Politicians from both parties long ago learned that fiscal prudence leads to electoral oblivion. Therefore, the absence of the deficit as a topic of conversation should surprise no-one. Publicly owned Federal debt is 99% of GDP and the Congressional Budget Office (CBO) is forecasting that this will reach 166% over the next three decades.

Trump and Harris have both made promises that will add to our debt. The Committee for a Responsible Federal Budget puts its central estimate for the Harris plan at $3.5TN and the Trump plan at $7.5TN over the next decade (2026-35).

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These both sound like ruinously high figures – and yet, they’re on top of total debt that’s already forecast to rise. The CBO’s forecast on current policies is that total debt, including that which is held by the Federal Reserve and in effect monetized, will grow by $18.7TN (2026-35) on present policies. In this context, the Harris plan is parsimonious and the Trump plan only somewhat less so.

The translation of those campaign promises into legislation depends on the composition of Congress. But both candidates plan to extend the Tax Cuts and Jobs Act (TCJA), provisions of which expire next year. Without Congressional action, individual income tax rates will rise (ie top rate from 37% to 39.6%) as will the $10K cap on State and Local Tax deductions (“SALT”).

Living in high-tax NJ I’m naturally in favor of retaining current tax rates and repealing the $10K SALT cap.

With both candidates pledging to modify the TCJA, and taxes set to rise with no action, it’s likely something will get done. The Harris plan allows tax rates to rise on households making over $400K, and her TCJA modifications are 85% of her plan’s ten year impact on our debt. Trump’s plan adds more than twice as much debt as the Harris one, and TCJA modifications are 71% of it.

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Meanwhile bond yields are drifting higher. It’s partly a steepening of the curve caused by the Fed’s 0.5% cut and a result of the strong September jobs report which made another big cut unlikely.

Inflation expectations (derived by subtracting the yield on TIPs from nominal treasuries) have moved 0.30% higher in the past month and near the highest levels of the year. It’s far from indicating a return of the bond vigilantes, but bears watching. Political concern about our fiscal outlook, never much in evidence, is completely absent.

A Hemingway character explained his bankruptcy as occurring, “Gradually, then suddenly”) in The Sun Also Rises. The US won’t go bankrupt. But if a fiscal debt crisis suddenly occurs, it’ll be because it was getting gradually worse in plain sight for decades.

In our opinion, inflation-sensitive assets such as midstream energy infrastructure offer good protection against the subsequent rise in inflation that would follow.

In energy news, we noted that China’s coal imports hit a record high in September, +13% on a year ago. Meanwhile the Sierra Club continues to oppose the supply of reliable energy. They recently persuaded a court to delay a 32-mile natural gas pipeline planned by Tennessee Gas Pipeline, a subsidiary of Kinder Morgan.

Natural gas has been the biggest cause of reduced US CO2 emissions by displacing coal. Globally, demand continues to grow. Even the International Energy Agency (IEA), whose forecasts are increasingly designed to cheerlead for renewables, is warning that insufficient investment in new gas production risks a supply shortage.

Along with rising construction costs and regulatory challenges in building LNG export terminals, this is impeding the shift from coal to gas that China and other developing countries must make.

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Lastly, a photo showing the damage a tornado can inflict on a solar farm. Duke Energy’s Lake Placid facility was the target. As a Florida homeowner on the Gulf of Mexico I can attest that weather damage is becoming more frequent. Hiring workers to shift sand off our property and back onto the beach at exorbitant prices is a cost of being there if admittedly a first world problem.

Florida Power and Light restored electricity within a few days, but it reminds why gasoline-powered trucks and other equipment will be irreplaceable at such times.

EVs are especially vulnerable to flooding and storm surge. With a conventional car your worst case is it’s totaled, but saltwater entering an EV lithium-ion battery creates a fire risk in addition to leaving it undriveable.  One fire marshall advised moving a water-disabled EV out of its garage, “so that you can worry about fixing your home instead of rebuilding it due to fire”

Internal migration to the south and south west is increasing the population in hurricane-prone areas like Florida. Sun and no left-wing politics will do that.

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

Energy Mutual Fund

Energy ETF

We received a few comments from readers in response to last Sunday’s Heat Pumps Need Natural Gas. While EVs are widely criticized for the issues with charging, where heat pumps are installed, they seem to operate with little controversy. Defenders were quick to point out the benefits.

One client in California uses solar power + a battery backup to run his heat pump and has eliminated his electricity bill. He’s also not exposed to power outages from California’s creaky grid prone to wildfires. He did concede that air reaching rooms at the far end of the house from the compressor don’t get as warm, but didn’t feel that was a big problem.

Another reader knows people in upstate NY and in Maine who use heat pumps with no problems. He noted that the state capitol building in Boise, ID relies on heat from water pumped 3,000 feet below ground – technically not a heat pump although elsewhere some do operate with geothermal energy.

Nobody contacted us to say they hated their heat pump. They have their place and will likely grow over time. Perhaps one day I’ll even own one.

In conversations with clients last week, the Middle East figured prominently. Higher crude oil has provided a boost to midstream prices, although as we noted recently (see Oil And Pipelines Look Less Like Fred And Ginger) the relationship is weak.

In years past some suggested that we might include a short oil position into our portfolios as a hedge. The problem with that is the hedge ratio is unstable. The oil hedge required for $1 million of pipeline stocks depends on the period of past performance you’re examining. The slope of the regression line over two years versus five years can vary widely. It becomes an oil bet.

One firm launched such fund a few years ago and it soon failed when oil rose while pipeline stocks fell.

Pipeline executives are not altering guidance based on oil prices. But energy sector sentiment does improve with higher crude, and pipeline stocks are not immune. Goldman Sachs estimates that options pricing reflects a 5% probability of a $20 per barrel jump in prices, corresponding to a loss of 2 Million Barrels per Day (MMB/D) over six months. This is approximately equal to Iran’s exports although in recent weeks they’ve been lower.

As Israel contemplates how to respond to Iran’s largely ineffective missile attack, targeting oil infrastructure is an appealing option. The White House has counselled against this, probably fearing an oil price spike so close to the election. This could tip the balance next month to Trump, who’s more clearly pro-Israel.

Iran’s oil infrastructure is vulnerable.

We regularly get questions on how the election will affect pipelines. Energy executives will cheer a Trump victory but are unlikely to “drill baby, drill” since such exuberance didn’t work out so well eight years ago. Financial discipline will likely continue, but a more pro-energy regulatory touch could help US production at the margin. This could be offset by a tougher stance towards Iran, curtailing their exports.

Most US oil and gas production is on private land, and US presidents have little influence. Kamala Harris’ position flip on fracking may excite some voters in Pennsylvania, but her views aren’t relevant because states decide such things, not the White House.

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We sometimes get questions about the sharp but brief drop in prices in March 2020 as the pandemic was taking hold. Potential buyers wonder if it could happen again. An important cause was the forced deleveraging of MLP Closed End Funds (CEFs).

Equity funds that invest in a single sector with added leverage are a dumb idea.

For MLPs, 4.0X was the prevailing Debt:EBITDA range among investment grade names. The CEF PM who thinks a portfolio of such similar names needs added leverage at the fund level is ignoring the figure that pipeline CFOs and the rating agencies have collectively agreed upon. In a triumph of hubris over humility, this PM thinks he knows better – and it is always a he.

March 2020 showed what happens when an undiversified portfolio with excessive leverage falls sharply. Forced sales result in a permanent loss of capital (see MLP Closed End Funds – Masters Of Value Destruction). Goldman Sachs, Kayne Anderson and Tortoise are among the firms whose risk management failed. The Tortoise closed end fund still hasn’t recovered its losses.

The good news is that it’s unlikely to happen again, because MLP CEFs destroyed enough of their investor capital that they’re permanently smaller. Their incompetence led to their irrelevance.

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

Energy Mutual Fund

Energy ETF

Some may find irony in BP dropping its goal of reduced oil and gas output by 2030 at the same time as Hurricane Milton is barreling towards southwest Florida – the second hurricane in two weeks.

Four years ago, BP pledged to cut hydrocarbon output by 40% within a decade. Two years ago they scaled it back to 25%. And now they’ve acknowledged reality because it’s easier to make money in traditional energy than in renewables.

Climate extremists will point to the millions in Florida preparing for another storm and the recent devastating losses caused all the way up to North Carolina as evidence of climate crisis. No one weather event can be attributed to a changing climate, but the Gulf of Mexico is a little warmer than normal. Naples, FL where we own a home endured a storm surge in 2017 (Irma), 2022 (Ian) and may get a second of the season as Milton follows Helene.

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Higher CO2 levels may be the cause – certainty for or against is illogical because climate is so complicated, but the evidence for is mounting. In Pakistan the rational response to heatwave deaths this past summer is to spend more on air conditioning. In Naples we’ll invest in making our property more resilient to storm surges. Confronting the consequences of a changing climate is demanding an immediate response. This requires more steel, cement and plastic, three of Vaclav Smil’s four pillars of civilization, along with more energy.

What’s clear is that left wing policy prescriptions to slow CO2 emissions are failing to make an impact, because they ignore the desire of developing economies to raise living standards, which requires energy. Solar and wind are a marginal solution, as they have been in the US as well.

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History will show that a credible effort by OECD countries to reduce emissions was overwhelmed by the desire for higher incomes and more energy consumption across developing Asia, Africa and South America.

Since 2000, renewables including hydro have gone from 2.0% of US primary energy to 3.5% last year. Natural gas has gone from 30% to 38%. BP’s languishing stock price shows that they’ve discovered how to make a small fortune investing in renewables – start with a big one.

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BP’s stock has lagged US peers Exxon Mobil and Chevron who never accepted that the world would quit using hydrocarbons. The transition to low carbon energy systems will be slow, needs to acknowledge that energy demand will grow and that solar and wind are an expensive, small element of the solution.

Public opinion is souring on the false promises of climate extremists that renewables are cheap and create jobs. The leader of Canada’s Conservatives Pierre Poilievre, likely to be Canada’s next prime minister based on opinion polls, has vowed to repeal the carbon tax that is intended to guide consumers towards low-carbon choices. He calls it, “an existential threat to our economy and our way of life.”

Neither Kamala Harris nor Donald Trump are saying much on climate change. There’s still no serious effort to help developing countries shift from coal to gas as the US has done. This remains the most obvious solution and as investors in natural gas infrastructure we’re positioned for it.

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Things have turned out well for investors who understand these trends, such as U-Vest Financial, a fast-growing firm led by CEO Mike Davino based in Tallahassee, FL. Last week I was invited back to their annual meeting to discuss midstream and the energy transition. They identified the opportunity early in the cycle, to the benefit of their clients.

Each year it’s exciting to see the growth at U-Vest and the dedication their leadership team brings to the business. U-Vest is expanding because of its results but also because they’re adding advisors. If you’d like to join your practice with a dynamic team, reach out to me and I’d be happy to make an introduction.

Or you can click on this link.

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BP is just one example of a growing realization that economics and public opinion aren’t with the Sierra Club and other climate extremists. Pragmatic choices are one result. The White House is backing more nuclear power. Constellation Energy hopes to restart a unit at Three Mile Island, although not the same unit that partially melted down in 1979. Microsoft is the potential customer. Holtec’s Palisades nuclear plant in Michigan is also planning to restart. Demand growth from data centers is driving this.

US natural gas is also benefiting, because it compensates for intermittent power and is abundant. BP has decided to stop paddling upstream. Others will follow.

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

Energy Mutual Fund

Energy ETF

I was surprised to read the other day that sales of heat pumps across Europe dropped 47% in 1H24 versus a year earlier. The EU has adopted more aggressive policies to combat climate change than any other region. Residential adoption of heat pumps is part of their green agenda.

We recently replaced an oil furnace with a gas one – doing our part to reduce emissions since the new furnace is more efficient and gas generates less CO2 per unit of energy output than heating oil.

Heat pumps utilize an ingenious technology which relies on increasing the pressure/temperature of a refrigerant inside a coil, warming the air passed over it.  This cools the refrigerant, which is recycled back through a compressor which raises the temperature back up. The same equipment working in reverse provides air conditioning.

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The electrification of energy consumption underpins the energy transition. Heat pumps use less energy and generate CO2 dependent on the source of electricity. So in the utopian vision of climate extremists, we’ll all heat our homes with solar panels and windmills.

We never seriously considered installing a heat pump. Because they work like a/c in reverse, they rely on ductwork to warm the house. Our 1928 home has radiators, and we weren’t interested in tearing out walls to replace them.

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Around 16% of US homes have heat pumps. They come with a lot of qualifications. Carrier, a leading US manufacturer of heat pumps, warns that, “… when outside temperatures drop below freezing, the efficiency of a heat pump is affected as the unit requires more energy to maintain warm temperatures inside the home.”

This is because the compressor is placed outside. Carrier suggests either installing an “auxiliary electric heater” for when the outside air is very cold but prefers adding a furnace (presumably natural gas) which would take over when needed.

This seems ruinously expensive. Figures on furnace augmented heat pumps aren’t available but it seems a common solution.

Natural gas power plants also provide reliable power when it’s not sunny and windy. The energy transition relies heavily on gas to compensate for shortcomings in equipment that’s supposed to enable us to do without it. This is supporting relentless growth in consumption globally.

There’s the added inconvenience that an accumulation of snow and ice on your compressor can impede its operation. So the homeowner might find she has to venture out in a blizzard to shovel snow off the unit.

Much of the information on heat pumps is from proponents, so is overwhelmingly positive. They seem to be best suited to mild climates where snow is rare – from North Carolina on south for example. They’re outselling gas furnaces in the US, although sales fell 17% last year. However, gas furnace sales were down 27%.

Heat pumps are more popular in Scandinavia than anywhere else, which suggests that operating in a very cold snowy climate isn’t insurmountable. Natural gas and electricity are both more expensive than in the US. In addition, there are financial incentives to reduce fossil fuel consumption, which also explains why Norwegians drive so many EVs.

Oslo sits on the 60^th latitude and the average low in January is 23 degrees F. Minneapolis is on the 45^th latitude, over 1,000 miles farther south and has an average January low of 7F. Norway’s weather is pretty mild compared to the midwest. I don’t think I’d buy a heat pump there, although Minnesota is providing subsidies to increase adoption.

Everything to do with the energy transition is more expensive and less convenient. EVs come with range anxiety. All my Tesla-owning friends love their car but have another conventional one. Solar and wind are costly, intermittent and require lots of room and extensive high voltage transmission lines. Heat pumps are expensive to install and may need a furnace in cold climates.

European heat pump sales fell because some subsidies were ended and natural gas prices fell following the jump that followed Russia’s 2022 invasion of Ukraine. Some households embrace low carbon solutions regardless of price, but many more are sensitive to cost. Luke Sussams, an analyst at Jefferies, wrote, “If the economics do not work, the consumer will not accept it.”

An enduring theme is that all these initiatives increase demand for natural gas. 43% of US electricity comes from natural gas, so EVs drive that higher. Heat pumps also need a natural gas furnace. Solar and wind couldn’t work without gas power for when it’s not sunny or windy.

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Natural gas is critical to the energy transition and unlike renewables doesn’t rely on subsidies. Its infrastructure will be in use for the foreseeable future. We think traditional energy offers the best investment prospects in the sector.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Revisions this year for the ten year growth outlook for US power demand because of AI data centers have provided support for midstream energy stocks, as additional natural gas will be needed (see The Coming Fight Over Powering AI). A recent report from Morgan Stanley (Global Clean Power – At a tipping point) expands this outlook to the rest of the world and reaches a similar conclusion.

Since the report is focused on renewables the positive outlook for solar and wind is not surprising. Morgan Stanley is forecasting a 3.5% annual growth rate 2022-2030 for global electricity demand compared with 2.8% over the prior decade. AI data centers will be 20% of demand growth. Along with EVs, they also expect an impact from rural electrification in countries such as India, where they expect 7.6% annual growth through 2032. China was two thirds of global power demand growth 2012-22 but is expected to drop to a fifth over the next decade as the rest of developing Asia gains ground.

Overall, around half of global demand growth will originate in Asia.

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This is going to make electricity markets tight, causing higher prices and, the report argues, will create a positive environment for power companies. Global prices for long term power contracts are +15% over the past year.

Hybrid generators that combine renewables with natural gas will play an important role in meeting this new demand. The report notes that wind/solar hybrids with natural gas have seen a sharp increase in tenders in India.

Williams Companies CEO Alan Armstrong has often noted that renewables growth was driving demand for the natural gas that moves through his company’s pipeline network. Weather-dependent, intermittent electricity sorely needs a back-up capability that can come online when needed. Natural gas power plants provide that. Tenders for power generation in India regularly receive more than half their bids from hybrid solutions where the cost is around $50-60 per Megawatt Hour (MwH). This compares favorably with wholesale prices expected to average $70 per MwH by 2025.

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Once renewables reach 30-40% of a grid’s power supply their dependence on sunny and windy days tends to be a limiting factor. In the US this is reducing the safety margin across almost all of our grid systems. New England runs the biggest risk of power cuts in the future because of its poorly conceived energy policies (see Why Liberal States Pay Up For Energy).

Interestingly, one of the risks to the hybrid power outlook is a slowdown in US LNG export permits. This will favor coal consumption, something that’s clear to the careful observer but evidently not the Sierra Club, who opposes US LNG (see Sierra Club Shoots Itself In The Foot). Orders for 15 gigawatts of new natural gas power plants were placed in 1Q24, the strongest demand in almost a decade.

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Nuclear power is also enjoying a resurgence. Japan and Germany notably cut back following the 2011 Fukushima accident, although in Japan its importance is now growing again. China is the clear leader, with plans to add capacity of 168GW, followed by the US at 50GW. Morgan Stanley thinks power generation from nuclear could roughly double from its current 390GW and expects output to hit a record next year.

An example is Microsoft’s recent agreement with Constellation Energy to restart a unit at the Three Mile Island nuclear plant in Pennsylvania. Data center operators often have ambitious low-carbon objectives. Microsoft is building one roughly every three days somewhere on the planet. Because AI servers need stable power 24/7, solar and wind are a poor choice.

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Many will be surprised to learn that nuclear and natural gas are set to increase their share of global power generation from 32% to 38% by 2030. By displacing coal this will represent a success for those who want to see reduced emissions, albeit one that’s contrary to the goals of climate extremists.

The outlook for natural gas demand is strong, because it generates less CO2 per unit of energy than coal and can compensate for the shortcomings of solar and wind. Increasing US LNG exports will help electricity reach more people in developing countries.

Morgan Stanley believes global power demand is at a tipping point, and it’s why the outlook for natural gas remains strong. We believe it will continue to support attractive returns from midstream energy infrastructure.

In other news, Saudi Arabia’s apparent willingness to abandon its $100 price target for oil is offsetting any geopolitical concerns caused by Israel’s demolition of Hamas and Hezbollah. Iran’s inability or unwillingness to respond to the decimation of its two proxies is reducing the market’s assessment of the risk of oil supply disruption. Weaker oil did correspond with softness in midstream stocks last week, especially those with more crude exposure such as Oneok and Targa Resources. However, the sector’s link with crude has steadily weakened in recent years as leverage has dropped (see Oil And Pipelines Look Less Like Fred And Ginger).

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

The outlook for crude prices is a frequent conversation topic among energy investors. We’re often asked for our thoughts – over the next several years we’re bullish as growing demand from developing economies competes with insufficient investment in new supply. But we don’t trade oil or reflect that outlook in portfolio construction.

Crude oil and midstream are linked in the minds of many. Over the last decade they have often moved together. The price chart shows a very close visual relationship in years past. The original appeal of MLPs a decade or more ago was that they operated a “toll model”, indifferent to commodity prices and reliant on volumes. The quantity of oil and gas consumed in America fluctuates much less than its value.

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The volume of crude oil and petroleum products supplied in the US has stayed remarkably stable for decades. We use around 20 Million Barrels per Day (MMB/D) with little regard for the economy other than the brief dip during the pandemic. This is why pipeline owners don’t spend much time worrying about the price of crude. Prices respond rapidly to changes in supply and demand and bring them back into alignment without much change in volumes.

Oil is heavily used in transportation. Economic slowdowns have little impact on the movement of people and goods. Lockdowns during covid did hurt demand and caused prices to collapse, but this was rare, and we can all hope that such loss of freedom will never be revisited on us again.

Interestingly, investors rarely consider the relationship between natural gas prices and pipeline stocks. There is no relationship – natural gas consumption for power demand and other purposes has been growing for years with little impact from prices.

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Crude prices and midstream stocks were searingly correlated in March 2020 when demand collapsed, oil prices went briefly negative and people stopped moving. The correlation (defined using daily changes over the prior three months) reached 0.87 on March 25^th. It was unforgettable.

That day marked a peak in the relationship. Although both crude prices and midstream stocks recovered strongly from that low, the link has steadily weakened. The 80% rally in oil when inflation jumped in 2022 was not matched by the American Energy Independence Index (AEITR) although the inflation-linked contracts widely prevalent in the industry underpinned the sector’s 21% return that year.

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The relationship continued to weaken, driven by falling leverage and capex among pipeline companies. Debt:EBITDA moved from 4-5X to 3-3.5X among most investment grade companies, a substantial reduction that made the stocks less risky. Capex came down as it became clear we mostly had the pipeline network we needed. Greenfield projects also ran into opposition from climate extremists such as the Sierra Club, whose ill-conceived policy prescriptions (anti-nuclear; anti US LNG exports to displace foreign use of coal) are helping drive global CO2 emissions higher.

The past three years of strong sector returns have come with little participation from oil, and the correlation has come close to zero at times this year. The recent jump above 0.30 is more reflective of a negatively correlated period dropping out of the past three months than of a changed relationship, as a visual inspection of recent price performance shows.

The weak relationship of recent years is the new normal, because the underpinnings of reduced leverage aren’t going away. Investors are increasingly able to assess the outlook without much regard for the price of oil, because it doesn’t matter that much. Oil and gas consumption will continue to grow, driven by developing economies.

This was vividly illustrated by a recent story about Indonesia’s challenges in reducing its coal consumption. Like many countries in Asia, coal is Indonesia’s biggest source of primary energy at 43% according to the Energy Institute’s Statistical Review of World Energy. Plans to replace some of the power generation derived from coal with renewables are running into problems because the government is worried that they won’t get enough financial support from rich countries like America to offset the increased cost.

Yes, renewables cost more, as is clear wherever they’re used. This is less of a problem than its consistent denial by climate extremists and others. Renewables cost more and they may be worth it depending on the consequent reduction in CO2 emissions. But they cost more, not less than our existing energy systems. Otherwise, we’d all be using solar and wind already and there wouldn’t be any need for subsidies.

Fuzzy thinking by climate policymakers is colliding with the reality of developing countries, in that they don’t want to pay more for energy. US LNG could solve this problem for Indonesia and others if opponents would get out of the way. We think pragmatism, inspired by the failure of today’s solar/wind obsession to meaningfully reduce global emissions, will eventually prevail.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

When a sector has enjoyed a period of good performance, the investor typically has to moderate her feelings of satisfaction at a choice well made with concerns about a crowded trade. When a good idea becomes widely acknowledged as one, prices are likely to overshoot as valuations become stretched.

This does not seem to be the case for midstream energy infrastructure, which has returned 16% pa over the last five years. It has generated very satisfactory returns without creating a destabilizing inflow of capital. Pipeline investors have enjoyed a stealth rally – a relentless appreciation that has not caught the attention of social media or most market observers.

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We talk to potential investors all the time. Reasons for not investing include fears that lower oil prices could hurt the sector as happened during the pandemic. This overlooks that midstream has delivered several years of good performance while oil and gas prices have languished. The S&P Energy ETF offers that type of commodity price exposure, but reduced leverage throughout the pipeline sector has dampened the relationship with oil.

Some still fear that the energy transition will lead to stranded assets as the world moves away from fossil fuels. But the evidence of recent years is that we’re going to use more of every type of energy. Global primary energy derived from renewables is growing only half as much as the demand for electricity. Peak fossil fuel demand is a long way off.

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We also run across investors who just find energy too hard, with numerous policy issues that require analysis. The White House has pursued an ambiguous approach – variously encouraging domestic oil production when rising prices caused electoral concern and flip-flopping on fracking (like John Kerry, Biden/Harris were against it before they were for it), but then pausing new LNG permits when left wing Democrats needed some love.

Joe Biden’s embrace of a renewables-based economy is largely based on substantial tax subsidies such as the Inflation Reduction Act. To paraphrase St Augustine, “Lord, give me chastity (or get America off fossil fuels), just not yet.”

Improbably, this has worked out quite well for the US economy, which continues to attract foreign direct investment from manufacturing powerhouses such as Germany where the “energiewende” is strangling domestic businesses with high prices. The 15% reduction in CO2 emissions we’ve achieved over the past couple of decades is short of what the EU has delivered but hasn’t been that painful either.

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Midstream’s strong performance hasn’t relied on strong fund flows, and as a result valuations have remained attractive. It’s beaten the S&P energy sector and crushed clean energy. To make a small fortune in renewables start with a big one. Midstream has even stayed marginally ahead of the S&P500 without including any high-flying AI stocks. It just keeps moving steadily higher.

Years of outperformance have accrued to comparatively few cognoscenti willing to invest the time required to understand the underlying fundamentals.

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Metrics such as Enterprise Value/EBITDA continue to show the sector as historically cheap. Free Cash Flow (FCF) yields have dipped over the past year as stock prices have climbed, but the growth outlook is such that at current levels yields are set to move higher. Without further appreciation, within a couple of years FCF yields will be headed back towards the high levels of 2021-22.

For the past seven years midstream funds have seen net outflows, typically around $1-2BN. Most months are negative, although this summer there were a couple months with small inflows. There is no panic buying in this sector.

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When midstream companies were organized as MLPs buybacks were rare. More common was the regular trickle of secondary offerings to finance “drop-down” purchases from their controlling general partner.

The MLP structure has lost favor to the single entity c-corp with its simplified tax reporting (1099 vs K1). This has coincided with reduced capex and improved financial discipline as companies have concluded that we mostly have the pipeline network we need, and climate extremists have made new construction torturous.

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The consequent growth in cashflows has enabled the midstream sector to start repurchasing stock. In recent years these purchases have exceeded the net fund outflows. This year’s stock purchases are over $4BN ahead of fund redemptions. The most informed are buying from the less informed, and the imbalance is growing.

Wells Fargo is forecasting that increasing cash generation by midstream companies will fuel further buybacks. This has helped the American Energy Independence Index (AEITR) to a 27% YTD return.

Imagine what might happen if fund flows turn positive.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

I spent two weeks recently touring southern England with my wife. It’s 42 years since I moved to the US, and I appreciate my old country more now than as a teenager itching to escape to the new world. We did some sightseeing and saw old friends. As we traveled around, the British approach to the energy transition was never far from my mind.

Despite voting for Brexit, which was a populist, right wing decision, Britain is a politically liberal country like much of Europe. Reducing greenhouse gas emissions to limit global warming is not a contentious issue. The Conservatives, who were in power from 2010 until an ignominious electoral drubbing in July, passed a “Net Zero” law in 2019 mandating zero emissions by 2050.

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The UK has been surprisingly successful in heading towards this goal. Emissions are down 44% from their 2006 peak, meaningfully ahead of the EU whose equivalent reduction is 31%. Germany may be the self-styled leader of the “energiewende” but Britain has been quietly getting it done.

In 1900 coal provided 95% of Britain’s electricity. As recently as 2012 it was still 40%. The last coal-burning power plant will be decommissioned by the end of this year. They’re also planning to add more nuclear.

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Renewables provide 20% of the UK’s primary energy, substantially ahead of the US (9%) and the OECD (11%). Last year wind provided 29% of their electricity, just behind natural gas at 32%. What the National Grid calls “zero carbon energy” (mis-named since manufacturing wind turbines relies on traditional energy) regularly produces most of their electricity and was 51% last year.

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The North Sea is a reliably windy place, and offshore wind turbines are far less controversial than in the US. We saw them from numerous spots while traveling along the south coast. Windpower suffers from cost and intermittency, but the view of turbines miles out to sea doesn’t strike this blogger as particularly offensive.

US windpower is overwhelmingly onshore. Offshore has been plagued with cost over-runs and cancelations. Coastal residents complain about the view, and a 300-foot fiberglass blade recently shattered near Martha’s Vineyard, with jagged pieces washing up on the beach. Voters along the New Jersey shore, politically red in a very blue state, are outraged at plans for offshore wind (see Windpower Faces A Tempest).

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In the UK you’re never far from a wind turbine.

Energy costs more in Britain. Electricity is around $0.40 per kilowatt hour, more than 2X the US. People commonly shut the lights off when leaving a room. One hotel we stayed at required your room key inserted in a slot for the lights to stay on, preventing guests from going out and leaving the lights on.

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Gasoline (petrol to Brits) costs around twice as much as the US because of higher taxes. But the cars are smaller and the roads narrower. Even though I learned to drive there, it was over 40 years ago. Driving through the English countryside, it felt like small cars were zipping around impossibly narrow lanes. But our 800 miles of driving cost £100 ($133), just under $0.17 per mile and similar to the average for US drivers.

British drivers grumble about the cost of petrol (and the traffic) but unlike the US it’s not a political issue. Everyone knows the British government has no influence over oil prices.

Americans drive more miles per year than most countries, which is why gasoline prices get people so worked up. Moreover, Britain’s more extensive public transport system generally gets you around faster than in the US. Taking a painfully slow NJ Transit train into New York compares unfavorably with the faster commuter trains servicing London.

In Britain, it’s household heating bills that earn the public’s ire.

Natural gas is widely used, and Russia’s invasion of Ukraine boosted winter heating bills. For a couple of years households were protected from the full impact of higher gas prices, through government caps, but that costly program has ended. During our trip the new Labor government’s plan to cancel pensioners’ annual heating rebate was a leading news story.

Britain has a good energy transition story to tell. But how do people feel about making a considerable effort while developing economies led by China overwhelm their efforts? Most haven’t given it much thought, and those that have shrug and say it’s important to “do your bit.”

Young people care more. My nephew, who’s a data scientist, even considers the energy required of a data center in constructing the form of AI queries he submits.

Unquestioning fealty to green energy is common among liberals. If climate change is such an existential threat, why don’t their governments make it a priority in dealings with China? I think it’s because the politics of climate change aren’t driven by solving the problem, but rather by imposing costly and inconvenient local measures that appear effective but are globally irrelevant.

Britain is ahead of its peers in reducing emissions, but the worldwide effect is inconsequential. The 44% reduction they’ve achieved since 2006 is only 0.6% of the total. For reference, the UK is around 3% of global GDP.

Climate extremists are driving policy in the UK as elsewhere and are missing the big picture. At its worst it’s wokeness trying to impose guilt on everyone simply for being here, on Planet Earth, living.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

If a single chart can illustrate the challenges in reducing emissions, it’s the scatterplot below showing per capita energy use and GDP. Raising living standards requires more energy. The relationship between these two variables is hard to break. Richer countries consume more energy, and becoming richer requires more energy. Everyone wants to move up and to the right. They want to live more like Americans.

This is the fundamental challenge to moving the world off fossil fuels. Reducing emissions means paying more for energy as well as using less of it, which is completely at odds with the desire in developing countries to develop.

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Per capita energy use varies enormously. Americans consume over 3X the global average. It’s not a perfect measure – China’s per capita energy consumption is close to the EU average even though incomes are less than half, which reflects the larger share of energy-intensive manufacturing in their economy as well as relatively low energy efficiency.

Canadians will be surprised to see what energy hogs they are. It’s not just their mix of economic activities. As my family in Ontario knows well, winter is long and cold north of the border, which pushes up energy consumption.

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Getting richer means using more energy, and a substantial portion of the world’s population uses comparatively little. Moreover, concern about global warming tends to be greatest among rich countries, who are ironically better able to invest in mitigation against flooding or heatwaves.

An extended period of high temperatures in Pakistan was blamed on global warming, although for any specific weather event it’s impossible to know (see Energy By The Numbers). While scientists will point to the imperative to reduce emissions, Pakistanis will understandably favor more air conditioning, which means raising incomes and using more energy.

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The International Energy Agency (IEA) publishes forecasts that are more aspirational nowadays, having dropped their original mission to provide unbiased analysis of energy markets. In their 2023 World Energy Outlook their Stated Policies Scenario, which is the closest to reality, projects 30 GigaTonnes (GTs, billions of metric tonnes) of CO2 emissions in 2050, down modestly from today’s 36 GTs. Even that includes heroic assumptions about declining coal use and sharply higher renewables.

The IEA calculates that if all the announced pledges on energy were implemented (their Stated Pledges Scenario), 2050 emissions would drop by two thirds to 12 GTs.

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Their Net Zero Scenario shows just how implausible it is to eliminate emissions over the next twenty-six years. It includes an almost complete phaseout of coal by 2050, and an almost two thirds drop in natural gas consumption. It also assumes that total energy consumption is 15% lower by 2050 even though the world’s population is projected to be 9.7 billion by then (versus around 8 billion today).

Net Zero assumes nuclear power output would double. As fanciful as this scenario is, it wouldn’t be sufficient for the Sierra Club who wants the world to stop using nuclear as well.

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The only way to square the circle is for rich countries who care the most about climate change to make enormous transfer payments (think $TNs annually) to poorer countries, to compensate for high-cost renewable energy. Climate extremists will counter that solar and wind are cheaper, but the contrary evidence is overwhelming. Germany has among the most expensive electricity in the world thanks to their big push into renewables (see Germany’s Costly Climate Leadership).

US electricity prices for households rose 6.2% last year as renewables gained market share (see Long Term Energy Investors Are Happy). This lowered the system’s overall capacity utilization. Solar and wind operate around 20-35% of the time. Their increased reliance means more back-up for when it’s not sunny or windy – typically large-scale batteries or more natural gas. The cost of solar and wind isn’t just the cost of using them to provide power. You have to include the back-up too.

Rich countries are not going to make the necessary transfer payments, which would be on a different scale than the current subsidies and tax breaks directed towards clean energy. Energy prices are politically sensitive – the Biden administration has been acutely sensitive to the oil market, even though allowing higher prices would boost the appeal of the alternatives.

The inherent conflict between raising billions of people out of poverty and reducing CO2 emissions is going to favor the former. As developing countries get richer, they’ll begin to share the climate concerns of western countries. There’s not much evidence that they do today. So we’ll use more natural gas along with every other source of fuel. The upside case is that policymakers make a serious effort to persuade China, India and others to use more natural gas and less coal.

US natural gas infrastructure looks like a good long term bet to us.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

It’s hard to overstate the global success of US natural gas production. Over the past decade we’ve grown output by 37 Billion Cubic Feet per Day (BCF/D), accounting for half the global increase. We now produce over a quarter of the world’s gas. And it’s cheap.

The development of fracking happened in America not elsewhere for many reasons. The geology, water availability, access to capital, technology and a culture of entrepreneurship. Least appreciated is the concept of privately owned mineral rights, which has enabled thousands of landowners to partner with drillers, earning royalties subject to state regulation and taxation.

All over the world except in the US, governments own mineral rights.

Several years ago, a Spanish E&P company found out how hard it is to drill when you’re not welcome. In the north of England, the British government granted Cuadrilla rights to extract natural gas using fracking. The local population was strongly opposed. Britain surely needs natural gas, but the residents living above the reserves saw no financial benefit while enduring all the noise and disruption. It quickly became a political issue and the government backed down (see British Shale Revolution Crushed: America’s Unique Ownership of Oil and Gas).

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The Energy Institute’s 2024 Statistical Review of World Energy provides informative detail on natural gas, which provides 24% of the world’s primary energy, up from 22% at the start of the century. It’s 23% of the world’s electricity. In the US it provides 43% of our power. Even the International Energy Agency, which has transformed from an objective observer of energy markets to a renewables champion, concedes that last year “Coal-to-gas switching was the largest driver behind emissions reduction in the US electricity sector.”

The US Energy Information Administration (EIA), credits coal to gas switching for 61% of the power sector’s emissions reductions since 2005.

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Global consumption has grown broadly, with the notable exception of the EU. Their strategic blunder of reliance on Russian piped gas along with ruinous climate policies have constrained GDP growth (see Natural Gas Demand Keeps Growing). German emissions are falling because they’ve made energy too expensive. They are de-industrializing, to the benefit of the US (see Gains From Energy).

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Gas is much harder to transport than oil, so only moves via pipelines or LNG tanker. Transportation costs are a much bigger percentage of the value of the commodity than for oil. Shipping costs from the US to Europe via LNG tanker are $1.50-$2 per Million BTUs (MMBTUs), but liquefaction can add another $2-$3.50. With US spot gas prices at $2, that still leaves a profit margin vs Europe’s TTF benchmark at around $10, but this shows why large regional price differences persist.

Shipping crude oil over the same route is around $2-$4 per barrel, so a much smaller percentage of the value of the commodity.

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Nonetheless, global trade in LNG is growing, even while intra-regional pipeline trade has shrunk with the loss of Russian shipments to the EU. Almost 14% of natural gas was shipped as LNG last year, up from only 6% in 2000. Pipelines represented another 10%.

LNG provides both buyer and seller optionality in a world more prone to geopolitical trade disruption. Pipelines linking neighboring countries require extremely stable relationships (think US/Canada, or UK/Norway). Nordstream 2 had its gas supply cut before it flooded with seawater after a sabotage. Pipelines reduce flexibility for both parties. It’s why the China-Russia negotiations over Power of Siberia 2 continue to drag on.

By contrast, the global oil trade was 68 million barrels per day last year, around two thirds of consumption. Oil and gas reserves are unevenly distributed. Coal trade was only 21% of consumption. It’s easy to move, but reserves are widely distributed. It’s why developing countries use so much of it – because it’s easily accessible.

Natural gas consumption will continue to grow, to meet the developing world’s relentless demand for more energy. Policymakers may even acknowledge that renewables are hopelessly inadequate to replace fossil fuels and instead emulate the US success by prioritizing coal-to-gas switching.

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Gas generates around half the CO2 of coal when burned for power, and also generates far less local pollution. Critics argue that flaring and methane leaks offset this advantage. However, the US is far stricter on flaring than other big producing regions such as Russia or the Middle East. We produce 26% of the world’s supply but only 7% of the flaring.

This all highlights the huge opportunity of US natural gas. Our supplies can help poorer countries meet their growing energy needs, while displacing more damaging coal. And because our environmental standards are higher than in Russia or Iran, our natural gas is a more climate-friendly product.

The simpletons at the Sierra Club and the knuckle draggers at Extinction Rebellion who hurl paint in art galleries will never embrace this. But increased US exports of natural gas are the most effective way to reduce CO2 emissions. In our opinion it offers continued attractive returns, and by delivering what is expected rather than unmet promises, it is the most ethical investment in the energy sector.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund