fargo highlighted the growing value of natural gas storage assets. Increased consumption of natgas isn’t being matched with commensurate additions of storage capacity, which is pushing rates up.

Wells Fargo estimates monthly storage rates have doubled over the past three years, to around $0.19 per thousand cubic feet. Williams Companies, Kinder Morgan and Energy Transfer are among those best positioned to benefit.

Renewables growth is contributing to storage demand, because increased reliance on intermittent energy means more natural gas must be held available for power plants when it’s not sunny and windy. And climate extremists are opposed to any new infrastructure that supports reliable energy.

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It’s fair to say the energy transition has been better for investors in traditional energy than renewables. Since the end of 2019, just prior to the pandemic, the American Energy Independence index (AEITR) has returned 15.5% pa versus only 5.4% pa for the S&P Global Clean Energy Index.

Investors in BP expect the company to scale back its climate targets. It makes little sense for them to produce less of what people want to buy until demand drops, which it is not. We noted this the other day (see Former BP Geologist On Energy). One investor said of investing in renewables, “returns are not there.”

It’s because proponents have wrongly claimed that renewables produce cheap energy, whereas electricity prices are rising wherever solar and wind gain share, including in the US.

The WSJ referred to “energy transition fatigue” in Households Wince at the Rising Price of Going Green. The article provides a lengthy list of costly surprises. Most notable is the Parisian who found that new energy efficiency rules forced him to spend €50K ($54K) on remediation before he could sell his apartment.

That’s what progressive policies will bring to the US if we don’t pay attention.

A couple of months ago we noted how environmentalists oppose any infrastructure, even when it’s new power lines to bring solar and windpower to customers (see Renewables Confront NIMBYs and watch America’s Looming Power Problem). A Federal judge had issued an injunction to invalidate a permit, preventing the last mile of a 102-mile project from being completed.

Last week a three-judge US appeals court overturned this injunction, allowing the project to be completed. It just shows that permitting for infrastructure projects needs an overhaul. If a developer can’t rely on previously issued permits from a government agency, nothing will ever get done. Climate extremists should especially want this because increasing our use of renewables will require substantial new infrastructure.

The energy transition is going pretty well.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

I traveled through Indiana last week. A day and a half of meetings in and around Indianapolis were followed by a drive south for an afternoon at Churchill Downs in Kentucky. If you’re lucky enough to be invited to a Jockey Club hospitality suite, a good time is guaranteed. Tye Uppinghouse, our Catalyst Mutual Funds regional partner, was once again a gracious host. I concluded my trip in Miamisburg, OH.

I always enjoy meeting our clients and prospects. America’s heartland is conservative and welcoming. The Hoosier state has yet to legalize medical marijuana, and one advisor I met predicted recreational use was at least a decade away.

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Recent earnings news from pipeline companies has been positive. Enterprise Products Partners raised their distribution by 5.1%, now 1.7X covered by distributable cash flow. Oneok raised 2024 guidance due to strong volumes in natural gas and synergies from last year’s acquisition of Magellan. Earlier this year they announced a 3% dividend increase.

A week ago, Targa Resources raised their dividend by 50%.

These three companies provided current evidence of the industry’s steady return of cash to shareholders. Payouts that yield around 6% are growing at 3-5%, providing a 9-11% total return. Share buybacks add another 1-2%. It’s a story that resonated strongly with many of the investors I met last week. Energy has been an overlooked sector for a long time despite strong performance. Morgan Stanley just reintroduced a 2% allocation to midstream for client portfolios.

The connection with the AI boom came up in most of my discussions. A WSJ story last week said, “in Virginia’s data-center alley, rising power demand means more fossil fuels.” This means more natural gas, increasing the use of America’s abundant, reliable resource that generates half the emissions of coal.

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The article went on to add, “Wind and solar can’t serve data-center demand around the clock, so growth will need to be supplemented by natural-gas-fired power generation, said Arshad Mansoor, chief executive of the nonprofit Electric Power Research Institute.”

Last year, output from wind turbines fell 2.1% even though capacity was up 4.4%. The weather is a fickle mistress. Renewables’ potential output has a tenuous relationship with power actually delivered.

Indiana has a realistic view of EVs – their 4.5% market share is less than half the US average. This is because virtue signaling is refreshingly absent in this solidly red state. Ford has delayed a second EV battery plant in Kentucky after finding tepid demand for electric light trucks. I suspect many of the people living in southern Indiana’s wide open farm country could have predicted as much.

I didn’t find anyone excited about the inconvenience of having to recharge their car for 30 minutes or more at a time, and plenty commenting on the declining value of used EVs. In Indiana they just want to get where they’re going without designing their journey around charging stations.

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Some people have amazing stories to tell. I had the opportunity to finally meet one of our long-time investors Fred Farhoumand, whose family fled Iran when he was a young boy prior to the 1979 revolution. He and his brother Ali have built One Resource Financial Consultants into a successful investment business in Fort Wayne, IN.

Fred’s clients have benefited from his well-timed investments in the midstream sector. We enjoyed a steak dinner together in Muncie where the waitress was honest enough to say she hadn’t tasted several of the entrees because she couldn’t afford them.

Hopefully after our visit she could.

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Perhaps as an immigrant myself I love to hear the success stories of others. Francis Almeida of Moneyline Wealth Management grew up in an Indian orphanage, won a scholarship to study hotel management in Switzerland and worked in the cruise industry before joining Moneyline 28 years ago. He began life with very little and has achieved so much. Francis would probably have been successful anywhere, but that he chose America shows why this great country is so richly endowed with driven entrepreneurs.

It’s also why Clare Lombardelli, the OECD’s chief economist, recently said the US economy was looking “remarkably strong”, with increasing evidence of it pulling away from European economies.

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I was overdue to finally meet in person with Jamie Schade, along with his colleagues Caroline Pratt and Matt Watson. Jamie runs a team with Mark Henestofel at UBS in Miamisburg, OH that correctly identified the opportunity in midstream energy infrastructure back in 2020.

Unsurprisingly, we agreed on much. The energy transition will play out over generations, boosting demand for all forms of energy. Balance sheets are strong and dividend coverage high. Climate extremists still impede new pipeline construction which is boosting free cash flow.

Hug a protester and drive them to their next event.

EV demand remains weak – there are certainly few on the roads in this part of the country.

Hybrids seem like a pragmatic solution – an EV without range anxiety.

Growing power demand from data centers is good for natural gas.

Our dire and worsening fiscal outlook makes a return to 2% inflation unlikely.

In our opinion this sector checks all the boxes.

I found many investors who are underweight energy are concluding it’s worth a closer look. Those with exposure are happy with the results.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Last week my partner Henry Hoffman and I had the opportunity to chat with Peter Hill. Peter holds board seats or is on the advisory committee of several companies where he provides energy advice, including Edge Natural Resources, Jaguar Exploration and Citizen Energy LLC. His long career includes 22 years spent at BP in various executive positions including Chief Geologist. He still retains contact with a number of people there. We were interested in Peter’s outlook for energy. His views are summarized below.

Peter thinks many commentators underestimate the scale of change that the energy transition entails. It will be a very slow process, as it has been so far. He expects that we’ll still be using oil and gas in 2100, and says the most effective way to reduce emissions is coal to gas switching. The Energy Information Administration regularly reminds us that this is the biggest source of US emissions reduction – far more impactful than solar and wind.

Peter thinks OPEC’s production at around 28.5 Million Barrels per Day (MMB/D) is at or close to its peak. He doesn’t think they have much undiscovered oil remaining. The Ghawar field, which was discovered in 1948, has produced around 65 billion barrels, far more than expected.

The US is becoming the swing producer, a consequence of the shale revolution. Peter noted that shale formations exist in Saudi Arabia, but there’s no appetite to exploit that resource at $60+ per barrel since they currently produce at under $5. They would also struggle to find enough water for fracking, and the oil services business is dominated by American firms who would have to invest significant sums in Saudi Arabia.

Saudi Arabia’s Jafurah Gas Field has 200 Trillion Cubic Feet (TCF) of recoverable natural gas, according to Crown Prince Mohammed bin Salman. This is enough to swamp world markets if produced, but Peter thinks the Saudis will never be willing to invest the $BNs necessary.

For reference, US daily consumption of natural gas averaged 90 Billion Cubic Feet per Day last year.

Peter thinks Russian production will tail off within 12-18 months. Having lived there, he feels Russia’s oil industry has no culture of maintenance. Given a new truck or any piece of equipment, they’ll use it until it breaks down and then discard it.

The Bezhenov Formation shale that sits at the base of the Siberian Basins in Russia is the biggest source rock system in the world according to International Energy Agency. Reserves are estimated at 2,000 TCF gas in place and 1,200 billion barrels of oil. The sanctions that followed Russia’s invasion of Ukraine have cut off any western expertise in extracting these resources. Peter dryly notes that Putin has inadvertently settled who will own these stranded assets once the energy transition takes hold.

For all of these reasons, Peter thinks crude oil is going higher.

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BP made a big mistake with their focus on renewables, which has so far consumed $40BN of capex. As a result, they neglected their core oil and gas business, something Peter called “a huge mistake”. This strategic error was ultimately responsible for CEO Bernard Looney’s firing. He was an unapologetic champion of renewable energy. Looney’s admitted affair with a subordinate, in violation of company policy, may have provided a convenient opportunity to shift BP’s strategy back towards more profitable fossil fuels.

We’ve seen this regularly – big energy companies feel pressured to invest in the energy transition but find that the returns are poor. American investors are more inclined to reward more disciplined capital allocation, which is why NY-listed energy companies trade at higher multiples.

Both TotalEnergies and Shell have publicly ruminated on shifting their stock listing to NY. In recent years pressure from left wing politicians created disingenuous enthusiasm for intermittent energy, for a while displacing astute financial judgment. Remorse is now common among those who drank too heavily of the progressives’ Kool-aid.

Peter has great admiration for Exxon Mobil. They are resilient, and seem to produce an endless succession of talented executives. He described the company’s culture of career specialization, aimed at putting the world’s best in each key role and paying them enough that they rarely want to leave. He contrasted this with BP’s approach of regular rotations, to develop more rounded executives.

On the Deepwater Horizon disaster in the Gulf of Mexico, Hill attributes it partly to a failure to follow the company’s own operating manual, a document on which he spent much time and describes as BP’s “bible”.

Peter feels the Eagle Ford basin in south Texas is a misunderstood shale formation with untapped potential. Current activity focuses on the “hard bands” of rock which are more easily exploited than the soft bands in between. He thinks improvements in technology and technique will eventually allow these soft bands to be more readily drilled.

In terms of emerging technologies, he puts hydrogen in the “too hard” basket, noting the significant technical challenges in handling it. We commented on this recently (see Discussing The Energy Transition With An Expert). Hydrogen has to be super-cooled to reach a liquid state so that it contains enough energy to be worth transporting, a process that is itself very energy-intensive and costly.

AI on the other hand offers huge opportunities. Peter said, “Seismic is made for AI.” He expects it to provide a “significant improvement in 3D.”

With data centers driving power demand higher, the energy sector is well positioned to be a winner from artificial intelligence.

Peter Hill offered many fascinating insights. We hope to check in with him regularly for an update.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Last week the WSJ published an interesting chart, reproduced below. It was in an article ominously titled America’s Economy Is No. 1. That Means Trouble. The chart shows that US share of global GDP has been increasing for over a decade. We’ve gone from 21% in 2011 to 26% this year.

It’s an amazing performance. A consistent theme since World War II has been the US gradually shrinking its share of the global economy. This was inevitable as emerging economies such as China and India opened up to trade and deregulated their economies.

Military strength goes with economic size.

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This trend implied that the US would need to confront a rising challenge from China as their defense budget grew with their economy. It’s a cycle explained by Paul Kennedy in his 1989 book The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500 to 2000. He chronicles the arc of previous empires such as the French and Spanish. He coined the term “imperial overstretch”, when maintaining an empire imposes unsustainable costs, ushering in the decline of one and the rise of another.

Kennedy marks World War II as the approximate end of the British empire and the rise of the American one, although it’s more accurate to refer to America’s cultural and economic leadership rather than dominion over foreign countries. Back in 1989 Japan was the new rising power. That forecast soon turned out to be wrong, as China took their place. But maybe that’s also going to be wrong.

The WSJ article naturally found reasons to worry about America’s strong economy. It’s not only journalists at the NYTimes that are trained to find the negative in any story. Fiscal stimulus is partly driving growth. Trump tax cuts, the pandemic, the Inflation Reduction Act, the CHIPS Act and student debt forgiveness ($138BN so far) are all boosting consumption. The massive entitlement bill is coming due as baby boomers retire.

For the first decade of the new millennium, the US and EU roughly tracked each other in declining GDP share. They parted company long before the fiscal largesse noted above.

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US oil and gas production began their long ascent around fifteen years ago, roughly the same time our share of GDP began increasing. Has attaining American Energy Independence heralded a newfound resurgence in American economic leadership?

A cynic might suggest that a blog on energy will link anything positive to the shale revolution. It’s a simplification to think one caused the other. But there’s also plenty of evidence that low domestic energy prices have boosted growth.

Germany’s disastrous energy policies (see Germany Pays Dearly For Failed Energy Policy) have so effectively constrained their own manufacturers that some are moving production to the US. Their emissions are coming down because they’re de-industrializing, to America’s benefit.

Japan’s population is shrinking, creating a GDP headwind. China’s population has also peaked, and they’re confronting too much infrastructure spending that hasn’t boosted productivity enough.

The latest example of the role American energy plays is the growing need for natural gas to power new data centers. Tudor Pickering is the latest firm to publish a report on the topic. They estimate as much as 8.5 billion cubic feet per day in new production will be required.

I have yet to read a story predicting more solar panels and windfarms due to AI.

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America’s gains in GDP aren’t easily attributed to either party, since they’ve continued with both Democrat and GOP presidents. Republicans will be tempted to claim success as the party of deregulation. But investors in pipelines as defined by the American Energy Independence Index (AEITR) have done much better under Biden than Trump.

The White House isn’t drawing attention to this, because Democrat progressives would prefer it wasn’t true. It shows that the institutional advantages of our economy have made this possible. These include private ownership of mineral rights, easy access to capital and a culture of entrepreneurialism.

There’s another reason why the US is gaining GDP share. Americans just work harder than Europeans. Nicolai Tangen heads Norway’s $1.6TN sovereign wealth fund that invests the profits from Norway’s oil and gas output. He said that American companies outpace Europeans on innovation and technology. He cited a difference in, “the general level of ambition.” He suggested that Europeans strive for a better work-life balance, meaning they work less.

I left the UK for New York 42 years ago. I agree with Tangen. That’s why I moved here. Americans are more ambitious and less afraid of failure. My generation cared little for work-life balance 20, 30 or 40 years ago. We get it now. I’m not sure the younger generation is made the same way but that’s another story.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Progressives will maintain that the planet is on track to burn up, but realists will see an unfolding positive story. Transitioning our energy systems is incredibly expensive, slow and inflationary.

JPMorgan just published research (The Energy Transition: Reality check needed) acknowledging this and calling for a reset.

No big company says anything about energy without approval from its senior executives. It’s hard to think of a more highly charged topic. Forecasts that don’t assume “Zero by 50” are immediately seized upon by climate extremists as absence of fealty to the UN’s goal. BP handed off their Statistical Review of World Energy, probably after concluding it offered climate critics a soft target.

Wall Street banks like JPMorgan are voluminous publishers of investment and economic research. Jamie Dimon can obviously peruse only a tiny fraction of this output. But you can be sure he read this one given the sensitivity of the topic. Moreover, you can assume he broadly agrees with its conclusions. He has recently been critical of the Administration’s pause on new LNG permits, and has said it’s impractical to think we can suddenly stop using fossil fuels, which currently provide 82% of the world’s primary energy.

Combined with other moves, such as withdrawing from Climate Action 100+, it shows that the bank is taking a pragmatic, realistic approach. In his annual letter Dimon said, “One of the best ways to reduce CO2 for the next few decades is to use gas to replace coal.”

JPMorgan’s Reality Check research estimated that coal to gas switching could reduce emissions by as much as 17%.

We think this is not just another piece of Wall Street research but reflects JPMorgan’s pragmatic assessment of the energy transition and their role in it. Jamie Dimon has called the Department of Energy’s pause on new LNG permits “enormously naive.”

Jamie Dimon is the adult in a room full of juvenile climate extremists.

Russia’s invasion of Ukraine pushed energy security up the policy agenda for western Europe. The pandemic boosted government spending, leaving less fiscal room to fund the transition, and the inflation that followed pushed up interest rates. These three factors have rendered objectives that were already barely reachable now implausible.

Reality Check has many other useful insights. Just the planned solar and wind buildout to 2030 will take 0.5% of global annual GDP. The energy required would emit 207 million tonnes pa of CO2, equivalent of Argentina, assuming today’s energy mix of 82% fossil fuels.

This type of analysis heralds a more practical approach built around what’s possible versus the fantasies of climate extremists. It means more demand for natural gas, to the benefit of US producers and the associated infrastructure that supports them.

Wells Fargo’s Midstream Energy Weekender suggested that the sector is due to reprice higher. Their favored metric of Enterprise Value/EBITDA (EV/EBITDA) is at 8.2X. Five years ago it was around 11X, and performance since then has been good. To put these figures in context, if EV/EBITDA improved by one turn (ie 8.2X to 9.2X) that would equate to a roughly 20% price appreciation since pipeline companies are typically financed with 50% debt.

Wells Fargo also noted, “a growing realization that a confluence of factors could drive significant growth in US natural gas demand over the next 5+ years.” LNG exports, increased domestic manufacturing and demand from AI centers were the reasons cited. As regular readers know, we have long argued that natural gas infrastructure assets are cheap.

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There are signs that investors are beginning to act on this opportunity. Over the past year the American Energy Independence Index (AEITR) has kept pace with the S&P500’s AI-fueled run and last week moved ahead. YTD the AEITR is +10% vs the market’s +5%.

Tesla’s stock price continues to adjust to the new reality of declining EV demand. A couple of weeks ago an Uber driver in a Kia EV with 14% battery charge remaining said he loves his car. Charging only took about 30 minutes and he could usually find a charging station within 30 miles. After dropping me at the airport he was planning to do just that.

Robert Bryce reminds us that Stanford University’s futurist Tony Seba forecast in 2014 that “By 2025, gasoline engine cars will be unable to compete with electric vehicles.” Seba predicted that Internal Combustion Engines (ICEs) would be obsolete by 2030. Tony Seba is a soft target.

Your blogger will shortly be buying a new car. I’m not opposed to an EV – they work well as golf carts for example. But the inconvenience of charging, the waiting time involved and range anxiety demand a price discount to an equivalent ICE in my opinion. Around 25% would be enough to induce me to buy one. The market’s not there yet although it’s heading in that direction. So I’ll be buying a conventional car.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

As we sat down to lunch in London’s west end earlier this month, Richard told me his family had been good friends with Patrick Moore, presenter of BBC’s The Sky At Night from 1957 until his death in 2012. He was a passionate amateur astronomer who taught viewers what they were looking at in the night sky and contributed to early mapping of the Moon. He spoke quickly and seemed rather eccentric. I remember watching his TV show as a young boy.

The Horsehead Nebula (pictured) draws its red color from ionized hydrogen gas sitting behind the dark nebula. It’s the type of shot Patrick Moore would have used on his TV show.

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Moore believed the Sun’s impact on climate was under-appreciated and dismissed human activity as the driving force behind recent climate change. Perhaps he’d have a more nuanced view today. He was old enough to have met Orville Wright and later Neil Armstrong, connecting the two most defining moments in aviation history.

Richard is a business development manager for a leading international energy major. He’s responsible for developing the case for hydrogen imports to Europe and investigates investment opportunities for clean energy projects, part of supporting their developing energy transition portfolio. Richard has spent his career in energy, including with several European majors. In university he studied climatology, and investigated some of the ways in which volcanic ash and solar radiation can impact the climate.

He reached out to me because of our blog. I always enjoy meeting our readers – Richard multitasks by listening to our blogcasts on his commute rather than reading them. He was able to leave the office for lunch during my recent trip.

Every big energy company has an energy transition strategy. As shareholder-owned commercial enterprises, they don’t have the luxury of accepting inferior returns to achieve politically correct targets. Renewables investments must compete with traditional energy for capital and other resources. Skeptics might argue that solar and wind projects provide political cover to focus on oil and gas, where the real profits are.

Richard is well versed in the challenges of the energy transition. Like most people who have given serious thought to the topic, he believes we need to use much more nuclear. This blog often asserts that nuclear opponents haven’t thought very hard about practical ways to reduce CO2.

Richard noted that small cars lend themselves to electrification. We think they’ll need to be cheaper than equivalent conventional cars to attain mass appeal, because of the inconvenience of recharging. He believes hydrogen is a more practical solution for large trucks and long-distance transport because storing enough power in batteries adds too much weight to be economically practical. Daimler and Hyzon are actively working on liquid hydrogen trucks.

The EU is targeting 10 Million Tonnes Per Annum (MTPA) of domestic hydrogen production along with 10 MTPA of imports to jump start region-wide consumption of hydrogen by 2030. The European Hydrogen Bank is providing up to €100BN in support of these ambitions. De-carbonizing steel and cement production, perhaps with hydrogen, are priorities although the technical challenges are significant.

Europe has always seemed a better prospect for hydrogen than the US, where cheap natural gas renders the economics of hydrogen unworkable without substantial government subsidies. European politics is also to the left of the US, meaning there’s greater tolerance for high energy prices in exchange for reduced emissions.

Liquifying hydrogen prior to transportation makes it denser, allowing for more energy to be moved per unit of volume. However, chilling it to a liquid state is very energy intensive. Boil-off is a common problem for LNG tankers. Some of the LNG must be released in transit as it warms up and becomes gaseous. Boil-off losses are typically around 1% per day for LNG tankers and shipping liquid hydrogen faces the same problem but to a much greater extent due to the larger temperature differential. Hydrogen needs to be cooled to below -250C so many companies are looking at alternative means of transport such as combining it with nitrogen to form ammonia, which is liquid at a much more manageable -33C.

In the US Carbon Capture and Sequestration (CCS) received a boost in the 2022 Inflation Reduction Act which offers tax credits of up to $180 per metric tonne for permanently sequestered CO2. Occidental is a leader in this (see How Occidental Invests In Lower Taxes).

Rock formations that previously held natural gas (methane) can be good places to permanently store CO2. There’s a wonderful symmetry in extracting carbon atoms as methane molecules (CH4) and returning them to their source after use as CO2. The Netherlands has identified storage capacity for up to 3.2 Gigatonnes, more than the EU emitted last year.

The Dutch Senate has now passed a law to end natural gas production at Groningen, one of Europe’s largest, from October 1st this year to limit seismic risks from hydraulic fracturing. Groningen is not currently contemplated as a repository for CO2. Its closure leaves untapped reserves, and some politicians argue it could jeopardize the country’s security of supply. Possible re-use as a carbon dioxide store is yet to be seen but would certainly pose new challenges.

The steel and concrete well casings, through which natural gas was originally extracted, can become corroded from prolonged contact with CO2, requiring the replacement of the installed materials. Hydrogen produces its own challenges when coming into contact with steel. It’s a very small molecule so can penetrate the metal and cause embrittlement.

Safely ensuring the integrity of former gas wells and pipelines if repurposed for CO2 or hydrogen use might prove too expensive, resulting in the need to drill or build new, specialized, infrastructure.

There are likely better options. As is often the case, the biggest challenges in reducing CO2 are economic.

Richard is well-versed in these and other technical challenges facing the energy transition. I spent an absorbing lunch listening to him. We are fortunate to have people with his knowledge and ambition working on the problem.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund