I’ve always wanted to visit an oil rig. It’s not easy. They don’t want every investor showing up and being a nuisance, distracting workers and getting in the way. Fortunately, Aaron Irving of Carlsbad, NM, a long-time investor, kindly offered to set up a visit through a friend of his, Arsenio Jones (EHS Field Supervisor) at Matador Resources.

It was a memorable day.

Oil and gas exploration isn’t conveniently located. In our case, after flying to El Paso my wife and I drove three hours to Carlsbad and then Arsenio drove us a further 45 minutes through scrubland to a patch of cleared dirt with an enormous drill sitting on it. On the way Arsenio gave us background on the site we’d be visiting and what life is like working in the oil business.

We had previously been told to show up in steel-capped boots and jeans. Upon arrival we were each kitted out with a fire-retardant sweater, personalized hard hat, ear plugs (drilling is noisy), safety goggles, gloves (splashed oil is apparently hard to remove) and a hydrogen sulfide (H2S) detector.

Loose jewelry had to be removed. We received two safety briefings. Anyone is empowered to call a “safety time out”. I hoped I wouldn’t need to. If someone needs urgent medical care, calling 911 will likely result in a helicopter being dispatched; such is the distance to the nearest hospital.

This is the Shale Revolution up close. On the site we visited, Matador was drilling a series of wells in different directions. Computer screens in the control center displayed numerous metrics. The current well had been drilled to over 20,000 feet. Then it turned horizontal before making a U-turn near the border of their assigned area.

Privately-owned mineral rights are unique to the US. We take for granted that oil found in your backyard is yours, but I’ve yet to come across another country where this is the case. Mineral rights can be sold separately from the land ownership. What I hadn’t appreciated was that mineral rights can be further spliced at different depths. So, an E&P company may have rights to 100% of the hydrocarbons down to 15,000 feet and only 60% for the next five thousand feet.

Boundaries are interesting too. A well might go within 150 feet of the boundary. But once fracked, it may inadvertently draw in oil and gas from across the boundary, depending on the geology. Being the first to drill near a boundary is generally a good idea.

It’s a world of enormous pressure — 3-5,000 pounds per square inch (psi) at the surface to circulate drilling mud down to the drill bit. Pressures can be 5-7,000 psi or more where the drill bit is operating. And weight; a drilling rig can weigh 2-3 million pounds.

It is physical work with heavy equipment, but it’s run by thoughtful people with engineering degrees. They’ve watched Landman and if real life was as dramatic as portrayed in the show, they’d be doing something else.

Toby Solis (Field Operations Manager) explained how important it is to be able to think in three dimensions, to visualize what’s happening several miles below ground. Toby is built like a linebacker and has two degrees, apparently often challenging new hires with math problems to test their aptitude.

On the day we visited the crew was preparing to pour the cement casing for the well. Imagine two steel tubes one inside the other running along a section of the well. The cement is poured down the inner tube and pressure applied from the wellhead to force it back up through the gap between the inner and outer tubes. It sets to create a concrete casing for the well.

Apparently, sugar added to the stored cement stops it from hardening before use. So the site takes deliveries from food distributor Sysco. By superstitious custom, a hard hat is never wiped clean but is allowed to retain its wear and tear. Only our group of visitors wore conspicuously clean hats.

Hydraulic fracturing (“fracking”) involves firing holes about 0.4″ in diameter along a section of the well. Then water mixed with fracking fluid and sand is pumped in at pressure high enough to create millions of fractures in the surrounding rock. The grains of sand prop these open, and when the wellhead pressure is relaxed, oil flows back up along with the water that was used to release it. They want the oil but if it’s like most wells in the region it’ll produce gas too, increasing in quantity as the well matures.

I was familiar with the process from having studied the sector for many years, but it was absorbing to be on-site and see the preparation.

As Frank Sullivan (Drilling Superintendent) explained, the rig can be disassembled and put together again nearby within about three days. It can also move slowly, on feet. The rig we saw was destined to move just 30-40 feet away to drill another well in a few days.

The crew members typically work twelve-hour shifts for two weeks, staying in nearby “man-camps”. They can then return home for two weeks. I chatted with one technician who was monitoring activity. He was once an auto mechanic before switching careers. To stay current on advances in technology, continuing education is part of his job.

Pay in the oil patch can be good. A new engineering undergrad can earn $100K in starting salary, in a region where there are few equivalent opportunities. Even a high school graduate can command almost as much and pay can rise quickly for those who demonstrate aptitude for the job.

Baker Hughes reports that there are 580 land rigs operating across the US. They are the result of the Shale Revolution, which was created in America and refined by people like those we met from Matador. They may not give it much thought, but strategically these highly skilled workers armed with engineering degrees and evolving technology have made the US energy dominant.

Voters may complain about the price of gasoline or diesel, but high oil prices benefit the domestic energy sector to a degree that almost offsets the drag from increased fuel prices across the rest of the economy. And we have among the world’s cheapest electricity thanks to natural gas whose price remains among the lowest in the world.

Frank Sullivan, Toby Solis and Arsenio Jones are leaders at Matador, a company that is playing a vital role in boosting America’s competitiveness. They are an impressive group, choreographing heavy equipment with technology to unlock resources miles below ground. They spoke warmly of CEO Joseph Foran (“Mr. Joe”) who has earned their respect through regular visits just to check in and see how they’re all doing. Other members of the executive team do the same.

Having spent a day with Frank, Toby and Arsenio, they represent the best of America, helping drive living standards ever higher with affordable energy. They are a fine example of what makes this country so relentlessly successful, making America great, one well at a time.

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

Energy Mutual Fund Energy ETF

 

 

An investor asked me the other day what’s the most interesting theme across our portfolios. It has to be the export story. This blog often chronicles the outlook for US exports of hydrocarbons. Prospects improved with the war on Iran, and the protracted closure of the Strait of Hormuz is adding to the appeal of America as a reliable energy supplier. Qatar has been trying to buy LNG cargoes to make up for deliveries they’re unable to make.

Oil dominates the energy headlines, but the big story is elsewhere.

A decade ago we were net importers of natural gas. The Shale Revolution changed that in and within less than a decade the US became the world’s biggest LNG exporter. Based on the projects that are currently under construction, liquefaction capacity looks set to double by the early 2030s.

The Natural Gas Liquids (NGL) export story is often overlooked. Volumes have tripled over the past decade. Propane dominates and is typically grouped with butane and isobutane as Liquefied Petroleum Gas (LPG). Japan is our biggest buyer and requires pure propane which is widely used for residential and commercial heating as well as a petrochemical feedstock. China also uses propane primarily as a feedstock.

Blended LPG can be cheaper than pure propane, and developing economies tend to be the buyers. Over half of US LPG exports go to Asia.

Five years ago China was our joint top destination along with South Korea for LNG exports. Evidently concluding that less US trade exposure is better, they slashed their volumes from just under 13% of our exports to virtually zero last year. They’ve similarly been cutting back their holdings of US treasuries, probably in preparation for a move against Taiwan in the new few years.

But there are no alternative suppliers of ethane, which China’s petrochemical industry uses to make ethylene for plastics and other industrial chemicals. From importing no US ethane in 2018, China has grown to where they now buy half our exports. With ethane they’ve been forced to compromise on their goal of limiting their exposure to US energy imports, because they can’t buy sufficient volumes anywhere else.

Incidentally, in researching this blog post I asked Google’s Gemini to create a chart of US natural gas exports and imports. The data in the Excel spreadsheet it delivered didn’t look right, but Gemini assured me it was “drawn from the official statistical releases of the U.S. Energy Information Administration (EIA)”

Unconvinced, I retrieved the data from the EIA myself and uploaded a comparison to Gemini asking it to explain why they were different. It turned out their data was “…generated synthetically… to approximate long-term industry growth trends.”

Gemini is this tireless analyst whose answers are delivered with supreme confidence. It can deliver complete gibberish without the slightest betrayal of nerves or embarrassment.

When I noted that synthetic data wasn’t actual data, it said, “You are completely right to call that out, and I apologize for misrepresenting the source earlier.”

AI agents are good at saying sorry. They need to be.

I imagine that Gemini learned from this episode, at my expense. I’ve learned to trust AI only when I can corroborate its work. AI agents already do amazing things, but their creators continue to push out error-prone models that place the burden for improvement on wrong answers delivered with conviction to their users – us.

Venture Global (VG) has been a regular topic in this blog recently. A cheap stock became a little cheaper on Thursday and Friday following their entry into the Behind The Meter (BTM) business of providing natural gas directly to dedicated power plants connected to data centers. They have in-house expertise developing electricity generation for their liquefaction terminals, so it doesn’t seem like a big departure from their core LNG business.

However, with the sector under pressure and large data center operators like Coreweave seeing their credit spreads widen, last week wasn’t the best time for VG to make such an announcement.

We still think it’s attractively priced.

I was in the Carolinas last week seeing investors. Clients of Jim Agostini and his team at DaVinci Financial Designs in Columbia, SC have benefited for many years from their allocation to midstream. I had a most enjoyable visit with them where we as usual found much to agree on across investing and politics.

In closing, I’m very sad to report that Bill Shepherd, a long-time friend and client who was featured here in April when he celebrated his 100^th birthday, passed away last week. Unfailingly cheerful, he was very proud of his English ancestors and our shared heritage. He will be missed.

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

Energy Mutual Fund Energy ETF

 

Midstream had a tough month in September, with the American Energy Infrastructure Index (AEITR) -8.3%, its second worst month in the past five years. Rising treasury yields pressured sectors traditionally owned for their income.  The S&P Utilities ETF (XLU) was –5.9% for the month and is now –5.7% YTD through the third quarter. The Vanguard Real Estate ETF (VNQ) was –6.3% and is now +4.2% YTD. The S&P 500 Low Volatility High Dividend Index was –7.7% and is +4.4% YTD. The Barclays Agg was –2.6% in September and is –2.8% YTD.

The AEITR’s YTD performance of +17.9% is well ahead of other income-generating sectors, even after a lousy month.

The 1.2% increase in ten year treasury yields over the past year has been fully the result of real yields moving higher. Inflation expectations, defined as the difference between ten year nominal treasuries and TIPs (Treasury Inflation Protected Securities) have not budged and sit at around 2.3%.

The University of Michigan survey of consumer expectations has future inflation at around 3%, but similar to the bond market, this figure has been stable.

This is consistent with a positive economic outlook. Real yields have moved up because the market is expecting strong growth.

An important confirmation of this shows up in fund flows. In the twelve months through July, foreign investors bought a record $942BN in US equities and equity funds, while their purchases of US treasuries cooled. China has been steadily reducing their holdings for over a decade, which at $618BN are less than half their peak of $1.3TN in 2013.

It’s also consistent with the S&P500 being +12.8% YTD. In March, weakness in bonds hurt stocks, which were –4.9%. The explanation offered was that the NPVs of growth stocks that dominate the index were acutely sensitive to a higher discount rate on their much higher profits many years out.

Bonds had a worse month in September, but the S&P500 was only –0.4%. Over the past year in eight of twelve months stocks have been up and only two months (March and June) were down by more than 2%.

Surveys continue to defy the positive outlook held by investors. The University of Michigan reported that Consumer Expectations fell to 46.3 in September, down 10.4% year-on-year.  Political affiliation skews the result, but the White House will be frustrated to see that Republicans are becoming more pessimistic at a faster rate than Independents or Democrats.

Your blogger, who has never been surveyed, retains his confidence in America’s bright future, which has always been right.

A steady if unheralded improvement in the financial strength of midstream underpins its 20% five-year annual return, handily beating the S&P500 over that period at 13.8%. Leverage has steadily come down, with many companies in the 3.0-3.5 range Debt:EBITDA, down by 0.5X to 1.0X over the past decade.

Years ago, Kinder Morgan (KMI) used to argue that their diversified asset base could support 5.0X. Rating agencies disagreed, and in 2015 KMI cut their $2 annual dividend by 75%. Even now it’s only $1.19.

Wells Fargo is projecting 4.9% annual dividend growth for the midstream sector.

Capex has been creeping up, but in another sign of improved stewardship it’s mostly financed through internally generated cash rather than public equity offerings. Midstream generates far less in capital markets fees for Wall Street than it used to. The industry has grown while the number of names has shrunk. Today it’s mainly an investment grade, large cap sector.

The growth outlook for natural gas remains dominated by increasing exports and greater power generation. Wells Fargo expects feedstock for LNG terminals to more than double by 2035 (10.2% CAGR), while gas for power generation will grow at 5.6% annually.

Consequently, we think midstream remains attractively priced. The rise in real yields that reflects a robust growth outlook is good for midstream companies, which benefit from higher volumes. The Iran war has boosted the outlook for US exporters of hydrocarbons. The weakness in September doesn’t seem justified by the fundamentals.

Just over four years ago Stuart Kirk, then HSBC’s head of Responsible Investment, gave a delightful presentation about the extreme hype over global warming that dominated the left wing and media. He accused presenters of trying to “out-hyperbole” one another, and noted that even though the presenter just before him had warned that humans would not survive, “…no-one ran from the room. In fact, most of you barely looked up from your mobile phones.”

The presentation hastened Kirk’s departure from HSBC, and he now writes a column for the Financial Times.

Since then, the shrill voices warning of the end of the planet have been replaced by more sober consideration that places climate change alongside other major challenges such as malnutrition, access to clean water and reliable electricity. Regulators in the US and EU have reduced the burden on companies to report on potential climate change impacts.

As for Stuart Kirk, he’s moved on to condemn the current fear that fiscal profligacy will condemn us all to penury (see The climate doom-mongers now dread sovereign debt blowouts). He’ll probably find a lot of familiar faces on the other side of this debate.

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

Energy Mutual Fund Energy ETF

 

 

Last week’s blog post about inflation (see Estimating Your Retirement Spending) resonated with quite a few financial advisors. Several noted that persuading clients to accept sufficient exposure to stocks with the goal of maintaining purchasing power is one of their biggest challenges. The examples showing that many retirees will find their spending increases faster than stated inflation was especially well received.

A former colleague from JPMorgan offered some useful insight into housing costs. 40% of homeowners don’t have a mortgage, a group that is overwhelmingly in or near retirement. This insulates them from the approximately third of the CPI that seeks to capture the cost of shelter through the weird concept of Owners’ Equivalent Rent. Its weaknesses are regularly chronicled here (see  Why You Can’t Trust Reported Inflation Numbers).

The top 5% of households by income referenced in last week’s blog are even more likely to be insulated from housing inflation and in many cases downsize – although as I was reminded, some towards the higher end of this cohort increase their household expenses  by adding a second home.

Another reader also noted that the biggest wealth transfer in history is unfolding as baby boomers pass on their wealth to the next generation. For those fortunate beneficiaries, the concerns over retirement purchasing power will be less acute.

The prior week’s blog post on private equity’s discovery of midstream also drew comments (see Private Capital Sees A Cheap Public Market). We think the market doesn’t fully appreciate the cashflow reliability inherent in many midstream businesses. This is what’s drawing in outside capital, with structures that seek to isolate this benefit without imposing any meaningfully higher risk on existing investors.

JPMorgan found that investors in Oneok were critical of a structure that used capital with an IRR of 7.25% or possibly higher to reduce debt yielding around 5%, although the reduced leverage does justify this for some.

Williams Companies (WMB) took a different approach in their partnership with Blackstone by carving out a portion of Behind The Meter (BTM) deals into a separate entity. This approach allows for a valuation of specific assets, potentially at a higher level than when embedded within the overall corporate structure. We think there will be more examples of this which should ultimately help the sector resolve to a higher valuation.

Higher crude oil prices garnered headlines last week, along with record prices for diesel. The continued move higher in global LNG prices has been just as impressive if less widely reported. The European TTF benchmark is above $26 per Million BTU compared with the US at below $3. Exploiting the vast arbitrage is available to those with spare liquefaction capacity, notably Venture Global. Their strategy of retaining some capacity for themselves is allowing them to profit more effectively from today’s opportunity than Cheniere, which has committed 95% through 2035. The two companies offer a different risk profile and exposure to LNG price differentials.

But both stand to benefit over the long run, along with NextDecade from Qatar’s protracted inability to ship LNG out of the Persian Gulf. US hydrocarbon exporters more broadly should see a boost over the long term, including Enterprise Products Partners and Targa Resources for their ability to supply LPGs.

My wife and I are in Europe, home of the world’s most dysfunctional energy policies and consequently some of the highest electricity prices. European natural gas stocks have been running below normal levels for this time of year while prices have inconveniently moved up. Replenishing those stocks in time for winter will likely require government subsidies to avoid the political damage of even higher household fuel bills.

Like much of Europe, Edinburgh, where we visited last week, consumes energy more sparingly. Hotel corridors have motion sensitive lighting. The electric hand-dryers in the washrooms shut off more quickly. Windpower has been relatively successful in the UK, providing over a quarter of the country’s electricity and on some days all of it. Coal has been completely phased out.

Scotland generates more than it can use, and the infrastructure to transmit the excess south to England remains inadequate. Regional pricing doesn’t reflect local abundance, so Scots grumble about subsidizing their Sassenach neighbors with cheap windpower.

Britain’s surrounding waters are reliably windy. We saw several jacket foundations, the steel yellow lattice structures that support wind turbines, lined up on the port in Leith ready to be moved offshore. They’re built in China where coal is the dominant form of energy and shipped from the other side of the world. For decades the North Sea has provided oil and gas. Now it’s also providing electricity.

Household electricity prices in the UK are roughly double the US average, while industry pays two and a half times as much. Renewables are expensive in most of the places they’re deployed at scale around the world, although the US also benefits from cheap natural gas. Around a quarter of UK power comes from gas, but given the prices noted above it’s expensive. With coal reserves exhausted, windpower seems like a sensible option.

Thanks to the shale revolution, America remains the home of cheap energy.

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

Energy Mutual Fund Energy ETF