Still Uncovinced By Oneok Magellan Combo

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It’s almost two months since Oneok (OKE) announced their proposed acquisition of Magellan Midstream Parners (MMP). Consummation of the transaction has never looked more promising than on the day of the press release.

By mid-May, the market was ascribing less than 30% odds of shareholder approval, based on the gap between MMP and the combination of OKE stock and cash that is on offer. Energy Income Partners (EIP), a significant holder of MMP, issued a public letter outlining the reasons for their opposition. We had made similar arguments in prior blog posts (see Oneok Does A Deal Nobody Needs).

EIP’s letter so far marks the nadir of the market’s support for the deal. Neither company responded publicly to EIP’s criticisms although both have been active behind the scenes. At a couple of recent industry events they were making the case to interested investors, and the market-implied probability of the deal closing improved.

The tax bill facing MMP unitholders is the most offensive element of the transaction. The longer you’ve held MMP, the lower your cost basis and the greater your recapture of taxes deferred on distributions. MMP business model is designed to encourage investors who plan to stick around. In their May 4 press release disclosing 1Q earnings, MMP said they remain committed to, “…maximizing long-term investor value.”

Except this isn’t true.

The merger with OKE rewards the short-term investor whose recent purchase doesn’t create a tax obligation. This includes the MMP management team who are embarrassingly paltry investors in their own company. By MMP’s own calculations, the investors who have held their units the longest are facing the biggest tax bill. Like John Kerry (“I did vote for (it) before I voted against it”) MMP wants investors with a long-term outlook until they don’t. Their pursuit of a combination with OKE prioritizes value creation for short term investors because they’re the ones without the inconvenient tax deferral.

Sell-side analysts are not unbiased, objective observers. There’s not much in underwriting fees to be gained from upsetting potential capital markets clients. Therefore, the lukewarm comments from several firms can be interpreted as a negative view ameliorated by their business models. It’s a form of code. The deal odds slipped below 50% a month ago and still haven’t broken above in spite of the management charm offensive. The market’s unenthusiastic response means that if the deal does get approved there will be many former MMP investors ready to dump their newly received OKE stock, since they’ll have no taxable gains. OKE/MMP remains, just, more likely than not to be voted down. We’re happy to be raising awareness.

In other news, the US Energy Information Administration (EIA) reported that global trade in Liquefied Natural Gas (LNG) reached a new record last year of 51.7 Billion Cubic Feet per Day (BCF/D). Recent increases have been driven by liquefaction capacity additions in the US. Europe’s loss of Russian pipeline imports has also helped, since these have been partly replaced by imported LNG.

NextDecade (NEXT) is a company we’ve followed for some time. They recently confirmed they have bank financing in place to begin construction of their Rio Grande LNG export facility. Bechtel, who has the contract, just awarded an order to Baker Hughes to supply three main refrigerant compressors as part of the project. NextDecade hasn’t yet announced a Formal Investment Decision (FID) to proceed but have indicated this is imminent. We continue to think NEXT is attractively priced at current levels. Announcement of FID should be reflected in the current price although may still provide a modest boost. In any event we think the stock offers good upside potential.

Finally, within the details of Friday’s employment report was the news that black workers have accounted for 90% of the recent rise in unemployment. Monetary policy is hardly the tool with which to combat such a development. Past history shows that minority unemployment rises faster during a slowdown. However, Fed chair Jay Powell has in the past stated a desire for maximum employment that is “broad-based and inclusive” (see Criticism Of The Fed Goes Mainstream). Democrat lawmakers have another reason to criticize the conduct of monetary policy.

Market expectations have shifted in recent weeks towards the blue dots from the FOMC’s Projections. Just two months ago Fed funds futures were priced for a policy rate of 2.75% by the end of next year. Since then, hawkish comments from the FOMC and moderately firmer data have led traders to revise this to 4.25%. Usually the market is better than the Fed at forecasting monetary policy. This time around, they’ve caught some traders flat footed.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

Celebrating The 4th of July

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Independence Day is a wonderful holiday. It involves being outside in warm weather with the family to eat and watch fireworks. What’s not to like? Perhaps more than at any other time of the year, Americans rightly feel pride at our great country. As a transplanted Brit for now 41 years, my riposte to the inevitable jokes about a long-ago war is to point out that if it had gone the other way I wouldn’t have moved. 

Ronald Reagan was my first president, and his sunny optimism has seemed right ever since. I have a small bust of him on my desk. He would chuckle to know that it was picked up at the Truman Little White House in Key West gift shop, a Republican memento bought at a museum honoring a Democrat president.  

At the 1992 Republican National Convention, former President Reagan said “America’s best days are yet to come.” Two years later in his poignant letter disclosing Alzheimer’s he ended with the same sentiment. Warren Buffett shares Reagan’s consistently positive outlook, but negativity is all too easily found in the media. As we argued recently, it doesn’t fit the facts (see So Many Pessimists).  

In April, The Economist declared that America’s economic outperformance is a marvel to behold. There’s no bad time for this view but rereading it while contemplating an afternoon of bbq then pyrotechnics will make a thoroughly agreeable day even better.  

The charts date back to Reagan’s time in office and his 1992 speech. There were plenty of reasons then to dismiss such simplistic optimism. In 1989 Paul Kennedy published The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500 to 2000. It remains an insightful history of how economic might usually drives military power (the EU is a notable exception). Eventually empires sink under the weight of maintaining global hegemony. But Kennedy’s prediction that Japan would eventually supplant America at the top of the economic pyramid was spectacularly wrong.  

China is our strategic competitor. But their economy is still only three quarters the size of ours with four times the population. And ominously, that is now declining. I like our chances better than theirs. And as far as where I’d rather live – well, let’s just say it’ll be a cold day in hell before China is fending off hordes of western immigrants seeking a Chinese lifestyle.  

In 1982 when I moved to the US, I left the UK’s GDP per capita of $10K for America’s $14K. Today’s figures are $46K and $80K. Decades of lower productivity capped with the self-destructive if understandable Brexit vote have taken their toll. British living standards have slipped behind Germany’s. Relative to the US, UK households are as far behind today as Italy was in 1980. Few would have made that bet. Vindication of a decision to emigrate 41 years ago relies on more idiosyncratic metrics. But, as in trading, it’s important to go with the major trend.  

The data also reflects American exceptionalism because nobody else has been able to keep up. Our problems include fiscal profligacy, a poorly functioning electoral process heading for a rematch of two polarizing old men that nobody wants, and wokeness out of control. We’re managing to overcome all those headwinds. Whatever problems we have are self-inflicted, and not insurmountable.  

We love our flags in America. In England the Cross of St George has replaced the British Union Jack at sporting events. The united kingdom is less so nowadays. Brexit exposed that the Scots would prefer to be run out of Brussels than London. They even root for England’s opponent in the World Cup. If a vote on Scottish independence was held in England they’d be sent packing. 

The British flag was on full display during Charles III’s coronation, and his mother’s funeral last year. It’s flown on special occasions. But normal British reserve constrains such overt patriotism.  

America is different. The waterway behind our shore house in Point Pleasant, NJ shows a flag at every home. These don’t just fly on Independence Day, but on every day. Ours is on the left. Proud of my English heritage, I originally added the Cross of St George appropriately positioned below our Stars and Stripes. Regrettably it was made from cheaper material that a few months of coastal breeze turned ragged. It had to be retired. Our American flag is indefatigable. Like America.  

Happy Birthday America.  

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

America’s Favorite Energy

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When it comes to energy, the media has a decided liberal bias. With a few exceptions, journalists covering this sector breathlessly highlight the phenomenal growth of renewables and criticize those evil fossil fuel companies who supply 82% of the world’s primary energy. The solar/wind juggernaut is barreling along and if you don’t jump on you’ll be on the wrong side of history.

Bloomberg’s Naureen Malik, who’s not an obvious proselytizer for intermittent energy, recently noted that natural gas power plants represent a disproportionate share of outages during bad weather. Natural gas is America’s favorite fuel, providing 40% of US electricity generation last year and projected to rise to 41% this year. That’s three times the share of solar and wind.

If natural gas power plants sometimes fail during extreme weather, it reflects choices made about investing in hardening them. In some cases, spending on solar and wind has taken priority. It doesn’t reflect any inherent flaw in natural gas, which is why it’s America’s favorite fuel.

Last winter natural gas provided a record amount of power. What’s disproportionate is the media coverage of renewables relative to their impact. Solar panels aren’t just vulnerable to cloudy days, but also to hailstorms, as the photo from Nebraska shows.

The chart showing share of electricity generation by source hardly suggests that utilities are drawn to the resilience of solar and wind. Bloomberg’s Malik might have presented a more balanced perspective by including such charts.

The EIA provides substantial data on current energy consumption as well as projected use. Their Annual Energy Outlook includes several scenarios as well as their Reference (or Base) Case. The most bullish natural gas scenario they model is the High Oil and Gas Resource and Technology Case. It’s labeled the Upside Case in the chart.

The steady growth in US natural gas consumption over the past five years hasn’t drawn much coverage, but since 2017 its use in power generation has grown at a 6% Compound Annual Growth Rate (CAGR), around the same as renewables. Because natural gas is our biggest source of electricity generation, the 418 billion kWh five year increase is almost double that from renewables (222 billion kWh). Coal use has declined at an 8% CAGR. This story doesn’t get told because it doesn’t align with the left-wing bias of most journalists. Too many energy news stories are little more than an op-ed.

The big story in US energy is the increasing use of natural gas, expanding at the most optimistic rate envisaged by the EIA five years ago. It’s also been our biggest source of reduced CO2 emissions, because coal use has simultaneously declined. The shale revolution generated mixed investment results, but it brought cheap energy that has boosted business here, can be exported to our friends and allies and provides energy security.

For several years the dark shadow of the energy transition dissuaded investors from committing capital to reliable energy. There’s a welcome turn in sentiment. Shell is trying to look more like US energy companies who resisted woke protesters to focus on maximizing returns. Blackrock’s Larry Fink has vowed not to use the term “ESG” since it’s become so maligned. Sweden recently adopted energy policies that dropped “only renewables” in favor of “clean”. This sensible shift allows for the inclusion of nuclear, and fuels like natural gas if the emissions are captured.

Midstream energy infrastructure has lagged the market this year, because it’s not a sector synonymous with AI. But relative performance in June was good with the American Energy Independence Index making up for some lost ground. The narrative around renewables and the energy transition is more subtle than the headlines, a realization that is spreading.

If you follow the energy sector you have to pick your journalists and outlets carefully.

The futures market continues to chart a rate path less hawkish than the FOMC’s blue dots. But the gap is narrowing, in an unusual case of the market correcting towards the Fed. The carnage inflicted on bank securities’ portfolios was shown in Bank of America’s disclosure that they have $100BN in unrealized losses on their securities holdings. They’ve benefited as recipients of deposits fleeing smaller regional banks, but it is depressing their net interest margin because they’re stuck with a lot of low-yielding bonds acquired by competing with the Fed during QE. It shouldn’t have been hard to limit bond exposure. Central banks rendered the entire investment grade sector useless to the return-oriented investor. Yields are still too low. Bank of America flubbed risk management. JPMorgan did much better.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

 

 

Using More Of Every Energy Type

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On Monday the Energy Institute (EI) published the 72nd edition of the Statistical Review of World Energy. BP handed off this responsibility last year. They probably felt that saying anything about energy consumption would inflame climate extremists without commensurate benefit.

The EI launched the publication with a webinar, which predictably was both upbeat on renewables while lamenting their slow penetration. The interesting data in the review mostly concerns fossil fuels, which one panelist complained remain at 82% of primary energy consumption despite renewables being cheaper. Unspoken was that it might be the result of a conspiracy by energy companies to willfully deny themselves the higher profits widespread solar and wind could provide. Or maybe they’re just not cheaper.

Renewables (defined to exclude hydropower and now four fifths solar and wind) nonetheless reached a 7.5% share of the world’s primary energy consumption last year, up almost 1%. China is the biggest consumer of renewables power at 29% of the global total. They’ve grown their consumption at almost 25% pa over the past decade. China provides many energy superlatives.

Some may be surprised to learn that global natural gas consumption fell 3% last year, but this was a demand response to Russia’s invasion of Ukraine. Prices paid by Europeans jumped as much as threefold, and in Japan almost doubled. US prices rose too but remain far below other global benchmarks.

The result was that natural gas consumption fell in every region of the world except the US, where it rose 5%. The US consumes 22% of global output and is also the biggest producer with a 24% market share.

Regular readers are familiar with the growth in US Liquefied Natural Gas (LNG) exports, up from almost nothing a decade ago to 104 Billion Cubic Meters (BCM) last year. Global trade in LNG used to be dominated by Asia, but last year European LNG imports rose 57%. The global LNG trade reached 542 BCM, up from 516 BCM the prior year with a ten year Compound Annual Growth Rate (CAGR) of 5%. Japan replaced China as the top LNG importer as the Chinese lockdown slowed domestic economic activity. However, China is expected to displace Japan this year or next. Increased LNG typically reduces coal demand, a goal most will find desirable.

Coal consumption grew slightly, although surprisingly not in Europe in spite of their need to replace Russian natural gas. Energy conservation and slower growth caused overall energy consumption to dip in the EU, while sanctions had a similar effect on Russia. China continued to burn over half the world’s coal, increasing slightly from 54.6% to 54.8% of global consumption. This is 9X the US, where consumption has been declining at a 5.5% CAGR.

The best news on China is its continued growth of nuclear power, which has a 15% CAGR over ten years. The US remains the global leader in nuclear, producing roughly 2X the output of China. But this lead will shrink as China continues to build new power plants.

The climate change debate pits OECD countries with high living standards against developing countries whose desire for western lifestyles requires more energy use. US per capita energy consumption is 2.5X China’s and an astonishing 20X Africa’s. Our figure is flat over the past decade, while for the non-OECD countries the ten year CAGR is 1%. Poorer countries still have a lot of catching up to do.

Our CO2 emissions from energy have a ten year CAGR of –0.5%, compared with 1.6% for China. If CO2 levels eventually reach a point that harms the planet, it’ll be because China’s emissions were the tipping point.

If you care about US natural gas consumption and exports, the review was full of encouraging realism.

The world’s major energy companies are confirming the long term future of natural gas with their spending decisions. The forecasts of declining global consumption are what’s required to hit increasingly unlikely net-zero emissions targets, such as the IEA Net Zero Outlook in the chart.

China keeps signing long term LNG purchase agreements, including one recently with Qatar. On Monday China’s ENN Natural Gas’s Singapore subsidiary signed a 20+ year deal with Cheniere. Shell’s CEO recently told investors “Liquefied natural gas will play an even bigger role in the energy system of the future than it plays today,”

This all fits well with America’s growing dominance in the global LNG trade.

The US Energy Information Administration (EIA) warned that much of the country is at risk of energy shortfalls this summer. US power generation has grown at 0.5% pa over the past decade, so the problem isn’t caused by soaring demand. But solar and wind edged up to 15% of electricity generation last year, from 14% in 2021. Their intermittency is increasing our risk of power outages. The eastern part of the country is assessed as low risk, so living in NJ has its good points. But if your air conditioning doesn’t work when you need it in July, blame the climate extremists.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

 

 

Infrastructure As An Inflation Hedge

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We’re getting used to 4-5% inflation. Using the Fed’s preferred measure, core Personal Consumption Expenditures (PCE), it’s been above 3% since April 2021. People are quietly mentioning the unmentionable – what if the Fed raises its inflation target? 

The Economist recently published a briefing warning that “failure to quell it quickly will transform financial markets”. Whether the Fed suppresses the economy enough to get inflation back to 2% or not, it’s already too late for it to be quick.  

Richard Clarida was vice chair at the Fed until he resigned in January 2022 amid controversy over well-timed personal stock trades just prior to a barrage of pandemic-related rescue programs. He returned to PIMCO. Clarida told the Economist the Fed, “… will eventually get the inflation rate it wants” adding, “It could be 2.8% or 2.9% when they start to consider rate cuts.” 

Clarida joins a growing chorus of Wall Street strategists who are asking the same question. There’s nothing magic about 2%. It’s predictability that’s important, although the Economist goes on to argue that higher inflation is damaging precisely because it makes future inflation harder to forecast.  

Don’t expect Fed chair Jay Powell to announce a revised interpretation of their twin mandate (full employment with stable prices). The last time they did that was following their 2020 Jackson Hole symposium. Powell expressed a tolerance for “…inflation moderately above 2 percent for some time.”  Thereafter, “transitory” became overused and then dropped from his lexicon.  

We know this Fed focuses on whichever element of its twin mandate is farthest from target. They do not anticipate events, even though the tools of monetary policy take many months to have an impact. A jump in unemployment could see them pivot away from inflation.   

As we’ve noted before, some investors are already considering how to respond (see 4% Inflation Is Our Least Bad Option). Aging populations in the rich world mean a shrinking labor force. Globalization, the big driver of disinflation for decades, is reversing as supply chains are modified to match national security needs. Apple is just one company planning to reduce its reliance on China by shifting iphone production to India.  

Treasury Inflation Protected Securities (TIPS) are expensive, their prices as much distorted by the Fed’s QE purchases as conventional securities. Ten year TIPs at 1.5% are priced for ten-year inflation expectations of 2.2% when subtracted from regular ten year notes yielding 3.7%. This calculation has been below 2.3% all year. It’s a mistake to infer credibility in the Fed’s efforts. The University of Michigan survey shows ten-year inflation expectations have been rising all year, and now sit at a twelve year high of 3.2%, almost 1% above TIPs. This shows the bond market can’t be relied on as a measure of what investors think will happen.  

Stocks are better than bonds in such an environment. Within the equity market, stocks with pricing power should offer protection. The Economist recommends physical assets including infrastructure, because they, “generate income streams, in the form of rents and usage charges, that can often be raised in line with inflation or may even be contractually linked to it.” 

The Economist adds that such assets are hard to access, often “…dominated by private investment managers, who tend to focus on selling to big institutional investors.” 

An important exception is midstream energy infrastructure, the regular topic of this blog. This sector might be the solution to any investor wanting a portfolio designed for a world where 4% is the new 2%.  

Right on cue, Wells Fargo just published Midstream: Capital Allocation Conundrum—What to Do with All That FCF? They see 10%+ price upside over the next five years from excess free cash flow deployed to either buybacks or dividends. Pipelines have pricing power, in that many tariffs increase automatically with inflation. These are scarce assets, thanks in part to climate extremists who have made new construction unappealing through persistent ruinous court challenges. Mountain Valley Pipeline will soon be finished, but the protracted timeline will serve as a warning that returns on growth capex can be uncertain. Hug a climate protester and drive them to their next protest.  

Dividend yields are around 6%. The Wells Fargo analysis includes baseline 4.3% annual dividend growth and steady capex. The excess cash flow they project is worth around 2% pa. Adding the three together results in a 12.3% pa five year return. That’s not assuming any repricing as investors are drawn towards publicly traded infrastructure, even though returns like this would probably create their own momentum.  

After reading The Economist’s Investors must prepare for sustained higher inflation, you’ll be relieved to turn to midstream energy infrastructure which just might be part of the solution.  

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

Stocks Aren’t Cheap

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The Equity Risk Premium (ERP) is a measure of the relative attractiveness of stocks versus bonds. It compares the earnings yield on stocks with the interest rate on ten year treasury notes. For much of the past decade it’s shown stocks to be relatively attractive compared to the average relationship going back to 1962 – of no particular significance also my entire lifetime.

Quantitative Easing (QE), first unveiled with acute insight by Fed chair Ben Bernanke during the Great Financial Crisis (GFC) and abused by successive Fed chairs ever since, made bonds unattractive. QE has evolved from a unique solution to a banking crisis into a form of partial Federal debt monetization. The problems facing regional banks trace their roots to many banks mistakenly concluding that if the Fed was loading up on long term bonds that must make it acceptable to do so. This suspension of critical thinking exposed the absence of competent risk management. America’s more than 4,000 banks have a greater need of chief risk officers than the pool of qualified candidates can supply.

Since the founding of your blogger’s firm, SL Advisors, in 2009, stocks have represented the only meaningful source of return. Bonds have had some good years because the Fed has more or less adopted permanent QE, at least judging from their balance sheet. Repeated promises to kick the QE narcotic habit have done little more than impose a brief pause in the inexorable growth of the central bank’s bond holdings.

The Fed’s eventual zeal to vanquish inflation has over the past year or so improved the relative appeal of bonds. But fixed income investors must still compete with return-insensitive foreign central banks, pension funds with inflexible investment mandates that require bonds, and our own Federal Reserve with its bloated [$8TN] in holdings. Bonds are a long way from cheap. Ten year yields of 3.75% remain inadequate compared with long term inflation unlikely to return to 2% and a Debt:GDP ratio heading relentlessly up. But some might agree that yields on shorter maturities justify the discerning investor in considering modest exposure. Treasury bill yields above 5% almost seems like a fair return, provoking nostalgic recollections of the time value of money and the “float” banks make on the days required in processing checks.

Last year we responded to the lethargy with which Charles Schwab Bank and its peers raise deposit rates by sweeping client cash into two year treasury notes. More recently our Florida homeowners’ association moved its funds in excess of working capital out of a parsimonious 2% bank “savings” account and into the glorious bounty of 5.25% 90-day treasury bills.

In April when we last examined the ERP, we concluded that stocks were not cheap. Behavioral finance teaches that overconfidence afflicts too many investors. Opinions come with much wider confidence intervals than are usually acknowledged. Humility among investors is acquired while learning this, if fortunate at only modest expense. There are many ways to value the market, some of which probably make it appear cheap. The ERP is not a secret.

Since April, earnings forecasts have stopped falling. This stabilization has offered hope that the recession promised for later this year will be postponed, helping propel stocks higher. The yield curve has similarly responded. At one point during the demise of Silicon Valley Bank, traders were betting on a Fed Funds rate below 3% by the end of next year, suggesting a cut of almost 2%. More recently, Fed chair Powell’s warning of a couple of years before rates come down left many unconvinced. But traders have shown him enough respect that the ignominy of a premature capitulation on inflation has been quietly shelved.

Stocks have looked beyond the end of declining earnings forecasts and anticipate upward revisions. Expected growth in profits for next year has moved above 10%. However, when stock prices and bond yields rise together, the inevitable casualty is equity valuation. Whatever you thought in April, an S&P500 at 4,400 is less appealing than the 4,100 of two months ago.

We’re not about to eschew stocks to become bond investors. There’s no alternative to equities for investors who wish to preserve their capital’s purchasing power. Tactically switching out of stocks and back in requires two good timing decisions. Taxes on realized gains make it even harder.

At the risk of repeating an admonition frequently offered on this blog, midstream energy infrastructure stocks remain dirt cheap. Ample dividend coverage, continued financial discipline and pipeline tariffs that are often linked to inflation make this a sector whose entry needs no skill at market timing. We’re not selling anything.

But for the investor with cash to invest in the broader market, we’d suggest that the need for action is not urgent. Today’s entry point is likely to be available again, and perhaps better ones too.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

Insider Sellers Get Suckered

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Insider trading hasn’t been eliminated, in spite of the SEC’s efforts. In March Terren S Peizer, CEO of Ontrak Inc, was indicted for selling stock in his company when he knew they were losing a key client. He did the trades using Rule 10b5-1 which governs when senior executives can dispose of shares.

Last week provided circumstantial evidence that insiders were selling NextDecade (NEXT). On Monday and Tuesday NEXT dropped $1, from $6.14 to $5.13, on higher than average volume. There was no news out to justify the drop. The company had most recently reaffirmed its intention to reach Final Investment Decision (FID) on its proposed Rio Grande LNG export facility (see Situations We’re Following). We weren’t aware of any revised ratings from analysts on NEXT. The drop was puzzling.

On Wednesday morning NEXT announced the issuance of the first of three tranches of equity to France’s TotalEnergies, on terms that the company estimates will result in the French energy giant owning 17.5% of NEXT at $4.86 per share.

It seems likely the issuance of NEXT shares at $4.86 was known to some unscrupulous traders. That’s the only plausible explanation for the stock’s precipitous drop in the days prior. Past direct sales of shares by NEXT have similarly been preceded by selling that turned out to be profitable once the announcement was made.

But this time it came with news of a large LNG offtake agreement, also with TotalEnergies. It means capacity for the first three trains is almost completely sold out, making FID highly likely.

This news caught many people by surprise – presumably including the recent aggressive sellers. NEXT stock soared 50% on almost 38 million shares, around 50X its typical volume. There was follow through buying on Thursday, which brought the stock to 62% above its Tuesday afternoon low.

Insider trading is alive and well. NEXT has a problem in maintaining confidentiality around its capital markets activities. Fortunately, this time those seeking free money were relieved of some of theirs.

Fed chair Jay Powell maintained the Fed’s posture as more hawkish than the market. He suggested that rates may not come down for a couple of years. Interest rate futures adjusted towards this view but traders are still far from convinced.

It was bad news for banks, many of which loaded up on low yielding securities and loans during QE and now face competition from 5%+ yielding treasury bills to retain their deposits. Tier One capital has sunk since the Fed began tightening last year, although it recovered slightly last quarter.

Federal Reserve Governor Christopher Waller feels no responsibility for the squeeze on net interest margins. “I do not support altering the stance of monetary policy over worries of ineffectual management at a few banks,” Waller said in a recent interview.

Too many bank CEOs have demonstrated weak risk management. Bailing them out is not the Fed’s job – but as their regulator they should face some tough questions on how monetary policy caught out the industry they are apparently overseeing. If the market is correct in forecasting lower rates next year, it’ll be because the squeeze on net interest margins has impeded credit creation. The 1.5% spread between one year treasury bills and ten year notes renders long term fixed rate exposure unattractive.

The energy transition is providing opportunities for behavior at both ends of the evolutionary spectrum. Sweden’s overly liberal penal code is insufficient to dissuade two morons from defacing a Monet to promote their dystopian vision. Along with their other sad export, Greta, Sweden is developing an unfortunate reputation for producing spoiled, poorly informed young people. If the Swedes can’t discourage such damage to art, perhaps they should send it to another country where it’ll be safe.

More constructive was Williams Companies CEO Alan Armstrong reminding us that increased deployment of intermittent solar and wind will increase the need for natural gas, to provide the reliability that weather-dependent power does not. Williams correctly noted that, “Nobody’s ever going to be comfortable saying: ‘Oh, we’re willing to risk that for five days, we don’t have wind or solar and we’re not going to have a back-up’.”

Our view aligns with Armstrong’s, which is why we believe natural gas and its related infrastructure continue to benefit from increased demand globally. Last week’s sharp move higher in NEXT as their planned LNG export facility moves closer to FID was an example. We expect an announcement from the company by the end of the month, which should include more detail on the mix of financing they intend to pursue. US natural gas is taking another step towards supplying our friends and allies around the world.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

 

 

Pushing Back On Climate Extremists

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New York and much of the northeast US was shrouded in smoke from Canadian wildfires last week. Westfield, NJ is around 21 miles from lower Manhattan, which is normally visible if you’re at a high enough point. Last Wednesday it was not. Neither was the sun. Millions of Americans experienced air quality more usually associated with New Delhi.

Global warming gets blamed for most unusual weather events. Whenever it’s exceptionally wet/dry/cold/hot/windy it’s because humans are increasing CO2 levels. Regular readers know we are in favor of strategies to lower CO2. Substituting natural gas for coal is a practical solution already responsible for US success in reducing emissions. More nuclear power seems obvious. We’re not excited at the prospect of increased reliance on weather-dependent solar and wind.

The New York Times duly reported that, “Human-caused climate change is a force behind extremes like these.” It fits the narrative. Except the data doesn’t support it. Over the past four decades the number of fires in Canada has been declining, and the worst years were in the 80s and 90s in terms of area burned. That’s not to say that lowering CO2 emissions isn’t good if pursued without impoverishing us all. Just that the smoke hanging over North America’s population centers isn’t evidence of a CO2 problem.

The world is beginning to tire of the shrill climate extremists intent on imposing economic devastation and austerity on the rest of us. In the UK the Just Stop Oil people have enjoyed extraordinary freedom to disrupt everyone else. Groups of them standing in the road blocking traffic are protected by police. There are several videos of irate drivers being arrested for trying to push the protesters out of the way.

The list of what makes America great is long. The absence of an American version of these protesters is somewhere in the middle of the list. They would be run over or perhaps even shot at. UK public opinion is asking why the wrong people are being arrested. Sometimes it looks like Little Britain.

In Germany, the Greens have long held outsized influence over policy because of their swing vote in the coalitions that typically form government. “Green getting too Brown” is a more severe criticism than it looks, referencing the brown shirts of the Nazi party. “Heizhammer” (heating hammer) is how many refer to plans pushed by the Greens to accelerate the adoption of expensive, energy efficient heat pumps.

Germany is a global leader in spending money on the energy transition, if not in results. Last year their CO2 emissions were unchanged because they increased coal use to replace Russian natural gas. This was in spite of a 4.7% drop in energy consumption, as industry responded to high prices by curtailing production and in some cases relocating to other countries, including America. Germany’s electricity prices are among the world’s highest. There’s little in their energy policies that others should wish to emulate.

German public opinion is shifting. The Greens now rank behind the far right AfD in polls.

US energy policies at the Federal level rely more on tax credits and other financial incentives. A few liberal states such as New York are making it harder to access reliable energy, by for example banning natural gas hookups to new buildings.

Nonetheless, domestic production continues to grow. Last year the Permian region in west Texas and New Mexico hit another record at 21 Billion Cubic Feet per Day (BCF/D). It’s second only to the Marcellus/Utica region (collectively Appalachia). The Energy Information Administration (EIA) reported that this past winter power generation from natural gas set a new record at 619 billion kilowatthours. Renewables are growing but America’s electricity still comes from natural gas.

The focus on renewables overlooks the fact that electricity is around 23% of global final energy consumption. Within US manufacturing for example, electricity use has remained roughly unchanged at under 15% of energy use for decades. Natural gas use is growing and represents almost 3X electricity.

Because the US hasn’t followed extreme energy policies like Germany, reliable cheap energy is drawing manufacturing here. Germany felt good about their ability to reduce energy consumption last year, but in part it represented production facilities relocating because they were losing competitiveness.

China, consumer of half the world’s coal and the biggest determinant of global CO2 emissions, recently said non-fossil fuel energy sources exceed 50% of their total installed electricity generation capacity. The problem is you can’t believe anything the Chinese government says. So it may or may not be true.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

 

 

 

 

 

 

 

Situations We’re Following

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Situations We’re Following
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The Mountain Valley Pipeline (MVP) has suffered countless delays because of continued legal challenges from environmental extremists. Permits issued by Federal agencies were on many occasions rescinded by judges. No infrastructure of any kind can be built with such a process. When the recently passed debt ceiling legislation deemed completing MVP “in the national interest” it implicitly acknowledged that the permitting process is broken. This overrode the prior legal judgments. Let’s hope this provides impetus for reform.

Equitrans (ETRN), whose frustrated efforts to complete MVP led to its extraordinary approval by legislation, has gained over 50% as a result. The stock had previously included no value for MVP, priced as if it would never be completed. NextEra, a partner in MVP, wrote its carrying value down to zero last year.

But ETRN remains well short of fully reflecting MVP’s value. Morgan Stanley has estimated a $14 sum-of-the-parts price target for ETRN. RBC has a Base Case of $10 and an Upside Case of $14. It’s currently at $9.50. The threat of further legal challenges remains. The legislation removed the jurisdiction of any court over actions by Federal agencies on this matter. But it allowed any claim against the law’s validity to be heard by the DC District US Court of Appeals. Analysts believe it’s highly unlikely any further legal challenges can disrupt MVP’s completion.

We think ETRN remains attractively priced.

Another situation we’ve been following is NextDecade (NEXT), whose planned Rio Grande LNG export project will be located on the northern shore of the Brownsville Ship Channel in Texas, with easy access to the Gulf of Mexico. By combining carbon capture with the condensing of natural gas that’s loaded onto LNG tankers, NEXT says it will be the only such US facility offering CO2 emissions reduction of more than 90 percent.

In April FERC re-approved the construction of Rio Grande. The next step is for NEXT to approve a Final Investment Decision (FID) so that construction can move ahead. CEO Matthew Schatzman expects FID to come before the end of this month.

Substantial uncertainty remains over how it will be financed. We estimate that building three trains with 2.3 Billion Cubic feet per Day (BCF/D) will generate $1.8BN in revenues and around $450MM  in income to NEXT annually beginning by 2028. This is an $11-12BN project for a company whose market cap is below $1BN.

NEXT valuation estimates have a wide range. So any estimate of NEXT depends heavily on the mix of debt, preferred and common equity that’s used for financing. The FID announcement should provide enough detail about how Rio Grande LNG will be financed to provide sufficient cash flow visibility that its perceived risk will fall.

We think at current levels it offers an attractive return potential.

The proposed combination of Oneok (OKE) and Magellan Midstream has dominated our recent blog posts. We won’t relist our reasons for being opposed as we’ve covered them extensively (see Oneok Does A Deal Nobody Needs).

The market-implied probability of the transaction closing has dropped steadily since it was announced on May 15, because the gap between MMP’s current and proposed price is widening. Jim Murchie of Energy Income Partners recently wrote an open letter to MMP where he voiced criticisms similar to ours in objecting to the deal. Investor mood is turning against. Both companies will need to address the market’s cold response to their work.

In recent conversations with investors, several have expressed surprise that the midstream sector isn’t performing better. Equity market leadership is incredibly narrow (see AI And The Pipeline Sector) so unless you own the half dozen or so stocks benefitting from the AI frenzy it’s hard to keep up.

But fund flows into MLP Products, which is a decent proxy for mutual funds and ETFs in midstream energy infrastructure, have been negative every month this year. Last year’s inflow followed four negative years.

1Q23 earnings were good. Capex remains low, helped by opposition to new projects (hug a climate extremist and drive them to their next protest). Dividends are growing by our estimation 2-4%, and buybacks are retiring 2-3% of the sector’s market cap annually. Together with 6%+ yields, this provides the basis for annual returns of 10% or more.

Clearly there’s no irrational exuberance causing investors to throw money at the pipeline sector. Irrational apathy might be more accurate. But the $837MM of net outflows through the first five months of this year is more than offset by the rate at which companies are buying back stock. There’s also the explicit link to inflation in that many pipeline contracts, representing up to half the sector’s EBITDA according to research from Wells Fargo, reprice using either PPI or CPI.

Eventually these persistently strong fundamentals will cause inflows to resume, as they did last year.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

 

 

AI And The Pipeline Sector

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In February, the transcript of the dialogue between Bing’s chatbot and a NYTimes journalist illustrated a weird, unsettling side of Artificial Intelligence (AI). Kevin Roose, the columnist, mischievously led the chatbot through a series of existential questions about feelings which culminated in advice that Roose was in love with Bing, not his earthly companion. It was amusing, except perhaps for the AI programmers at Microsoft who have likely since dialed down Bing’s sentient scale.

Shortly afterwards I started using ChatGPT. I soon found that it can write a blog post. I shall immodestly claim that they are not as informative as my own, at least for now. But I assume their quality will improve, and I’ll have to do the same or risk being an AI unemployment statistic.

The Alerian MLP ETF is a true embodiment of the Moopy-Lacka-Doo syndrome. It’s confusing, risky, and prone to leaving you in a state of bewilderment. So, if you’re considering investing in this ETF, make sure you have a sense of humor and a sturdy pair of financial roller skates. You’re going to need both.

This is the closing paragraph of ChatGPT’s response to “write a funny blog post critical of the alerian mlp etf”. You can read the full piece here.

It’s like a broken seesaw with a weight limit that only exists to crush your hopes and dreams.

It has no substance, and is short of facts compared with, say, our recent missive, AMLP Has Yet More Tax Problems. But it uses more colorful analogies.

It’s like riding a rickety old roller coaster with no safety harness while juggling chainsaws.

ChatGPT is not burdened with having to write in the fair and balanced way SEC regulations require. Our AMLP pieces seem quite tame by comparison. Perhaps this is how a future roboadvisor will persuade clients to dump AMLP for a more properly structured fund, part of fixing portfolios acquired from the underperforming human FA.

I couldn’t resist emulating the NYTimes journalist with Bing, but ChatGPT dryly responded to my overture, “As an AI language model, I don’t have the capability to experience emotions or form personal attachments.” The programmers can learn too.

AI is fast becoming the must-have acronym. Until recently it was ESG. That always looked like a fad to us. ESG Is A Scam and ESG Has No Clothes resonated with our investors and readers. ESG’s relevance doesn’t extend beyond its impact on fund flows.

Advisor-managed client portfolios are mostly lagging the S&P500 this year, because who can run a portfolio with just five stocks (Microsoft, Amazon, Nvidia, Alphabet and Meta)? When the other 495 companies in the S&P feel underappreciated, you know what’s coming next. Those slides in the generic investor presentation dedicated to ESG or the energy transition will soon be amended to demonstrate the company’s AI bona fides.

The energy sector has been using “machine learning” (what AI used to be called) for years. Enbridge promotes it in their management of wind farms. EOG Resources has earned industry respect for its use of analytics to optimize its E&P activities. As far back as 2017 they were extolling their use of real time data to improve operating performance.

Last year Williams Companies partnered with Context Labs to improve their delivery of clean energy using AI.

Exxon Mobil uses “autonomous drilling” relying on AI in Guyana. Chevron,  Occidental and Shell all publicize their use of AI. Before long not using AI will be the exception, the story worth reporting.

And of course, the computers running AI software require energy, so the sector can benefit both by operating more efficiently and from increased demand for its output.

In the late 90s every company needed a dot-com strategy. Remember Pets.com? At the time ordering pet food online seemed as ridiculous as buying books. But not to Jeff Bezos. Just as with the adoption of the internet, even when it became ubiquitous companies still made sure investors knew they were adopting the new technology.

AI is not a fad. But it’s not as new as it looks either. And it can generate some startling images.

Machine learning existed long before it was rechristened. Genetically modified food seems recent but really goes back millenia. Vaclav Smil has chronicled how the world’s reliance on just a few varieties of grain for nutrition can be traced back to experimentation in the fertile crescent, when early humans were evolving from hunter-gatherers into farmers.

The market has already anointed the big winners from AI. But many more companies have been using machine learning, dynamic data analysis or continuously optimized algorithms for years. Expect to hear more of them boasting about it.

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

Energy Mutual Fund Energy ETF Real Assets Fund

 

 

 

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