Of Christmas Lights And Ladders

Christmas is a time of traditions, which in turn create nostalgia. Like endorphins, this is a free and harmless narcotic.  

Putting up the external Christmas lights, which we typically do right after Thanksgiving, usefully expends a few calories and kicks off that warm Yuletide feeling. Hunting through dusty boxes in the chilly attic for last year’s lights inevitably evokes Clark Griswold. It reminds me not to get locked up there. 

Draping colored lights over the bushes near our front door easily adds Christmas cheer. 

I’m especially pleased by the wreath, which hangs fifteen feet up above the front door over a window. Its positioning may not look especially challenging, but my first attempt required considerable planning. The stone façade ruled out hammering a nail into the wall. I spotted a hook twenty five feet up near the roof that originally supported a window awning nearly a century ago. I concluded the wreath needed to hang from there. 

I devised specialized equipment, including a long pole repurposed from changing light bulbs too high to reach. I had to ascend most of the way up a twelve foot ladder, then use the pole to snag a looped piece of wire onto the hook. 

Still poised unsteadily on the ladder, I then threaded the wire through the wreath. It was finally secured by reaching out to it through an upstairs window. I have been performing this feat annually ever since. My younger daughter holds the ladder and offers moral support, so between us we project a visible expression of Christmas with no other assistance.  

Over the years I have drawn some pride from solving this installation problem. Most of my accomplishments at home maintenance involve writing a check to someone more skilled than me at resolving the issue at hand. This annual demonstration of practical competence provides modest satisfaction.  

I don’t just keep the house running by changing lightbulbs.  

We live in a neighborhood where it’s becoming increasingly common to have the Christmas lights hung professionally. Landscaping contractors are finding it a useful sideline during the offseason. Snow removal, which some of them also provide, has been unprofitable in New Jersey for the past couple of years. Blame global warming.  

A crew of six armed with long ladders and a staple gun can quickly transform a suburban home into a light extravaganza. Illuminations are effortlessly strung at heights I’d rather not scale. The entire house glows Christmas cheer.  

I am a big fan of progress, but I find this trend towards commercial light installations a disappointment. 

I never considered our lights to be in a competition. We’re doing our bit to show ’tis the season to be jolly, to spread comfort and joy. But I must confess to a slight feeling of inadequacy as I drive back home past displays that wouldn’t look out of place adorning a hotel or in the Magic Kingdom. That I invested greater personal effort seems rather foolish when considering the results. The others put in less work. And less love. They just wrote a check.  

Nonetheless, I am not about to join the crowd and outsource the Christmas lights. Next year I’ll just have to create a more extensive display without climbing on the roof. The neighboring houses offer plenty of inspiration.  

The result will still be less than others nearby. But it’ll be my own work, and infinitely more satisfying as a result. 

I hope this anecdote made you smile and boosted your festive spirit. Normal market commentary will resume on Wednesday. 

Merry Christmas or, if it’s more appropriate, Happy Holidays.  




The 2023 MEIC Conference

Last week the Midstream Energy Infrastructure Conference (MEIC) held its annual event in Palm Beach, FL. SL Advisors partner Henry Hoffman was there and today’s blog post recounts highlights reported by Henry.  

Oneok’s (OKE) proposed acquisition of Magellan Midstream (MMP) was a common topic, especially the unwelcome recapture of deferred taxes facing MMP. When a c-corp, in this case OKE, buys a partnership (MMP), the limited partners in the target get a bad tax outcome. 

For this reason, Crestwood, LP CEO Bob Phillips told us they’d never sell to a c-corp buyer. Since he’s never sold a unit of CEQP, his recapture of deferred taxes would presumably be significant. Williams CEO Alan Armstrong recalled paying a hefty tax bill on his own holdings of Williams Partners, LP when it was acquired by the parent company in 2018. There are few painless exits from an MLP investment. 

One sell-side analyst reported that MMP had decided to sell because they didn’t see an obvious path to growth short of significant capex, and believed their company was undervalued. Overall companies expressed predictable interest in making bolt-on acquisitions but there was little indication of any other large deals in the works.  

Gabe Moreen of Mizuho Securities, Adam Breit, from Truist and Chase Mulvehill from Bank of America generally agreed that strong balance sheets would allow further industry consolidation but were skeptical about any other large deals like OKE-MMP.  

 Natural gas takeaway infrastructure and permitting reform were two themes that recurred in discussions. Lunch speaker Dan Reicher, former Assistant Secretary for Energy (1997-2001), brought attention to the issue of consistent underinvestment in public infrastructure, particularly in areas that don’t provide immediate private returns. He underlined the criticality of bipartisan dialogue and collaboration in addressing the complex challenges of the energy sector.  

A panel discussion covered potential opportunities for private equity deals, the escalating need for gas takeaway capacity, and the evolution of energy project permitting in the light of increasing social justice focus. J.P. Morgan’s financing panel predicted a challenging environment for upstream financing but expressed optimism for the LNG debt sector noting that financing has continued unabated. 

Another lunch speaker, Dr. Amrita Sen from Energy Aspects, highlighted the robust Asian demand for Liquified Natural Gas (LNG) and the global increase in Natural Gas Liquids (NGL) demand. She noted the persistent underinvestment in the supply of both LNG and NGLs. 

Highlights from interactions with individual companies are below: 

In a fireside chat, Enterprise Products Partners (EPD) Co-CEO, Randy Fowler, shared his perspectives on acquisitions. Fowler emphasized the importance of quality in three main areas: contracts; the producers underpinning those contracts; and the quality of systems in which these contracts operate. Specifically, he cited the Navitas acquisition as an example.  Fowler also reflected on the company’s response to the COVID-19 pandemic. He noted that most staff returned to office work within 2-3 weeks, with the exception of immunocompromised individuals. He made it clear that remote work was not an option for their field workers and office workers should share the same ethos.   

In a separate panel discussion on the topic of ESG, Fowler pointed out that with 30% of the world’s population living in energy poverty, EPD’s export of propane is making a tangible difference in people’s lives. He noted that EPD exports more propane than Saudi Arabia, a statistic that underscores the scale of their operations. He highlighted the fact that more people die annually from unsafe cooking practices than did from COVID-19 during the peak of the pandemic, emphasizing the vital role of liquefied petroleum gas in addressing this issue. He described LPGs from shale as a ‘true miracle.’  

EPD also reiterated their commitment to the Master Limited Partnership structure. 

Energy Transfer’s (ET) CFO, Dylan Bramhall, provided an update on the regulatory challenges the company is facing. He expressed shock at the Department of Energy’s denial of a permit extension for the Lake Charles LNG project. ET is appealing the decision, the results of which are expected within a month. Bramhall cautioned that this development may signal a shift towards more regulatory activism, potentially introducing a new layer of uncertainty and complexity in securing project financing.  

Bramhall revealed plans to share financing responsibilities for Lake Charles with the individual equity partners rather than at the project level, with ET retaining a long-term 25% stake in the project. He highlighted the financial flexibility of the company and pointed out potential upstream synergies of Lake Charles. Bramhall also shared an ambition for more mergers and acquisitions, ideally financed through cash reserves expected to accumulate after a predicted upgrade to their credit rating later this year. 

Jesse Arenivas, CEO of Enlink, concentrated our group session on the company’s Carbon Capture and Sequestration (CCS) initiatives. He projected that this business would represent 25% of the company’s EBITDA by 2030. Arenivas conceded that weather conditions had negatively impacted the company’s Q1 performance but remained optimistic about Enlink’s future prospects. He suggested that the company’s current market undervaluation makes acquisitions unattractive, effectively eliminating any M&A concerns. 

Breck Bash with CapturePoint, a Texas energy distribution company, also reported seeing huge opportunities in CCS especially after the passage of the Inflation Reduction Act which includes substantial tax credits. 

Alan Armstrong, CEO of Williams Companies, stressed that strong demand for the company’s services is challenging their capacity to deliver. With a long list of promising organic projects in the pipeline, Armstrong suggested that the company is not presently interested in pursuing M&A strategies. He drew attention to the Supreme Court hearing on the Chevron Deference case, indicating that its outcome could have considerable implications for the permitting process in the energy sector.  

Nearly 40 years ago, in Chevron v. Natural Resources Defense Council, the US Supreme Court ruled that courts should defer to a federal agency’s interpretation of an ambiguous statute as long as that interpretation is reasonable. The Supreme Court has agreed to reconsider that ruling.  

In a highly engaging conversation, Targa’s CEO, Matthew Meloy detailed his strategic approach to capital allocation. He highlighted his willingness to buy back his stock at a 7X EV/EBITDA multiple while identifying low-risk investment opportunities in contracted projects at a 4X multiple. Meloy offered insights into the potential sale of non-core assets in South Texas and the Badlands, which require minimal capex and yield stable cash flows. Meloy’s ten-year NPV approach to Targa and its assets displayed a keen sense of value. While he currently sees numerous opportunities, he acknowledged a potential surplus of free cash flow versus investment opportunities in the next 3-5 years. Consequently, Meloy expects a substantial increase in dividend payments in the future, although not near-term. 

Lastly, Tellurian is optimistic about their prospects for securing equity partners by the end of July for their LNG project. They estimated that bank debt would be finalized within two months following the equity financing deal. Despite skepticism in the market, they argued that successfully securing equity financing would significantly boost their stock value. We have been critics of Tellurian, because of CEO Souki’s excessive compensation and a business model that until recently retained natural gas price risk in their LNG contracts which has made achieving financing more challenging.  

Overall attendance at the 2023 MEIC was reported as similar to last year. One analyst was surprised it wasn’t greater given the frequent positive conversations he’s having with investors. 

We found that it confirmed our bullish outlook, based on strong balance sheets, continuing capital discipline and continued global demand growth for US gas, NGLs and crude oil.  

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

Energy Mutual Fund

Energy ETF

Inflation Fund

 




Market Volatility Is Becoming Normal

Every investor is aware that the market’s been volatile recently. The VIX is high but converting it into typical daily moves isn’t intuitive. Several readers like the chart below, which shows what % of the last 100 trading days have seen the market move by more than 1% in either direction. It’s currently 55, so more than half of the past 100 trading days have seen such a move.

The prevalence of this “more likely than not to move 1%” metric is unusual; over the past quarter century such a regime has prevailed only 8.5% of the time. We’re approaching the volatility that Covid caused, but still short of the 2008-09 financial crisis. This metric is indifferent to direction, but it peaks during bear markets because volatility induces selling.  

2% daily moves are occurring 24% of the time. 100 day periods like that have occurred only 7% of the time since 1996. 

There have been few places to hide. The 17.3% fall in the S&P500 has been accompanied by a –10.9% YTD return on the Barclays Agg fixed income benchmark. The 60/40 portfolio is down 14.8%.  

The drop in markets this month has been especially hard on the energy sector, although the American Energy Independence Index is still +11% YTD. Increased odds of a recession have hurt cyclical stocks, and midstream energy infrastructure has been dragged down in the process. The Fed is entering a tricky stage – having made one policy mistake in being too slow to confront inflation, they’re trying to fix it without committing a second error. Their critics have momentum, because so far they’ve been right. Former NY Fed chief Bill Dudley warned that The US Economy Is Headed for a Hard Landing. 

In Senate testimony Fed chair Jay Powell conceded that a recession was possible and avoiding one depended on factors outside the Fed’s control. Cynics may regard this as preparing the next set of excuses. It’s easy to see events unfolding such that the Fed loses the few friends it has. Senator Elizabeth Warren offered a preview of what may become criticism not limited to the left: “You know what’s worse than high inflation and low unemployment? It’s high inflation and a recession with millions of people out of work,”   

The 60% of CEOs that expect a recession within eighteen months assume that the Fed will overdo tightening.  

Whether the consensus turns out to be right or not, the fundamentals for the energy sector keep improving. Unsurprisingly, Russian natural gas supplies to Germany through Nord Stream 1 are down sharply. It was never plausible that Russia would co-operatively keep the gas flowing right up until Germany no longer needed it. Rationing of natural gas supplies is looming as German citizens pay the price for decades of poorly advised energy policy.  

A string of US Liquefied Natural Gas (LNG) deals were announced last week. Cheniere decided to move ahead with an expansion of their Corpus Christi LNG export facility. Chevron signed purchase agreements with Cheniere and Venture Global to buy 2 million tonnes a year of LNG from each of them. 

Germany is considering expropriating part of the Nord Stream 2 natural gas pipeline that Russia’s Gazprom built but has never been used. That part of Nord Stream 2 that is on German territory might be cut off from the rest of it and repurposed to facillirate LNG imports.

Japan announced that they will stop offering low-interest loans to developing countries to build new coal-burning power plants. According to Bloomberg, Japan accounted for more than half of the $6.6 billion of coal support from G-7 countries in 2019. No meaningful progress on emissions reduction is likely without persuading emerging economies to reduce coal consumption. Cutting off cheap financing is at least consistent with that goal. It will make natural gas power plants more attractive. 

Berkshire Hathaway added to its stake in Occidental Petroleum, taking advantage of recent weakness. Berkshire now owns 16.3% of the company.  

Research from Wells Fargo estimates that approximately 55% of midstream EBITDA has built-in inflation escalators. Liquids pipelines are often regulated by FERC, which permits tariff increases based on the PPI (currently running at 11%). Among the companies best positioned to benefit from this are are MPLX, Oneok and Magellan Midstream. Wells Fargo expects this inflation protection will boost midstream sector EBITDA by around 5.3% this year, a permanent step-up in EBITDA since negative PPI is implausible.  

This is why pipelines offer useful protection against higher inflation. If the Fed beats the consensus and is successful in avoiding a recession, it’ll probably be because economic weakness induces a premature declaration that inflation is vanquished. Real assets will offer valuable upside in such a scenario.  

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Please see important Legal Disclosures.




Why You Should Worry About Inflation

Watch this nine-minute video to learn:

Why You Should Worry About Inflation

 




Profiting From The Efforts Of Climate Extremists

Last week was hailed as a big victory for climate activists. In a 1-2-3 punch on Wednesday, a Dutch court ordered Royal Dutch Shell (RDS) to further reduce emissions from its products; Exxon Mobil (XOM) shareholders elected two new directors proposed by an activist hedge fund against management’s recommendation; Chevron (CVX) shareholders approved a proposal to reduce emissions caused by its customers. 

All three companies will become less invested in future oil and gas production than they were previously. For those who regard energy companies as the cause of global warming, rather than the billions of individuals who buy their products, Wednesday’s three events were a watershed. 

Vanguard, Blackrock and State Street are XOM’s three biggest shareholders and also members of the Net Zero Managers Initiative which is committed to “net zero greenhouse gas emissions by 2050 or sooner.” It’s often believed that you can do well by doing good, and a popular narrative is that ESG funds are delivering good returns because ESG-oriented companies deliver better operating performance.  

The biggest ESG fund (ESGU), run by Blackrock, is imperceptibly different from the S&P500 (see Pipelines Are ESG). XOM and CVX are both holdings in ESGU. Blackrock’s ESG definition is flexible, like most proponents. Lockheed Martin is a perennial member of the Dow Jones Sustainability Index, so pretty much every company claims ESG-ness. Big natural gas pipeline corporations really are ESG, since they are helping displace coal for power generation in the U.S.  

Engine No 1, the activist shareholder in XOM, argued that the company was risking its very existence by continuing to provide the world with oil and gas. This is a non-ESG view based on an assessment of the company’s business prospects, but conveniently aligned with the climate change goals of its three biggest shareholders. XOM will presumably now chart a course that directs more investment to renewables.  

CEO Darren Woods clearly wants to keep his job – he has welcomed the new board members, even though in the past he’s questioned XOM’s strategic advantage in pursuing renewables. The business of fossil fuel extraction, processing and distribution (geology, refining, petrochemicals, retail gasoline) would seem to offer few synergies with building solar farms and windmills. Woods has in the past noted that they have little more than money to offer to such efforts.  

Perversely, all three developments from last week make the rest of the energy business more attractive. Future supply will grow less than it would have, while demand will continue to be led higher by emerging economies in Asia and elsewhere. Oil and gas prices will likely drift higher. All the focus of climate extremists is on supply, not demand. Consumers are far less susceptible to changing their behavior in support of reduced emissions. 

Based on how all three stocks reacted, these developments were not enthusiastically received. Shifting investments away from what these companies know to new areas with very different economics isn’t a compelling way to drive higher returns. The real winners are likely to be privately-held oil and gas producers, and OPEC nations who will welcome the increased market share at higher prices that last week promises.  

XOM, CVX and RDS all finished down for the week, lagging crude oil which is usually a reliable barometer of energy sector sentiment. They were also outperformed by North American pipelines, as represented by the American Energy Independence Index (AEITR).  

In the same week Tellurian (TELL) announced a ten-year agreement to sell liquified natural gas to Gunvor, a commodities firm. It shows that demand for natural gas remains strong. Privately-held Gunvor is relatively immune to climate extremists and must regard the strategy shifts forced on the three companies as vindicating their deal. But they and TELL can also claim to be constructively lowering CO2 emissions – without the natural gas they’ll be providing to customers in Asia, it’s likely more coal would be burned to meet the region’s growing demand for electricity. Switching from coal to natural gas is the most effective way for the world to reduce emissions, as America has demonstrated for the past decade.  

As shareholder-activists and litigants force uncommercial strategies on energy companies, it is creating profitable investment opportunities elsewhere in the energy sector. If supply is constrained too far, much higher prices will cause demand destruction and improve the relative pricing of renewables. But it looks increasingly likely we are heading into a Goldilocks period – growth capex sufficiently reduced to boost free cash flow and cause higher prices, but still enough supply to stop prices from spiking ruinously. The key will be to invest where activists don’t, so as to profit from their efforts. 

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




Pipelines Are ESG

ESG is in the eye of the beholder. There are multiple lists of stocks that score well on Environmental, Social and Governance metrics. My favorite is Lockheed Martin (LMT), a perennial member of the Dow Jones Sustainability Index. If building weapons to blow up people and property can be done in a sustainable way, then ESG is a generous mistress (see Pipeline Buybacks and ESG Flexibility).

There are currently 138 ESG ETFs traded on U.S. markets, with almost $90BN in AUM. The most important thing about ESG investing is that it’s growing faster than the market. A cynic might regard the rush by CEOs to demonstrate ESG-ness as driven by asset flows rather than altruism. ESG-driven investors can note with satisfaction the market-beating performance of such funds. The largest ESG ETF is the iShares ESG Aware MSCI USA ETF (ESGU), with $15BN in AUM.

The pipeline sector offers 7% yields, growing free cash flow and strong recent performance. It has been out of favor more often than not in recent years, but Joe Biden’s arrival at the White House has ushered in rising energy prices with less growth spending (see Is Biden Bullish For Pipelines?). Investors are warming to policies that encourage parsimonious funding of new projects, something that eluded them during Donald Trump’s presidency.

Some may avoid pipelines because of historic volatility, although operating performance last year was scarcely affected by Covid. The energy transition deters others, although a pragmatic desire not to wreck the economy means natural gas retains its bright future as part of the solution to reducing emissions. A third cohort thinks fossil fuel companies are bad, even though it’s how the world has reached today’s living standards. There’s a belief that the energy sector has much to apologize for.

It may surprise this last group to learn that ESGU has a 2.5% weighting to energy, virtually indistinguishable from the S&P500’s 2.6%. ESGU holds Kinder Morgan (KMI), Cheniere (LNG), Oneok (OKE), Targa Resources (TRGP) and Williams Companies (WMB), all components of the American Energy Independence Index. Relative to the S&P500 it has modest overweights in Chevron (CVX) and Exxon Mobil (XOM). It also overweights Nextera Energy (NEE), one of the largest producers of electricity from natural gas.

ESGU has some interesting underweights, including Alphabet (GOOG) and Microsoft (MSFT) both companies with plenty to say about their ESG credentials. Clearly ESG-ness isn’t a binary issue, or Facebook’s dual share class would knock them out on the Governance scale. Instead, it trims them to 1.81% in ESGU versus 2.06% in the S&P500. Berkshire Hathaway (BRK) is ESGU’s biggest underweight, at 0.84% versus 1.47%. Those omitted from ESGU are an eclectic bunch, including Tyson Foods (TSN) and Boston Scientific (BSX). The complete absence of airlines in ESGU fueled some of its outperformance. Covid crushed the sector rather than any ESG shortcomings.

These differences are trivial, which means ESGU looks a lot like the S&P500 and tracks it closely. For the past couple of years, their daily returns are 0.99 correlated, and ESGU has outperformed by 2.1% p.a. It’s unlikely that ESG-run companies offer better long-term performance than the market. More likely is that investors just want to own them a little more, which is boosting their stock returns.

Index providers continue to compete to be the market standard for ESG-ness. Current standards vary. Since probably every member of the S&P500 has ESG slides in its investor presentation, it’s hard to avoid virtue-claiming companies.

If ESG doesn’t impact operating results, then eventually ESG funds will underperform the market because buyers will have overpaid. But for now, metrics from the past two years tempt the virtue-signaling investor – good odds of roughly tracking the market, some chance to beat it and the claim to morally higher ground than one’s peers.

The substantial overlap between ESGU and the S&P500 simplifies the choice facing an ESG-motivated investor. ESGU’s portfolio signifies approval of almost the entire S&P500. There’s no discernible difference in virtue between an investor in ESGU or the S&P500 itself. What ESGU does offer is a small bet on continued flows into ESG funds.

ESGU’s energy holdings represent an endorsement. An investor hesitating to take advantage of the high yields and growing free cash flow of pipelines because of a misplaced concern that her liberal friends may frown can point to ESGU for absolution.

Energy, and pipeline companies specifically, sit at market weight or better in many of the biggest ESG funds. They should – coal to natural gas switching in the U.S. has done more than renewables to lower emissions over the past decade. U.S. exports of liquified natural gas offer other countries the opportunity to emulate our success. Pipelines are ESG.

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




2021 Pipeline Outlook




Reviewing The Deficit Myth

Stephanie Kelton’s The Deficit Myth opens with the startling assertion that the only reason today’s fiat currencies have any value is because citizens need to acquire them to pay taxes. Without that requirement, there would be no need to hold dollars, euros or yen. I first heard this argument from Warren Mosler twenty five years ago when he was a partner in hedge fund Illinois Income Investors in West Palm Beach. I found this view quixotic at the time, although our meeting was too brief to fully refute it. Today Mosler is regarded as the father of Modern Monetary Theory (MMT), seized by progressive Democrats as evidence that the Federal government can pay for everything.

To prove that tax liabilities are necessary to give money value, Kelton recounts a story I heard personally from Mosler in the 1990s. Suppose he assigned household chores to his children with payment promised in business cards. With little of value being offered in exchange for the work, the lawn would remain uncut and the car unwashed. But if Mosler the Dad then imposes a monthly tax of 30 business cards from each offspring, on pain of being grounded, they suddenly have value. The work gets done.

From this follows the logic that the government needs to spend money in order to provide the means with which to pay taxes. The government, as the sole issuer of currency, can pay in regular green dollars, or in yellow interest-bearing dollars (i.e. they can borrow to pay their bills). They can never run out. So they can never go bankrupt. Therefore, deficits don’t matter unless they exhaust the economy’s productive capacity, which is inflationary.

I’m still not convinced taxes are necessary to give a fiat currency value, although behind every such currency lies a government taxing and spending it. For much of human history money has been linked to gold. When the US left the gold standard in 1971, the severing of the link ushered in fiat currencies that derived their value from the issuing country’s policies. But it’s definitely clear that a country can never be forced into bankruptcy in its own fiat currency, as they can always issue an unlimited amount to pay their bills. In this narrow sense, debt doesn’t matter.

So far, this is a non-partisan exercise in economic theory.

Kelton then seizes the access to unlimited credit to gorge on a left wing dream of largesse. Trillions of dollars are breezily allocated to student loan forgiveness, upgrading our infrastructure, fighting climate change and dealing with the pandemic. Because the Federal government can never go bankrupt, deficits don’t matter. The twin looming crises of social security and Medicare don’t matter, because the government will spend whatever it needs to, since its ability to borrow in its own currency is unlimited.

It sounds implausible, but here Kelton misses the opportunity to strengthen her case. Today, America’s fiscal outlook provokes widespread hand wringing and dismay. Retiring baby boomers will command an unsustainably growing chunk of Federal spending. There is nothing remotely optimistic to be said on the topic. Yet long term government bond yields remain defiantly low. The empirical evidence that deficits don’t matter exists in Uncle Sam’s continued ability to fund its needs at rates below inflation. An even more brazen MMT advocate would argue low bond yields are the market’s vindication that deficits don’t matter.

The failure of conventional economic thinking to explain apparently costless fiscal profligacy offers at least an opening for the progressives who have hijacked MMT to drive through. Kelton misses her chance.

The risk is of course inflation. If the government tries to pay for more output than the economy is able to provide, inflation will follow. If Mosler the Dad started adding new chores, he’d have to offer more business cards per hour to motivate his exhausted children. Had his progeny begun saving these cards for the future, the resulting inflation would diminish their value. Kelton does admit to limits on spending, but these are imposed by inflation not deficits. She argues that government spending should rise until it’s inflationary, ensuring maximum utilization of the economy’s potential.

That is in effect current policy, administered by the Federal Reserve’s twin objectives of maximum employment consistent with stable inflation. Kelton would prefer the Federal government was explicitly responsible for the twin mandate rather than the Fed. In doing so they would rely on fiscal, rather than monetary policy.

Since inflation has remained so consistently low that the Fed is trying to overshoot its 2% target, it’s a reasonable argument that pursuing NAIRU (the Non-Accelarating Inflation Rate of Unemployment) through interest rate policy alone is leaving millions of potentially productive people out of the labor force. The Fed can be criticized for over-estimating NAIRU, but there’s no reason to think Congress would do any better. They would inevitably synchronize economic booms even more closely with the election cycle, and there would be no reason to expect anything but a bad outcome. This is why independent central banks are part of every well-run economy.

However, Kelton goes further, advocating government spending until everyone has a job, supported by a Federal jobs program for all. “The federal government announces a wage (and benefit) package for anyone who is looking for work but unable to find suitable employment in the economy.” she writes.

Kelton’s faith that a huge program of useful jobs could be run productively without abuse is naive. Would the government fire lazy workers? Under her approach, “It takes workers as they are, and where they are, and it fits the job to their individual capabilities and the needs of the community.”

It would descend into a jobs program for those unemployable in the private sector. Don’t MMT advocates even believe in workers learning marketable skills?

Many questions are left unanswered. Most obviously, what would the Federal government do when its spending caused inflation? If the ability to issue debt in your own currency is so valuable, why do countries give up sovereignty and join currency unions, such as the euro, or peg their currency to the dollar? What does MMT say about serial defaulters like Argentina? What about Germany’s hyperinflation that preceded the rise of Hitler? And while Kelton argues we should not worry about future entitlement obligations, what would MMT prescribe if those future payments ultimately drive up inflation? She fails to identify a single country that has successfully relied on deficits to maximize economic output.

MMT has become shorthand for unlimited government spending to solve every problem progressives can identify. Stephanie Kelton’s expansive vision of MMT’s possibilities cemented the conviction of many that our economy needs protection from the more liberal elements of Joe Biden’s party. It’s the type of thinking that denied Democrats a stronger electoral showing. Warren Mosler is rich enough to indulge such economic fantasies today, but I doubt 25 years ago he would have favored big government on such a scale.

In Lunch with the FT, journalist Brendan Greeley was disappointingly deferential. There’s little insightful in Kelton’s policy prescriptions. The type of profligate government spending she advocates has invariaby led to ruinous inflation elsewhere. If practised here, progressives would likely blame a Wall Street conspiracy for the economic destruction they had wrought. MMT isn’t a new idea, and isn’t a new source of money for liberals to spend. It should drift from the fringes of policy discussion to complete oblivion.

 




Stocks Are Still A Better Bet Than Bonds

In late April, a month after the low, we noted how stocks were cheap (see The Stock Market’s Heartless Optimism). The Equity Risk Premium (ERP, the difference between the earnings yield on the S&P500 and ten year treasury yields) is a useful barometer of relative value between the two major asset classes.

At the lows in March, the ERP on 2020 S&P50 earnings reached 5.0, and was 6.5 for 2021.

Now that the market has made a new all-time high, capping the briefest bear market in history, it’s no longer cheap although still attractive by historical standards. The 2020 ERP is 3.4 and 2021’s is 4.1.

The rally has mostly been characterized by multiple expansion. No big stock epitomizes this more than Apple (AAPL), which has almost tripled in value since the beginning of last year. It used to trade at a low double digit earnings multiple – it’s now at 30X 2021 Bloomberg consensus earnings. At $2TN in market cap, AAPL is over 7% of the S&P500.

As 2021 earnings forecasts were revised down through the worst of the pandemic, they still never dipped below last year’s. In other words, even at the depths of Covid despair, the earnings story remained that this was a one year hit that would see profits quickly rebound to prior levels.

Earnings forecasts for the following year are typically most optimistic in January. As time passes they are usually revised downward, probably as cautious management guidance gets reflected in analyst estimates. This makes it easier to subsequently beat expectations. But in recent weeks, 2021 earnings forecasts have been revised up modestly. The improved profits outlook has more than offset cautious guidance.

Given the impact on our lives and the relentless media reports of death, the stock market has provided an almost offensively optimistic perspective (see Is Being Bullish Socially Acceptable?).

The ERP shows stocks to be cheap because interest rates remain so low. Stocks are cheap relative to bonds. In the past we’ve illustrated this by calculating how much money invested in stocks would deliver the same ending value as $100 put into ten year treasury securities. The dividend yield on the S&P500 is around 1.8%, 1.2% above the ten year. Dividends grow while treasury coupon payments do not, and dividends are also taxed at a lower rate – at least, for now. The result is that it takes a lot less than $100 invested in stocks to match a ten year bond, assuming stocks don’t wind up lower in a decade.

The contrast is especially stark when applied to pipeline stocks. Enterprise Products Partners (EPD) maintained its payout through the 2014-16 energy downturn and, so far, through the Covid pandemic. Its dividend provides a 9.7% yield, a level that might suggest a high degree of investor concern about their prospects. However, bond investors see little to worry them. EPD recently issued ten year notes that currently yield 1.9%. A 30 year bond issued at the same time yields 3.3%.

Using the assumptions in the table, an investor about to commit $100 to EPD’s ten year debt could instead put just $8 into EPD common shares with the rest in cash (i.e. treasury bills), and achieve the same return. Even in a highly improbably EPD bankruptcy, a loss on the bonds of greater than 8% would still leave the equity as the less risky choice.

This math reflects the tyranny of low rates, and has been driving investors into stocks for years. Inflexible investment mandates that require holding bonds without regard to return are keeping rates low. The stocks in the American Energy Independence Index, of which EPD is a component, yield 8.8%. For those with sufficient flexibility, the stocks of these issuers are far more compelling than their bonds.

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

 




Natural Gas Is November’s Winner

Citibank published some interesting research recently, making the case for higher natural gas prices in the months ahead. Oil production in the U.S. has fallen sharply as a result of Covid. Gasoline demand has recovered from its low point in April, but remains about 9% below normal.

Natural gas demand has shown much less impact, because it’s not used in transportation. The chart shows that it’s running the same as a year ago, although last week power consumption dipped. Power outages from Tropical Storm Isaias may have been partly to blame.

Citi’s forecast of higher natural gas relies on two factors: the drop in oil production has also reduced output of associated gas, which was most common in the Permian in west Texas. Oil prices drive the economics of drilling in that region. The resulting gas production was pressuring prices as well as causing more flaring (watch Stop Flaring).

The second factor relies on a Biden administration, which is looking the more likely outcome based on recent opinion polls. The thinking is that a Federal initiative to lower CO2 emissions will start with accelerating the phase-out of coal-burning power plants. This trend has been under way for several years, and represents the easiest steps an incoming President Biden could take to fulfill campaign pledges on clean energy.

Deferred natural gas futures pushed higher in recent weeks, reflecting higher prices a year out at the same time as opinion polls continue to show Biden in front.

Natural gas power plants typically release half the CO2 emissions of coal for equivalent energy production, and are also free of particulate matter and other pollution such as nitrogen oxides, sulfur dioxide, mercury and other hazardous substances that the local population inhales.

The Biden Plan for Climate Change targets “net-zero emissions no later than 2050.” However, the Biden-Sanders Unity Task Force says, “Democrats commit to eliminating carbon pollution from power plants by 2035.” A Biden administration would be under pressure from extreme liberals to adopt the more aggressive target, which Citi believes is likely.

Citi Research calculates that retiring the nation’s coal plants at a uniform rate would take approximately 10 Gigawatts (GW) of power offline annually. Assuming these plants are running at 48% capacity, as was the case last year, the country would need to add 4.8 GW of new natural gas power every year, requiring about 1 Billion Cubic Feet per Day (BCF/D).

Foreign demand is also increasing — both China and India have long term plans to use more natural gas. Nord Stream 2, which is being built to supply more Russian gas to Europe, continues to draw U.S. sanctions which may yet impede its ultimate completion.

Last year, the U.S. produced 92 BCF/D of natural gas, consuming 85 BCF/D domestically with the difference made up by exports (5BCF/D) and withdrawals from storage (1.4 BCF/D). Decommissioning coal plants could increase domestic demand by 1% or so annually.

So far, cheap natural gas has motivated the switch away from coal. Citi expects higher prices to reduce the economic advantage, but also believes this will stimulate increased production by 2022.

Although Trump’s election victory was welcomed by energy executives, their enthusiasm for a Republican administration freed their animal spirits in recent years, and investors have borne the cost. A pro-fossil fuel administration has been an excuse for many upstream and a few midstream companies to dump financial discipline and allocate capital with overly optimistic assumptions.

It may seem perverse, but a Biden victory could be good for pipeline investors, because it would impose a more cautious  assessment of new projects. An industry held responsible for climate change by extremists in the president’s party would more likely be parsimonious in spending its cash.

New greenfield pipeline projects are already a non-starter because of relentless legal challenges, which many investors have welcomed (see Environmental Activists Raise Values on Existing Pipelines). Solar and wind projects are just as vulnerable to the same delaying tactics using the court system. New England is famously opposed to new pipelines (see An Expensive, Greenish Energy Strategy). But in 2017 an offshore wind project also fell victim to interminable delays, from property owners defending their ocean view (see After 16 Years, Hopes for Cape Cod Wind Farm Float Away).

Russell Gold recounted in Superpower: One Man’s Quest to Transform American Energy the challenges that defeated Michael Skelly in building high voltage transmission lines to send electricity from windy, unpopulated regions to cities.

New natural gas power plants retain a substantial cost advantage over renewables, even after many years of subsidies. It’s likely that a sharp increase in solar and wind farms, along with the associated power lines, will collide with the same NIMBY opposition through court challenges. Energy infrastructure that is already installed, such as natural gas pipelines, has an advantage.

Much can change over the 79 days until the election, but pipeline stocks have been outperforming the S&P500 since earnings were kicked off by Kinder Morgan last month (see Pipeline Earnings Provide A Boost). Dividend yields of 8-9% are drawing buyers who are looking beyond the opinion polls.

There’s no reason for equity investors in midstream energy infrastructure to be scared of a Biden presidency (listen to our recent podcast, Joe Biden and Energy). Bond investors see little of concern — Enterprise Products Partners (EPD) for example recently issued 30 year debt at 3.2%, while their equity offers a dividend yield over 9%. Compared with the past four years, equity returns are likely to be much better.

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