SL Advisors Talks Markets

Nothing Ventured, Nothing Gained

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One source of recent volatility in midstream has come from a stock that wasn’t even listed – Venture Global (VG), the LNG exporter whose IPO priced on Thursday. The fundamentals could not be more positive. Trump has reversed the LNG export pause, wants US energy dominance and asked our trading partners to buy more American oil and gas. It’s hard to conceive of a better environment to launch an LNG IPO.

VG rather overplayed their hand though, originally seeking a valuation of over $100BN, double Cheniere’s (symbol: LNG) who handles half of all US LNG exports.

As investors contemplated VG’s proposed valuation, the effect was to highlight how cheap Cheniere is. Its stock duly rose, along with NextDecade (NEXT), a company we like that is building its first LNG export terminal.

Underwriters found quite a pushback from potential buyers on VG’s lofty pricing, and repeatedly lowered the target range. On Friday it priced at $25 – far below the mid 40s valuation underwriters had been suggesting a week earlier. Gains in other LNG stocks quickly evaporated. LNG and NEXT have gyrated without any actual trading in VG.

We still think the IPO price for VG is high – or more accurately, we think it highlights how cheap Cheniere is, at around 11X EBITDA vs 14X for VG. IPO buyers should still prefer these two stocks in our opinion.

VG also has a mixed reputation with its customers. While they have the same type of long-term sale-purchase agreements common to the industry, the spike in global natural gas prices following Russia’s invasion of Ukraine enabled them to delay commissioning of their Calcasieu Pass terminal. Although the facility was exporting LNG, VG said it wasn’t yet fully operational, and they were therefore not bound to supply gas under the long term contracts. Instead they sold supplies on the spot market, reaping $BNs of additional profit.

Shell, BP, Galp and Repsol initiated arbitration proceedings claiming that this gas should have been supplied to them. The plaintiffs claim VG improperly gained $3.5BN. This dispute is a risk factor in VG’s S1 filing with the SEC.

It seems that Shell and the other buyers are guilty of not negotiating a tight enough contract. VG offered attractive liquefaction pricing, and perhaps the buyers accepted more delivery risk as a result. VG also took an aggressive interpretation of their obligations, evidently surprising their customers. It looks like VG’s CEO Michael Sabel is cut from the same cloth as Energy Transfer’s chairman and former CEO Kelcy Warren. It’s great to be in business with him as long as you’re sure your interests are aligned (see from 2018: Energy Transfer: Cutting Your Payout, Not Mine).

Last week in Naples, FL was miserably cold, a condition that drew little sympathy from family and friends enduring single digit morning temperatures in the northeast. The freezing weather once again showed the importance of reliable, dispatchable energy. The PJM grid, which extends from NJ to Illinois and Tennessee used record amounts of natural gas to generate the electricity customers needed to stay warm.

The claims of climate extremists that solar and wind are cheaper than traditional energy have been thoroughly discredited. Opportunistic power that’s only available when the weather co-operates requires natural gas back-up. This surplus capacity raises costs, as the chart from Bjorn Lomborg illustrates.

It’s fortunate that in the US progressives haven’t done any lasting damage with their policies, other than in a few liberal states such as California, Massachusetts and New York. Our friends on the Jersey shore are certainly happy that plans for offshore windpower appear to have stalled.

Some solar and wind can work as long as a grid doesn’t become too reliant on them. At low levels they can drift in and out of the supply mix. Dependence is costly.

It’s one of the reasons the FT wrote Davos hits ‘peak pessimism’ on Europe as US exuberance rises. Former climate czar John Kerry made time to fly there in his private jet to talk about climate change. The European energy policies that he no doubt admires prompted Christine Lagarde, president of the European Central Bank, to say it was “not pessimistic” to say that Europe was facing an “existential crisis”.

Lastly, the FT wrote something we’ve long noted – US stocks at most expensive relative to bonds since dotcom era. Valuation isn’t a good timing tool, and stocks have been relatively expensive for at least a year. But it’s worth noting, because midstream energy looks like the exception to us (see Pipelines Are Cheap; Stocks Are Not).

Last week’s post, The Energy Story’s Trifecta, makes the case and has generated a lot of positive feedback.

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

SL Advisors Talks Markets

More Gas Demand Is Coming

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Last week the Energy Information Administration (EIA) released their Short Term Energy Outlook (STEO). People are often surprised to learn that US power demand has remained the same for the past couple of decades – at around 4,000 Terrawatt Hours (TwHs). The economy and population keep growing but offsetting this is improving energy efficiency.

Electricity demand changes slowly. Utilities need to plan for new supply years in advance to allow enough time to add new generation and supporting infrastructure. So although the projected increase looks visually small, it’s a long time since the industry has had to plan for any meaningful increase.

The PJM grid system, which extends from mid-Atlantic states to Tennesse and Illinois, is forecasting 2% annual demand growth over the next decade. ERCOT, which covers Texas, is expecting similar annual growth through 2030. The EIA expects 2% demand growth across the country this year and next, although this will be spread unevenly with some areas seeing 2-3X as much.

Renewables’ advocates typically promote added generation capacity as evidence of the energy transition to solar and wind, although as we regularly note the real transition is to natural gas (see The 8X Energy Transition). Last year the US added 50 gigawatts of solar and wind capacity, which produced an additional 50 billion kilowatt hours.

Adjusting for the different orders of magnitude and assuming the new capacity came online smoothly during the year (ie on average was available for half the year) gets to a 28% capacity utilization. That’s less than a third the uptime of natural gas power plants, which are also needed to compensate for the absence of solar and wind during dark and windless conditions (wonderfully named Dunkelflaute in German). We also added 10 gigawatts of battery storage.

Nobody knows if this was money well spent, because cost-benefit analysis doesn’t intrude on the deliberations of climate extremists. But we did use less coal, which was unambiguously good because it’s the highest emitter of greenhouse gas emissions per unit of energy output.

The EIA STEO is forecasting that this year natural gas derived power generation will drop by 55 TwHs even while total demand rises by around 70 TwHs. They expect increased solar to approximately equal the new demand.

We think that’s an unreasonably pessimistic natural gas forecast. Natgas has been gaining market share over the past decade, rising from 28% in 2014 to 42.5% last year. Over that time it’s captured more than half of the incremental demand and in 2024 was 76%.

We know data centers are driving the increase in power demand, and that they need reliable power that’s not dependent on the weather. Midstream companies such as Williams report high levels of interest in “behind the meter” arrangements by which a data center contracts directly with a gas supplier to supply a dedicated power plant. This bypasses the grid and can offer a faster solution.

The US Department of Energy thinks AI could consume up to 12% of all US power generation within the next three years.

Energy consulting firm Enervus thinks as many as 80 new gas power plants could be added by 2030, representing 46GW of new capacity. This is almost 20% more than was added over the past five years.

So a forecast that the share of US electricity generated from natural gas will decline this year seems to overlook what we know is happening with AI, and the clear commitment of the incoming Trump administration to favor domestic hydrocarbon production.

The STEO forecasts that LNG exports will reach 16 Billion Cubic Feet per Day (BCF/D) by 2026, up from 12 BCF/D last year. Pipeline exports will also grow, by 1.4 BCF/D as flows to Mexico increase.

The LNG story received a boost from Trump’s November victory since it assured that the permit pause announced a year ago would be lifted. LNG terminals represent best in class energy infrastructure assets since they have 20-30 year contracts, providing unprecedented cash flow visibility.

Privately held Venture Global, which operates the Calcasieu Pass and Plaquemines LNG export terminals, is planning an IPO that could value the company at over $100BN. The pricing looks a little ambitious to us, but it has drawn attention to publicly traded LNG companies Cheniere and NextDecade, whose comparatively cheap valuations have drawn in new buyers. Both stocks have rallied strongly since Venture Global announced its IPO.

US LNG remains one of the most attractive sectors in our opinion. Cheap US natural gas and a president who wants energy dominance is a powerful combination. We think the return potential from LNG is not yet fully recognized by the market.

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

SL Advisors Talks Markets

Pipeline Earnings Or Cashflow?

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Wells Fargo has recently suggested that the market may start paying more attention to the P/E ratios of midstream stocks. The sector has historically been valued using Free Cash Flow or Distributable Cash Flow (DCF), which is FCF less the maintenance capex necessary to preserve the value of existing assets.

P/E hasn’t been used much in the past because depreciation tends to understate the cash flow potential of infrastructure. The tax code allows for pipelines and other assets to be depreciated, while their ability to generate cash flow improves over time. Properly maintained, midstream infrastructure consists of appreciating assets.

I’m often reminded of the Transcontinental Gas Company’s pipeline built in the 1950s to move natural gas from Texas to population centers in the north east as far as New York City. This pipeline, long ago depreciated to zero, is part of the Transco system owned by Williams Companies. Allowing the owners to write down their investment for tax purposes didn’t reflect the actual value of the asset.

Wells Fargo thinks that the entry of generalist investors into midstream will encourage a more conventional approach to valuation. They cited South Bow (SOBO), the liquids pipeline spinoff from TC Energy last year, which looked unattractive based on DCF but better on P/E, and subsequently outperformed the sector.

Wells Fargo goes on to note that the midstream sector does trade at a P/E discount to the S&P500 (18.2 vs 21.7).

There has been some discussion that the new administration may reintroduce accelarated depreciation on some assets such as real estate although this could extend to infrastructure as well. By frontloading depreciation expense instead of using the straight-line method, it would depress near term earnings making P/Es look less attractive.

The spurt in power demand from data centers is likely to push capex higher for some of the natural gas-oriented pipelines. Because of this, investors relying on P/E are still likely to consider DCF and FCF yield as well in order to gain a more complete understanding of a company’s prospects. Earnings and cashflow are both important.

Friday’s strong payroll report cast more uncertainty on the prospects for further rate cuts from the Fed. The FOMC has the luxury of doing nothing for several months while the new administration’s policies take shape. Tariffs are widely considered inflationary. Extending the low tax rates due to expire this year will add fiscal stimulus to an already strong economy.

It’s a short step from the FOMC on hold to worrying about a potential resurgence in inflation. Should this happen, pipelines could offer useful protection since valuations are still attractive and roughly half the sector’s EBITDA comes from tariffs that have explicit inflation escalators built in. This was behind 2022’s 21% return on the American Energy Independence Index versus the S&P500’s -18%, when CPI inflation peaked at 9%.

Last year the world’s temperature averaged 1.5C above pre-industrial levels, the first time we’ve reached this threshold beyond which scientists warn that irreversible climate change is likely. It’s an incongruous thought at a time when most of the continental US is enduring well below average temperatures.

Sometimes I flippantly note that if global cooling was caused by rising CO2 levels, I’d be moved to install solar panels, buy a Tesla and adopt all the other virtue-signaling behavior of liberal zip codes. There’s a reason I leave New Jersey for Florida at this time of year.

What we’re seeing is the wholesale failure of progressive policies to reduce emissions, because they ignore the desire of developing countries to raise living standards with increased energy consumption and they naively believe intermittent, weather-dependent energy is the total solution.

It’s possible that policymakers may learn from this and adopt a pragmatic path to success, which would be a worldwide effort to encourage coal to gas switching for power generation. Critics of this approach argue that natgas still generates CO2. But it’s on average only half as much. Don’t let perfect be the enemy of good. Emissions would come down.

The US has achieved the world’s best combination of reduced CO2 and economic growth by doing exactly this. The correct choice is to encourage similar behavior around the world, especially in emerging Asia.

The China Coal Transportation and Distribution Association expects output to rise 1.5% this year, an outcome wholly inconsistent with reducing emissions and one that makes a mockery of the constraints imposed on their citizens by liberal US states.

Even with the US withdrawing again from the Paris Climate Accord, we are well situated to support the successful implementation of such a coal-to-gas policy. This is the world’s best option. US exports of LNG can do more to reduce global emissions than the failing efforts of the past couple of decades.

We’re invested in natural gas infrastructure because we expect this will increasingly become clear to policymakers. Growth in US natural gas output continues to swamp renewables.

Last week my daughter and I braved frigid cold to ski in Vail with long-time friend and client Bill Edwards, whom we annually credit with also being Vail’s Best Ski Instructor. Like many of our clients, he was a friend first. Any skiing ability I have is a credit to his patient  instruction over many years. The lapses are my own work.

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

SL Advisors Talks Markets

Last Year’s Favorite Blog Posts

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We enjoy the feedback from our blog readers, which along with the pageviews inform future topics. Looking back over last year’s posts, natural gas growth, the challenges facing renewables and obstructionist climate extremists were among the themes that resonated most.

The most popular post was The Inflationary Energy Transition, which reviewed how US electricity prices have been rising. This ought to shock renewables proponents, because we’re constantly told that solar and wind are cheaper than conventional energy. The overwhelming absence of supporting evidence has done little to silence this crowd. Indeed, the International Energy Agency (IEA), which has adopted the mantle of renewables cheerleader, reiterated this belief last year. Hopefully under Trump the US will cut its funding.

An op-ed in the WSJ last week by Bjorn Lomberg included a chart showing that electricity prices rise with solar and wind penetration all over the world.

If the IEA and others would simply say that renewables cost more and are a better choice because of rising CO2 levels, at least they’d have credibility on the issue. But by misrepresenting the economics they’ve lost any right to be taken seriously.

A Concentrated Bet On Renewables Stumbles showed how Costa Rica’s grid has moved almost fully to renewables, led by hydropower at 73%. A drought blamed on El Nino forced daily power cuts on consumers. Renewables Are An Energy Footnote showed how modest the impact of solar and wind has been in the US in spite of enormous subsidies and glowing media coverage. Natural gas production has increased 8X renewables over the past decade, and even if you eliminate exports and just count the gas that’s consumed domestically, it’s still 4X as big.

What became clear to us last year is that we are experiencing The Natural Gas Energy Transition, One day we’ll run out. One day perhaps everything will run on electricity from nuclear plants. But over any meaningful forecast period natural gas demand will continue to grow. Investment returns last year reflected this. The S&P Global Clean Energy Index was –25% last year. Midstream energy infrastructure was +45%. On Thursday there were new reports of closures among German solar firms.

The Energy Transition Towards Natural Gas showed how the US is benefitting from this, at least in those regions where energy policy hasn’t been hijacked by progressives (ie New England and the Pacific northwest). For more, see Blue State Energy Policies.

Sierra Club Shoots Itself In The Foot showed how environmental extremists’ use of the courts to slow projects was likely to prolong use of coal across developing countries where energy demand continues to grow. NextDecade’s (NEXT) construction of an LNG export terminal in Brownsville, TX was cast under some uncertainty due to the ruling. The stock lost almost half its value in the days following.

However, by the election it had recouped some of that and Trump’s victory propelled it higher. In recent days it’s back to its levels prior to the August court ruling, as investors have concluded that the project will continue to completion with minimal if any delay.

In this video (watch Let’s End The Sierra Club) we noted how they’re even against nuclear power with a set of dystopian policies that would impoverish billions of people and cause widespread starvation.

We’ve long believed that natural gas would remain a crucial source of energy for the foreseeable future. It seemed to us that greater renewables penetration would require natural gas to provide reliable energy for when it’s not sunny and windy. Slow renewables growth simply means greater use of reliable gas. Both themes are at work. Natural Gas Demand Keeps Growing and A Gassier World explained why.

And in 2024 the demands of data centers for reliable power added to the strong fundamentals.

Consequently, Drilling Down On AI was one of our most read blog posts. The Coming Fight Over Powering AI reminds that power demand growth is on a trajectory that will challenge the ability of utilities to add necessary infrastructure.

Last year not a single client commented on the relationship between crude oil and midstream – unsurprisingly, since oil finished down on the year. We reviewed this in Oil And Pipelines Look Less Like Fred And Ginger. Persistently strong operating performance and reduced leverage have finally broken whatever connection existed – and that only arose at times of strong energy sector sentiment (usually negative).

Someone once said that if you want to understand a topic, write a book about it, the point being that the research required will make you an expert. Writing a blog is similar, and astute readers can be relied upon to catch any sloppy analysis. It’s also an enjoyable part of my job.

Thank you for the regular feedback.

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

SL Advisors Talks Markets

The 8X Energy Transition

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Over the years I’ve developed a few soundbites to help investors remember why they should invest in midstream energy infrastructure. Once it became clear that climate extremists’ efforts to impede new pipeline construction were boosting free cash flow, I proclaimed that we should all hug our local climate protester and drive them to their next event.

As the absence of profits in renewables led inevitably to poor returns, I noted that the way to make a small fortune in solar and wind was to invest a big one and wait.

More recently, I’ve enjoyed using data to highlight that the Natural Gas Energy Transition is the only transition of any consequence in America. One of the least appreciated statistics is how growth in US gas production has swamped the increase in renewables.

Solar and wind output have almost tripled since 2000, from 1.2 Exajoules (EJs) to 3.5 EJs last year. Left-leaning and superficial journalists routinely hail this as clear evidence that hydrocarbons are on the way out.

What they willfully ignore is that natural gas production has grown from 18.7 EJs to 37.3 EJs over the same period. This is a mere doubling, a compound annual growth rate of only 2% versus renewables 2.7%. This is the type of arithmetic sleight of hand on which so much energy reporting rests.

But in energy equivalent terms, natural gas production is up by 18.6 EJs vs 2.3 EJs for renewables. We’ve added 8X as much new energy from gas as from solar and wind combined so far this century.

The Natural Gas Energy Transition is 8X as big as the renewables version.

8X

This is the statistic that every apologist for intermittent, weather-dependent power should explain before they mistakenly talk about the wrong transition.

Some might argue that this is too long a period, that solar and wind have really taken off more recently. Over the past decade, natural gas production has increased by 13.7 EJs versus 1.6 EJs for renewables. That’s a ratio of over 8X. It’s a similar story over five years, and from 2022 renewables growth has stalled.

It could be argued that since some of this production has gone to exports, the comparison overstates the penetration of natural gas in our economy. But domestic consumption has still grown by 9.3 EJs over the past decade, 4X the growth in renewables.

The sudden jump in power demand for AI data centers will provide further impetus to domestic natural gas consumption. There are no reports of frantic purchases of new solar and wind output, because data centers need power 24X7. In time nuclear power will hopefully meet some of this need, but given the time required even to restart an existing nuclear plant, natural gas is the only viable solution. So consumption will grow at a higher multiple of renewables in the future.

By any objective measure we are pursuing a natural gas energy transition. If left wing journalists were focused on this objective instead of their dystopian one of limited, intermittent and expensive energy, they could claim the right side of history. If they’d also embraced nuclear and used their platform to promote the low risk of this carbon-free energy, they might have helped sway public opinion behind a virtuous gas/nuclear combination that would displace coal and render solar and wind obsolete.

But they didn’t.

The Natural Gas Energy Transition is a huge success in that millions of words have been spilled on climate change, providing consumers with all the information they could need to make choices. That burning hydrocarbons raises CO2 levels has been understood for at least fifty years.

Many people have changed their behavior. They’ve installed solar panels, bought EVs that hopefully don’t run on coal like China’s, and switched from heating oil to gas to heat their homes (like your blogger).

But generally, with the exception of a handful of left-wing states, choices have been driven by incentives, not imposed by taxes. We’ve lowered greenhouse gas emissions from their 2007 peak of just under 6.2 Gigatonnes (Billion Metric Tonnes, GTs) of CO2 equivalent to 5.1GTs. We’ve dropped from 18.2% of the world’s total to 12.7%.

We’ve done it without impoverishing people or crushing our economy. Germans now watch for Dunkelflaute, periods of cloudy calm weather that renders those solar panels and windfarms little more than expensive, useless hardware. For an energy strategy to avoid, look no farther than Germany.

Incoming President Trump can tell the rest of the world they could do worse than emulate our energy mix. And our natural gas exports are here to help them do it.

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