SL Advisors Talks Markets

Some Energy Forecasts Are Aspirational

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00:00 / 00:05:57

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Long term energy forecasts are nowadays subject to a partisan test by many readers based on whether or not they project a rapid energy transition. The biggest oil and gas producers such as Exxon Mobil and Shell understand that the media interprets their published long run energy forecasts as reflecting their capex criteria. The result is a set of projections leavened with cheerleading for renewable energy, leaving the reader to separate the two.

The International Energy Agency (IEA) recently published their 2022 World Energy Outlook, and for the first time it projects a peak in natural gas consumption around 2030. The shift is caused by the loss of Russian exports to Europe, which has driven prices for LNG higher. The EU will import over 1.7 Trillion Cubic Feet (TCF) of additional LNG this year. This has caused many regions, including the EU, to turn to rely more on coal, as a workable alternative to high natural gas prices. But over the next decade, the IEA has increased its forecast of solar and wind power generation too.

The IEA’s base case is the Stated Policies Scenario (STEPS) which assumes current policies continue. Other scenarios envisage new policies, including a set consistent with achieving zero emissions by 2050. The world isn’t even consistent with STEPS, although it remains the most plausible of the IEA’s three scenarios. Including more extreme outcomes allows the IEA to be an energy transition champion if not an unbiased forecaster.

The 2022 Outlook includes many useful facts: this year fossil fuel producers have enjoyed a $2TN jump in net income (a “windfall”) versus 2021; governments have committed over $500BN in tax breaks and energy subsidies to households, hence the trend towards taxing windfall profits in Europe. Permitting and construction of overhead electricity transmission lines can take up to 13 years, with developed countries often the slowest. 75 million people who recently gained access to electricity are likely to lose it this year.

How likely is the IEA STEPS to be right?

The US Energy Information Administration (EIA) sees consumption of all energy sources increasing. They see renewables output more than doubling over three decades and gaining market share. Rising energy consumption to support higher living standards in the developing world is the dominant theme. The EIA sees global energy consumption rising by over 40%, a 1.2% annual rate of increase. This is slower than the 1.9% annual rate of increase the world experienced in the decade (2009-19) leading up to Covid.

By contrast, the IEA STEPS outlook based on existing policies projects a growth rate collapsing to under 0.3% per annum. There is no basis in history to support this. It implies a much longer path to the rising living standards that are the aspiration of developing countries. Their other scenarios assume almost no growth and an actual decline.

In 2020 the world’s ten year growth rate in energy consumption dipped to 1% pa for the first time in several decades because of Covid. Last year’s 5.8% annual increase brought the ten year growth rate back up to 1.3%, and it’s likely to edge higher again after this year. Forecasts are becoming less neutral and more aspirational, a form of political correctness at large organizations that requires more skeptical reading. In BP’s projections of global energy consumption, their three scenarios are called Accelerated, Net Zero and New Momentum. Their projected annual growth rates are 0.3%, 0.1% and 0.6% respectively.

The EIA, an agency of the US Department of Energy, provides the most plausible growth rate of the three. Accepting even the most realistic forecasts of the IEA or BP suggests billions of poor people acquiescing to constrained improvement in living standards.

Meanwhile Shell sees a bright future for LNG.

The chart showing a sharp drop in EU wind turbine orders illustrates some of the challenges facing that industry. Russia’s invasion could have been a big boost for wind (watch Why Aren’t Renewables Stocks Soaring?), but companies are struggling to make a profit.

The Economist magazine is projecting an increase in deaths this coming winter, with even a mild winter causing a seasonally adjusted rise. Such are the consequences of Europe’s failing energy strategy.

Lastly, Tellurian CEO Sharif Souki is the subject of a WSJ article that examines his failure to repeat the success he enjoyed at Cheniere (see US Natural-Gas Pioneer Struggles in His Second Act). Souki is a visionary, but he’s been handsomely paid for not delivering. We highlighted this “pay for performance in advance” in a recent video (see What’s Next For Tellurian?).

Souki admitted recently that his mistake had been to retain the price risk on shipped LNG. He’s bullish on prices, but lenders don’t share his enthusiasm for the risk. Conventional LNG projects charge a liquefaction fee that largely leavers the price risk with the buyers and sellers.

Although Tellurian has been forced to adjust its business model, Souki’s expectation for continued growth in energy demand from emerging economies looks realistic to us. Forecasters such as the IEA might benefit from considering it.

SL Advisors Talks Markets

Why Aren’t Renewables Stocks Soaring?

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2022 should have been a great year for renewables. The prices of fossil fuels, which they are supposed to replace, have jumped. Russia’s invasion of Ukraine has heightened the importance of energy security, which solar panels and windmills offer because most countries can find places to build them. And global Green House Gas emissions (GHGs) have rebounded following the dip caused by the pandemic. So why aren’t renewables stocks riding high?

One reason could be that some of them had benefited from the long rally in tech stocks. Investors in both sectors are typically relying on high growth rates which means years of waiting for a reasonable free cash flow yield. Rising interest rates put a higher discount rate on those delayed future earnings.

A more likely answer is that investors are becoming more realistic about the profitability of renewables. Germany’s north coast is windy, but they and others scrambling to replace Russian natural gas did not bid up the price of windmills. Instead, they hoovered up every available Floating Storage and Regasification Unit (FSRU) on the planet. The onshore pier, pipelines and electricity lines for the first one were completed last week in a brief 194 days in Wilhelmshaven on the North Sea. They’re also planning to build onshore import terminals for LNG, which have greater capacity than FSRUs.

European LNG prices famously reached ten times the US price earlier in the summer before dropping back to around 5X now. European storage is full in preparation for winter. Dozens of LNG tankers are idling offshore waiting for better prices before they unload their cargoes. Many analysts expect it’ll be harder to replenish stocks for next winter, since Russian gas was flowing west through Nord Stream 1 for the first half of this year.

Coal prices have soared as developing countries have been deterred from competing with Europe’s new appetite for LNG. Among non-OECD (ie developing) countries coal provides 46% of their power, versus only 19% in the rich world. And developing countries are where energy demand is growing.

China burns half the world’s coal and relies on it for 63% of their electricity.   They’ve even justified new coal plants as necessary for energy security (what’s Chinese for chutzpah?). Egypt is making government buildings and shopping malls turn their air conditioning up to 77° F, thereby reducing domestic demand for natural gas so they can export more.

Coal and gas together provide 59% of the world’s electricity, and both are much more expensive than a year ago. It’s as if the world had agreed on carbon taxes to improve the economics of renewables. There are numerous articles stating that solar and wind are cheaper than reliable energy, most of which pre-date the run-up in coal and gas. Renewables stocks should be soaring.

But they’re not. Danish wind turbine manufacturer Vestas expects a profit margin this year of minus 5% and recently reported a bigger 3Q loss than expected. They are optimistic that they can boost prices over the long run.

The CEO of Siemens Energy reminded viewers on CNBC that, “renewables like wind roughly, roughly, need 10 times the material [compared to] what conventional technologies need.” Current fiscal year EBITDA is down 42% and the company isn’t planning to pay a dividend.

UK solar operator Toucan Energy has gone bankrupt, with debts including £655 million ($779 million) to Thurrock Council, the local government where it operates. Neighboring London averages 1,481 hours of sunshine a year, which is 17% (Tampa, FL is 33%). 48% of UK electricity comes from natural gas. Although solar is 7%, UK solar farms can expect 83% or more downtime. Combined cycle natural gas power plants are typically down 5% of the time for maintenance. That’s why Toucan borrowed money from a local government rather than return-oriented investors.

The five biggest renewables ETFs are beating the S&P500 but lagging the American Energy Independence Index (AEITR). The global economy is rebounding from Covid, apart from China. Relying on foreign countries for energy is suddenly riskier. Fossil-fuel inputs for almost 60% of the world’s electricity have jumped in price. All these factors should have made renewables a hot sector.

Instead, a weary realism has cooled belief in a rapid energy transition. Developing countries are looking for very large payments from the rich world to help them invest in cleaner energies. This challenges the claims of those who argue that solar and wind are already the cheapest way to generate electricity.

The International Energy Agency (IEA) forecasts 0.5% annual production growth in natural gas through 2030 in their Stated Policies Scenario (STEPS). This is the most plausible one because it doesn’t assume every government’s climate pledges will be fulfilled. In their 2022 World Energy Outlook the IEA expects unconventional gas production (ie shale, overwhelmingly US) to grow at 2% annually. They estimate 750 million people don’t have access to electricity, and 2.4 billion don’t have access to clean cooking (meaning they cook using fuelwood, charcoal, tree leaves, crop residues or animal dung). Getting these families onto natural gas would improve their lives and leave the planet better off as well.

SL Advisors Talks Markets

Energy Pragmatism Is Beating Extremism

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As the world’s leaders meet in Egypt at the COP27 climate change conference, there are reasons for optimism among those who yearn for a pragmatic approach to reducing global Green House Gas emissions (GHGs).

The Economist magazine front covers over the past couple of years provide an evolving perspective from one publication that likes to think of itself as a thought leader. In 2020 clean energy was expected to remake geopolitics; the energy shock of 2021 was well underway before Russia invaded Ukraine. Notwithstanding the White House narrative, high gas and gasoline prices are not solely Putin’s doing.

Today there’s a growing recognition that the extremist approach championed by left-wingers and the Sierra Club is an abject failure. The purist solution of having the world transition rapidly to solar and wind is being shown to be a technical and commercial impossibility. Developing nations, responsible for all the growth in global energy consumption, and thereby emissions, aspire to western living standards more than they worry about climate change.

The loss of Russian natural gas exports to the EU did not cause a dash for more windmills. Instead, Germany has snapped up all the available floating storage and regassification units available worldwide to import Liquefied Natural Gas (LNG). The construction of permanent onshore facilities with greater capacity is underway.

The rich world’s desire for lower GHG emissions hasn’t been matched by promised cash payments to help developing nations upgrade their energy infrastructure. Since the 2015 Paris agreement OECD nations have failed every year to deliver $100BN in promised climate finance. It shouldn’t be a surprise; US politicians have rightly concluded there are few votes in writing big checks to China and India where official policy is to maintain GHG growth at least until 2030.

As Namibia’s petroleum commissioner, Maggy Shino, said, “If you are going to tell us to leave our resources in the ground, then you must be prepared to offer sufficient compensation, but I don’t think anyone has yet come out to make such an offer.”  Speaking on the sidelines of the COP27 in Egypt, Saudi Arabia’s energy minister Prince Abdulaziz bin Salman said: “The world is hoping to crucify us.

Reliable energy is well represented at this year’s conference, with a record 636 lobbyists registered to attend. This is a positive development, because the industry best positioned to help guide the energy transition is the one that provides 80% of the world’s energy today. Nowadays, The Economist talks of adapting to climate change as much as mitigation. An increasingly pragmatic assessment will lead to increased use of natural gas at the expense of coal, the dominant fuel for many poorer countries because it’s easily burned for power generation. Growth in demand to support rising living standards also means that coal plants in developing countries are younger and have a longer remaining useful life.

3Q22 earnings for pipelines included strong natural gas results. Last week, TC Energy’s natural gas segment was largely responsible for their beating expectations. They raised full year EBITDA guidance to C$9.76BN. Although the midstream sector’s footprint is almost entirely in US and Canada, TC Energy has partnered with Mexico’s Comisión Federal de Electricidad to build the $4.5BN Southeast Gateway pipeline along the Gulf of Mexico coastline. It will move 1.3 Billion Cubic Feet per Day, helping increase Mexico’s use of natural gas.

Mexico also has ambitious plans to become an export hub for LNG, the supply for which will be US since Mexico produces almost no natural gas of its own. Six of eight proposed export terminals are located on Mexico’s Pacific coast where they would offer sharply reduced travel time to Asia compared with Cheniere’s terminals in Louisiana and Texas. Opposition to proposed LNG export terminals in California and Oregon spurred renewed interest in Mexico. Pembina dropped plans to build Jordan Cove in Oregon following local opposition.

The two-day market rally following Thursday’s better than expected CPI report took the S&P500 6.5% higher. Equity buyers eagerly await anything that suggests the Fed may moderate its tightening cycle. FOMC members were quick to welcome the news, showing that they also would like the data to allow a policy shift.

However, inflation remains a long way from the Fed’s target. The most recent Employment Cost Index is increasing at a 5% annualized rate. Persuading workers to accept 2% raises is critical to getting inflation back to that level, although this means millions of people accepting a drop in real living standards. The pipeline sector may offer a way to protect against inflation that remains stubbornly high.

SL Advisors Talks Markets

Wage Rises Complicate The Inflation Outlook

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Fed chair Jay Powell and the American worker do not have an alignment of interests. In his remarks, following another 0.75% rate hike, Powell said the FOMC is, “acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation.” He always says that, so as to remind that some must sacrifice their jobs due to the Fed’s pursuit of higher unemployment. This will cool the labor market, and inflation, for the rest of us.

The Fed’s inability to engineer a million or two lost jobs renders Powell’s warnings anodyne, because so far the tightening cycle hasn’t claimed any casualties. Reducing inflation requires taming wage growth. The US Employment Cost Index (ECI) for all civilian workers is increasing at 5.0%, the highest since 1984.

This is marginally below the Personal Consumption Expenditures (PCE) deflator which is increasing at 6.2%. For now, the American worker is accepting a 1% drop in real purchasing power. It probably feels worse. CPI inflation is 8.2%. PCE is a more accurate measure because its weights update dynamically, but CPI is more widely used, including for the social security cost of living adjustment which will be 8.7% next year.

It’s unclear why anyone should accept a pay raise below inflation. Why should firefighters, teachers or indeed any worker whose annual income doesn’t include a healthy dose of variable compensation accept reduced purchasing power? Workers didn’t cause inflation. Supply disruptions due to Covid lockdowns, the excessive $1.9TN Democrat stimulus early last year and the Fed’s ponderous restoration of monetary normalcy all played a part. Action and inaction by government agencies are to blame, with reduced real living standards the result. The White House hasn’t articulated the case for restraint in pay negotiations. It’s not an easy one to make. But as long as pay raises are running at 5%, restoring the Fed’s 2% inflation target will be hard.

Powell noted that, “the labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies still very high, and wage growth elevated.” This empowers union negotiators to demand more, and they are.

For example, President Biden recently approved a 4.6% raise for Federal employees, more than two times the Fed‘s inflation target.

San Antonio is raising pay for city workers by around 7%, although some will receive raises of up to 20%.

NJ is increasing the minimum wage from $13 an hour to $14.13 (8.7%).

Teachers in many states across the country are receiving their biggest raise in decades. For example, in New Mexico base salaries are going up by 20%.

Railroad workers are threatening to strike, even though the Presidential Emergency Board, which is trying to mediate between the union and the railroad companies, recommended a 24% increase over the next two years.

Europe, as is often the case, is worse. Workers on London’s subway system (“the tube”) have scheduled a series of strikes over a 3% proposed pay raise and pension cuts. Transport For London, which oversees the city’s public transport, sent out an email one day last week that breezily reminded that there are “lots of public transport options” if you have weekend travel plans but went on to warn of “some planned strikes taking place.”

In France, demonstrators have clashed with police as they protest about inflation.

It’s easy to understand why workers left worse off by rising prices are fighting back. The US job market remains very tight. Unless you work at Twitter, it’s reasonable to expect your pay to at least keep up with the general price level. Unions are negotiating higher pay on behalf of their members. But employers are also often having to raise salaries to compete.

This is making it harder for the Fed to bring inflation back down. Unless inflation starts to fall rapidly and soon, it’s likely to strengthen the conviction of workers determined to maintain living standards.

The Fed needs job market softness now, in order to temper the trend towards higher wage increases. Jay Powell has been equivocal in his warnings, but on Wednesday he allowed that, “we may ultimately move to higher levels than we thought at the time of the September meeting.” When asked about the window for a soft landing, he said, “I would say the path has narrowed over the course of the last year.”

While it’s impossible to be confident about the rate cycle peak, continued low inflation expectations present the Fed an ever-present exit ramp. But for now, rates look set to keep rising. Friday’s strong employment report didn’t help. The dynamics of wage negotiations are adding to upside risk for rates.

SL Advisors Talks Markets

How Seaweed Can Fight Global Warming

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00:00 / 00:06:40

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A few weeks ago, my wife and I were fortunate enough to attend a wedding quite literally next door at our neighbors’ house. Freed from any concern about driving us both home safely, I was already in a mildly ebullient mood when I met Australian Stephen Turner. Now I may be promoting a stereotype and therefore betraying my absence of woke-ness, but I have yet to meet an Aussie who isn’t worth hanging out with over a couple of drinks. Call it positive profiling.

Upon meeting, we Brits comment on their lineage from 19^th century convicts dispatched to Australia’s penal colony. They immediately remind us of Australia’s persistent cricket victories over England (“the Ashes”). We both chuckle at this predictable introduction and a thoroughly enjoyable evening follows.

Stephen Turner managed to make a discussion of seaweed interesting without in any way shaking my association of Aussies with conviviality. Steve is Chair of Sea Forest, an Australian start-up founded in 2018 that aims to use seaweed to combat global warming. Efforts to reduce Global Greenhouse Gases (GHGs) generally focus on CO2.

Solar power and windmills, electrification of the transportation sector, carbon capture and myriad other efforts are intended to reduce CO2 levels in the atmosphere. But methane (natural gas) is also a potent GHG. Per molecule, it is far more potent than CO2 over a few years, but over decades it decomposes. Scientists generally assume twenty year equivalency between the two, meaning they assume the potency of methane after two decades before converting it into CO2 equivalent.

Methane is around 11% of US GHG emissions, with CO2 the biggest at 79%. The main source of methane is from wetlands through the decay of organic waste, but it also comes from landfills and methane leaks in the handling of natural gas. The US Environmental Protection Agency estimates that over a quarter of US methane emissions come from enteric fermentation – that is to say from ruminants (mainly cows and sheep) burping and farting. The UN estimates that global livestock is responsible for 14.5% of all anthropogenic (human-based) GHG emissions.

In early 2019 we pondered the impact on GHG emissions of a worldwide phasing out of cattle – not slaughtering them but simply stopping their breeding (see The Bovine Green Dream).  We were prompted by material supporting Progressives’ “Green New Deal” which conceded that “…we aren’t sure that we’ll be able to fully get rid of farting cows…” within a decade.

Sea Forest is developing a more practical and humane solution. Asparagopsis is an edible red macroalgae, or seaweed. It is highly invasive and attaches itself to other forms of seaweed such as in the Mediterranean and other warm climates. Hawaiians eat it in fish salad.

Asparagopsis is known to inhibit methane production in ruminants (mainly cattle and sheep). Sea Forest harvests it and produces a form (called SeaFeed) that can be given to farm animals as a feed supplement. It is native to the waters of Tasmania, where Sea Forest aims to cultivate it on a commercial scale. They have found that added in very low quantities (0.2%) it can reduce ruminant methane emissions by up to 98%.

As Sea Forest’s Steve Turner explained, “It works thanks to bioactive compounds that inhibit the enzymatic pathway producing methane at the last stage of ruminants’ digestion. When more energy is available to the animal, instead of being spent in the digestion process, it grows faster and the whole process is more efficient, e.g., less feed is needed.”

SeaFeed customer trials are ongoing with Australian beef producer AA Co, Kingston Wool whose sheep supply MJ Bale’s Tasmanian Merino wool suits and New Zealand dairy co-operative Fonterra.

MJ Bale is an Australian menswear business that promotes its “carbon-neutral fashion brand” because the sheep whose wool the company turns into clothes have processed Asparagopsis added into their feed.

It’s easy to see how this could have broad appeal. Organic food already has a strong following. Many consumers pay more for smaller vegetables because they like to eat food that wasn’t produced using man-made chemicals.

Steve told me one of their challenges is convincing farmers that SeaFeed isn’t harmful to their very valuable herds and flocks. But assuming farmers can be convinced that SeaFeed won’t kill off their assets, “climate-friendly” beef and lamb could become popular. Sea Forest estimates that at commercial scale SeaFeed would cost roughly A$1 per cow per day.

For beef cattle, they calculate that 25% of the cost of SeaFeed would be offset by the GHG tax credit if farm animals qualified (assume A$50 per tonne). More efficient conversion of nutrition into energy means 20% fewer days in the feedlot. The nutrition benefit for dairy cattle is around 11%.

The result is an inconsequential 0.2% increase in the cost of beef. So the economics don’t sound insurmountable. They estimate the total addressable market worldwide at 1 billion cattle generating methane equivalent to 3 billion metric tonnes of CO2.

Although solar panels and windmills gain most of the attention when it comes to reducing GHGs, there is far more going on than simply increasing our dependence on unreliable, intermittent power generation.

Sea Forest is another example of an innovation that may change the world. They have received numerous awards and grants in recognition of their work so far. All of us have a stake (no pun intended) in their success.