Modern Monetary Theory (MMT) argues that because a government can never go bankrupt in its own currency, the only constraint on spending is inflation. Applied to the U.S., this justifies pandemic stimulus checks, spending on infrastructure and clean energy initiatives, expanded Obamacare and doubtless other initiatives too. Price tabs begin at $1TN nowadays. Stephanie Kelton’s book, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy is worth reading to better understand where this theory will take us. We reviewed it last November.

There are no votes left in fiscal discipline, and investors don’t seem too worried either. With 30 year yields at 2%, there’s little evidence that voters should be more concerned than the bond market.

Kelton was an advisor to Bernie Sanders, now head of the Senate Budget Committee. We are embarked on MMT – although even Kelton’s advocacy of fiscal profligacy recognizes the inflationary constraints of the government outspending the economy’s ability to deliver goods and services. She quaintly believes Congress should score spending plans based on their potential to cause higher inflation, as if election cycles had ceased to exist. No such concern burdens Biden’s $1.9TN proposed Covid relief plan.

Betting on higher inflation, and rising rates, has been a losing proposition for over thirty years. It would seem foolish to expect anything different now – except that making such a bet is extraordinarily cheap.

The eurodollar curve, which reflects market expectations for three month Libor, is very flat. It’s true Fed chair Powell has said the Fed plans to keep rates low for a long time, and is willing to see inflation move above 2%, compensating for periods when it’s been stubbornly below their desired average. The futures curve takes him at his word.

But the stage is set for the market to test this view. The kindling includes unprecedented fiscal stimulus, almost $5TN in money market funds, up $1TN in a year (some of which is entering the stock market via Robin Hood) and a probable burst of pent-up consumption once pandemic lockdowns are eased. This may all be easily absorbed by the economy – but many are watching carefully, and a couple of high CPI figures will confirm the worriers.

Commodity prices have been rising. Energy companies are more cautious with their investment plans, which is going to constrain supply in the future. Pipeline opponents have made new construction prohibitive. Investors in the sector like higher energy prices and lower growth capex, so are finding the Democrat agenda surprisingly appealing. These are encouraging circumstances for midstream energy infrastructure, up 11% so far this year.

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Bond yields are slowly rising to reflect inflation risks, but remain uninvestably low. Sovereign debt ceased offering real returns (i.e. above inflation) years ago. Those days may never come back – MMT advocates will eagerly grasp this vindication of their policies.

December 2022 eurodollar futures yield 0.30%, just 0.10% above today’s three month Libor with 22 months to go and reflecting equanimity about the possibility of higher rates over that time frame. A short position will lose roughly half a basis point per month — this is the cost of negative carry. If the market develops even the slightest fear that rates may rise, a 25 or 50 bps move in eurodollar futures is likely. The Fed probably will remain on hold – but there’s little to be made betting with them, and little cost in betting against.

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Stocks remain modestly attractive, but that is dependent on bond yields. Factset 2021 and 2022 earnings forecasts for the S&P500 are moving steadily higher, albeit still not back to pre-pandemic levels. But 2021 forecast S&P500 EPS of $173 per share is nonetheless $10 ahead of pre-pandemic 2019. Covid has changed millions of lifestyles for the better and created big winners and losers among businesses, but history will show a one year dip in public company profits.

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Energy companies dominate the list of 1Q21 upward revisions to earnings. The Equity Risk Premium (ERP), the difference between the S&P500 earnings yield and ten year treasuries, is supportive. However, if long term interest rates were to rise, say, 1% stocks would be less alluring.

The goal of MMT is to push the edge of the envelope. Both political parties have discovered that increased deficits carry no penalty. Now that we’ve informally adopted MMT, higher inflation one day is assured. We just don’t know when. But Federal government spending policies reflect an enthusiastic pursuit.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Last week the U.S. Energy Information Administration (EIA) released their 2021 Annual Energy Outlook (AEO). It is produced by their Bipartisan Policy Center, and presidential elections aren’t supposed to affect their work. It isn’t a policy document but is intended to make forecasts based on current policies and known technology.

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Past AEOs are taken down from their website, which is a pity because it can be fun comparing current forecasts with prior ones. Fortunately, we save it every year, and the comparisons are interesting.

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Our initial thought in watching the webinar that launched their new release was that they see a very different energy future than the new Administration, one that still relies primarily on fossil fuels. Joe Biden ran on a platform of getting the U.S. to net zero greenhouse gas emissions by 2050. The AEO projects a modest drop over the next decade before growth resumes. Energy-related CO2 emissions are projected to remain below 5 gigatons by 2050, roughly unchanged over the next three decades but clearly not zero. Nonetheless, it’s a more optimistic than the 2016 AEO. Since then, switching from coal to natural gas for power generation and the Covid-recession have brought emissions down from above 5 gigatons back then. Changed policies and new technologies will be needed to alter that projection.

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The 2021 AEO projects faster growth in renewables than five years ago, but oil and gas consumption still dominate. In fact, growth in natural gas consumption is expected to track renewables closely, with both gaining market share. Coal has seen a big downward revision since 2016 but will continue to provide more energy than nuclear. If we can’t flip that around over three decades, it will represent a significant missed opportunity.

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One controversial element of the 2021 AEO concerns consumption of petroleum and other liquids. By contrast with AEO 2016, this is now expected to grow, in apparent defiance of everything the Administration and many others have to say. The explanation is greater industrial use of liquified petroleum gas (LPG) which is mostly propane and butane. The U.S. produces 40% of the world’s Natural Gas Liquids (NGLs), almost three times the next biggest (Saudi Arabia, at 14%). NGLs, which include propane and butane and are usually separated from “wet” gas, are one of the Shale Revolution’s big successes. In recent years, increasing domestic production has spurred investment in domestic petrochemical facilities and driven greater exports.

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But even gasoline consumption is expected to remain close to current levels over the next thirty years. That it won’t grow reflects increased electric vehicle penetration as well as continuing efficiencies in traditional internal combustion engines. GM recently announced plans to only sell zero-emission cars and trucks by 2035. The incongruity between AEO 2021 and GM’s investment plans lies in policy expectations. GM is preparing for a world of government-imposed constraints on gas-powered automobiles, whereas the AEO 2021 Reference Case assumes unchanged policies. In 30 years we can look back and see which one of these was way off

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The other big change is in natural gas exports. In 2016 the EIA expected the U.S. to be a net importer of natural gas, while five years later that has reversed. An interesting chart which is more relevant today shows high oil prices stimulating increased natural gas production, because of substitution. The continued decline in capex for new oil production across the industry makes supply-constrained higher oil prices more likely than in the past. Previous AEOs have long considered this link, but it now is a higher probability. Democrat policies are designed to promote higher energy prices, an unintended benefit for energy investors.

The 2021 Annual Energy Outlook offers support to energy investors convinced that today’s weak security prices reflect a far too pessimistic outlook. In fact, we can’t think of a serious forecast of natural gas demand that doesn’t project steady growth for decades. It may not be what progressive Democrats would like to see, but since global energy demand is going to keep growing, we’ll need more of every energy source.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Last week John Kerry, Climate Czar, warned that natural gas pipeline assets could become “stranded assets” within 30 years. Democrat attitudes toward fossil fuels remind one of St. Augustine (“Lord, make me chaste—but not yet.”). Three decades of debauchery before celibacy shows self-discipline, under the circumstances. Since Biden now owns U.S. climate change policy, indulging the fantasies of climate extremists must be balanced with keeping the lights on.

Fortunately, bond investors’ optimism extends farther still. Transco, a wholly owned subsidiary of Williams Companies (WMB) and operator of the eponymous natural gas pipeline network, has numerous long-term bonds outstanding with yields of 3-3.5%. Transco 3.95% 5/2050 bonds trade at 3.28%, within 1.5% of the U.S. 30 year bond.

Investors and management of natural gas assets recognize that they offer the fastest path to lowering emissions, not solar panels and windmills. Power generation from renewables will grow to be sure, but with global energy consumption expected to increase by half through 2050, every energy source will grow.

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Last week we chatted with senior management from Tellurian (TELL), to discuss their plans for exporting Liquified Natural Gas (LNG). Reaching a Final Investment Decision (FID) to construct their Driftwood export facility in Louisiana relies on getting enough customers signed up. Japan is the world’s biggest importer of LNG, with China second. Asia is almost three quarters of global LNG trade, therefore critical to global trends.

News in recent months has been encouraging. Extended cold weather in north east Asia drove spot LNG prices to over $35 per MCF, more than 10X the U.S. benchmark at Henry Hub. Prices have eased since, but the January 2022 JNK futures trade at $8, a sufficient premium to U.S. prices to cover transportation costs.

TELL management sees LNG as critical to emerging Asia, as it struggles to reconcile the desire for rising living standards with controlling emissions. China intends to increase its emissions for at least the next decade, notwithstanding their vague commitment to get to zero by 2050.

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Last year Beijing temporarily relaxed some of the constraints on coal that had caused some switching to natural gas, to boost growth during the pandemic. But TELL drew our attention to last year’s creation of PipeChina, a $32BN entity created from Sinopec and PetroChina to own the country’s trunk pipeline network for natural gas. The intention is to deregulate LNG imports, creating more competition and increased sensitivity to demand.

There is enormous potential for China to use more natural gas, which provides less than 10% of their primary energy needs and only 3.1% of power generation as of 2019 (according to IHS Markit). Reducing China’s current and projected coal consumption must be the focus of any climate change discussion. The world should hope that China’s natural gas pipelines are heavily used, and for much longer than the three decades our globe-trotting climate czar envisages for similar U.S. assets. Regasification capacity, a measure of China’s ability to import LNG, is going to almost double over the next five years.

In 2019, China imported 62.5 million tons of LNG, equivalent to 8 Billion Cubic Feet per Day (BCF/D) of natural gas. The U.S. is currently exporting around 11 BCF/D of LNG.

Check out What’s Cool About LNG?, a fascinating six-minute video that shows how natural gas burns with less carbon output than a candle, and how a lit cigarette isn’t hot enough to ignite LNG.

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India is another growth market, although developing domestic long haul natural gas pipelines has been slowed by regulatory uncertainty and land rights issues. Potential LNG importers must look enviously at China’s relentless prioritization of national interest over individual rights.

Nonetheless, Indian LNG imports more than doubled over the past decade, with Qatar shipping the most. Regasification capacity is set to grow significantly over the next five years, albeit not as fast as China. With domestic production falling, LNG imports are likely to provide more than half India’s natural gas for the foreseeable future.

Coal consumption is moving strongly in the wrong direction, fueled by non-OCED demand in Asia. In John Kerry’s Augustine moments, he’ll realize that the world needs natural gas to get us off coal. The natural gas industry understands that too.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Last week Williams Companies (WMB) held their first ever ESG Event. As might be expected, the most interesting parts were on the “E” (Environmental). It’s hard to find much original to say on Social issues, and Governance should simply mean following industry best practice.

WMB is in a position to be a big winner from policies to combat climate change. If pragmatists seize control from renewable evangelists, which they should now that Democrats own the issue, they’ll realize that measurable progress on reducing emissions will come from natural gas. Rising CO2 emissions over the next couple of years will be no surprise after almost a year of lockdowns. But the deteriorating mix of power generation (i.e. more coal and negligible increase in clean energy) mean that President Biden isn’t assured of overseeing lower emissions during his current term.

There may be valid reasons but failing to reduce emissions below their prevailing level at Trump’s exit will represent failure. Gains in natural gas over coal for power generation are set to reverse this year, because of higher prices for the former (see Emissions To Rise Under Democrats). Democrat policies to inhibit oil and gas production are already having an impact. Spending on new production continues to fall.

WMB moves 30% of America’s natural gas, much of it via their extensive Transco pipeline that runs from Texas to NY. Originally built to supply natural gas from the southeast to New York, in recent years it’s switched directions in places. Some natural gas now moves south, from the Marcellus Shale to Cheniere’s LNG export facilities in Texas and Louisiana.

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WMB has identified 77 coal-burning power plants that are within Transco’s “footprint”. That is, they operate in a state through which Transco passes, and therefore can be supplied with natural gas should they be converted. Converting them all would lower US energy-related CO2 emissions by over 8%.

It must be the easiest 8% reduction available over the next few years, if the Administration can find a way to do it. WMB CEO Alan Armstrong clearly grasps the opportunity.

While America stands to benefit from shutting down coal plants, the world needs China to head in this direction. China burns half the world’s coal. They have four times the power output from such plants as the U.S. Much of the world’s planned investment in new coal burning power plants is in China. The Administration is already publicly calling for China to toughen its targets on greenhouse emissions, which are scheduled to keep rising for at least another decade.

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It’s no coincidence that 68% of global trade in Liquified Natural gas (LNG) is in Asia. Last year a sudden drop in demand caused shipments to plunge from Cheniere’s Sabine Pass LNG facility in Louisiana. But helped by a cold winter, European and Asian demand has driven shipments to a new record. U.S. LNG exports last year were up 10% on 2019, a result that seem improbably six months ago.

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China sources almost half of its LNG imports from Australia, and the rest from other Asian countries and Qatar, because shipping costs are significant. American natural gas prices have been rising but remain among the lowest in the world. The EIA expects higher prices to drive increased production next year.

Even though U.S. LNG exports to China are incopnsequential, our LNG exports will still benefit. The recent price spike in Asian prices has slashed European LNG imports – because shipments have been diverted to Asia. Consequently, Morgan Stanley recently raised its 2021 price for European natural gas by 35% (from $4.30 per MCF to $5.80). They expect global trade in LNG to grow at a 4% compound annual rate through 2030, with Asia driving over 80% of this increased demand and rising to 73% of the global market.

The U.S. opportunity in natural gas is to substitute it for coal. The global opportunity is to take advantage of low U.S. prices to meet growing Asian demand. WMB is well positioned to be part of both solutions.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

By the end of President Biden’s first year in office, his administration’s report card on climate change will offer some uncomfortable facts. Natural gas, after taking market share from coal for power generation under the Trump administration, will see those gains reversed. In the U.S. Energy Information Administration’s (EIA) most recent Short Term Energy Outlook, they forecast that U.S. coal consumption will increase its share of power generation from 20% last year to 24% by next. The biggest source of falling CO2 emissions in the U.S. has been the reduction in burning coal, a trend that pre-dated the last administration but continued through it.

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President Biden will no more accept the blame for this unhappy shift than Trump could claim credit for the positive trend that preceded it. But policy changes are partly the cause.

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Natural gas consumption grew over the past several years because it was cheap. Trump’s pro-energy stance stimulated oil and gas production, much to the chagrin of investors who would have benefited from less. Prices have been rising recently, and although there are many global macro factors at play, the chilling effect of Democrat policies on new fossil fuel production is playing a part.

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Over the next two years, world liquids fuel consumption is expected to recoup the Covid slump, so that 2022 will look much like 2019. The same is true in the U.S.

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Optimists will point to the growth in solar and wind energy, whose share of U.S. electricity production is set to increase, from 12% last year to 16% in 2022. However, nuclear power will lose 2% (from 21% to 19%), as continued opposition which includes climate extremists reduces one source of zero-emission power. Add in a 1% drop in hydropower, and clean energy is set to gain 1% market share over the next two years – hardly dramatic.

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As a result, U.S. CO2 emissions are going to begin rising again. By the middle of Biden’s term, there will be little to point to in terms of actual U.S. results on climate change. The entire story will be one of hope. It’ll be hard to lecture China on the need to curb their emissions, which are forecast to keep rising along with rising living standards.

Fortunately, U.S. natural gas exports are expected to keep rising. Over the next couple of years it looks as if America’s biggest contribution to curbing global emissions will be enabling the foreign buyers of our natural gas to use less coal than they otherwise would.

It’s hard to pivot towards cleaner energy. The two places where public policy has been aggressive (Germany and California) have little to emulate. Increased coal consumption to counter renewables’ intermittency (Germany), unreliability (California) and high prices (both) aren’t an appealing destination for the rest of us.

The politics of this will be fascinating. Climate extremists are likely to be frustrated at the lack of results. The Democrats’ razor-thin margin in the Senate make sweeping policy changes unlikely.

Reducing coal consumption is the low hanging fruit of reducing emissions. It not only generates twice the CO2 emissions of natural gas when burned, but also pollutes locally with fine particulate matter and nasty chemicals such as mercury. Executive actions via the Environmental Protection Agency and aggressive enforcement of existing environmental laws could increase the cost of coal, offering the new administration some chance of improved results.

Trump won three of the five biggest coal producing states (Wyoming, West Virginia and Kentucky) with Pennsylvania and Illinois voting for Biden. Democrats might therefore conclude that they have little to lose by taking on the coal industry, a move that would be easily supported by the science. It’ll be a tricky decision though, because they’d risk losing the other two.

The biggest weakness in policies to combat climate change is their reliance on supply constraints. Billions of people use fossil fuels, and we are all contributing to emissions to varying degrees. But rather than raising prices directly on the consumption of energy, policies more often seek to manage sources of supply. Public support to reduce emissions is shallow – if people believed the planet was truly at risk, nuclear energy would be an obvious solution. We’d have a carbon tax in the U.S., but that’s a political non-starter. So policy focuses on supply, because the impact is less visible.

The logical progression is to engineer higher coal prices. The natural winner would be natural gas, the only energy source with the capacity to quickly compensate for, say, a 5% drop in coal production.

Democrats own the U.S. response to climate change for the next four years. Higher energy prices are part of their strategy. It’s what energy investors would like too.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

In early November when Pfizer’s vaccine announcement triggered a strong rally, technology stocks lagged small cap value. Having been out of favor for years, the Russell 2000 sprang to life, drawing in buyers at the expense of tech.

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The relative movement of tech to value, defined as the ratio of the Nasdaq and Russell 2000 indices, crossed through its two hundred day moving average. This signaled an end to tech’s previous ascendancy, at least for those who follow charts.

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The pattern has continued since, with the ratio now solidly below its two hundred day. It looks like a new trend has begun. Pipeline stocks are beginning to show up on recommended lists. US News included Kinder Morgan (KMI) among their ‘7 Best Value Stocks to Buy for 2021.’ Barrons regularly pushes midstream energy infrastructure for yield. The components of the American Energy Independence Index, undoubtedly a value play, still yield over 8% on a market cap weighted basis even after rallying 12% in January.

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Coincident with this shift in leadership, signs of inflation are appearing. Liquefied Natural Gas (LNG) prices have soared in Asia because of unusually cold weather. JNK LNG, the regional benchmark, recently traded up eightfold from last April with some Asia-bound shipments trading at 10X the price of the US Henry Hub benchmark last week. This is great news US LNG exporters.

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The JNK squeeze is dramatic but temporary. However, other commodities have also been rising sharply. Crude oil has firmed up on hopes that vaccinations will allow a return to our former lives by summer. China’s sharp economic rebound has more than doubled the price they pay for iron ore compared with March. Even rice has risen over a third since October.  Prices for hot rolled steel have doubled. Inflation is increasingly a conversation topic among investors, and is drawing more media attention such as Higher inflation is coming and it will hit bondholders in yesterday’s FT.

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Gold has been weakening in recent months, but Bitcoin has soared, perhaps becoming the refuge of choice for some fleeing fiat money.

The Federal government is doing its best to cause bond investors sleepless nights. This week incoming President Biden will press Congress to approve an additional $1.9TN in pandemic relief, our third package in a year. The Federal Reserve is actively seeking inflation above its 2% target, to compensate for years of undershooting.

If inflation doesn’t rise, it won’t be because we didn’t try. It’ll reflect the continuation of disinflationary forces that have constrained it for so long.

Money Supply as measured by M2 is growing at the fastest rate since records exist. However, nominal GDP is not similarly rising, since money velocity is plunging to new depths. During the 2008-09 financial crisis, when the Fed’s Quantitative Easing led to M2 growth less than half as strong as it is now, some feared a resurgence of inflation. However, the extra liquidity sat in bank reserves and was only slowly recycled into the economy.

The difference today is that money market funds for institutional and retail accounts are $4.3TN, far higher than a year ago. The US savings rate soared above 30% last April, and although it’s been falling since then it remains historically high.  By contrast with 2008-09, these balances are readily available to fund consumption.

There is substantial dry powder for households to spend, should they so wish.

But there’s also substantial overseas demand for US treasuries, which yield the most of any G7 nation. Japan holds $1.3TN, and China $1.1TN. Theoretically, interest rate parity means that yield differentials among different sovereigns shouldn’t matter once the cost of FX hedging is factored in. But as this article implies, Japanese buyers of ten year treasuries aren’t using ten year forward FX trades to hedge their risk – they’re most likely hedging within one year, where interest rate differentials are narrower and liquidity better, making it cheaper. In effect, they’re taking yield curve risk between short term and long-term rates, but it’s been working for years. With the Fed unlikely to raise rates in the near term, it probably still looks low risk.

The bottom line is that, as long as U.S. inflation remains low, long term rates are likely to remain low too. But as lockdowns finally end, many months of frustrated purchasing power could be unleashed. How that plays out will determine the path for bonds. The market isn’t pricing in repeat of the ‘Roaring 20s’, a century after the first one.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Modern Monetary Theory (MMT) is taking hold. Relying on the insight that a government can never go bankrupt in its own currency, it posits that deficits don’t matter until they cause inflation (see our review of The Deficit Myth by Stephanie Kelton).

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On a week that incoming President Biden unveiled a $1.9TN package to fight Covid and the economic downturn, ten year treasury yields fell. This was helped by Fed Chair Powell, who said, “When the time comes to raise interest rates, we’ll certainly do that, and that time, by the way, is no time soon,”

Meanwhile, JPMorgan, Citi and Wells Fargo released $5BN from their loan loss reserves because of the improving economic outlook.

Empirically, deficits don’t seem to matter. The Congressional Budget Office (CBO) projects that Federal Debt:GDP will reach 107% in two years, eclipsing the past high that followed World War II. After a brief pause, it is projected to move stratospherically towards 200% and beyond. This projection was made last September, so omitted the $1.9TN that Biden proposes to add.

Meanwhile, thirty year bonds, which encompass the period during which Debt:GDP will soar, yield under 2%.

MMT remains a fringe theory among mainstream economists. Paul Krugman, liberal credentials burnished by his regular NYTimes op-ed slot, is a critic. Far across the political divide, Larry Summers describes it as a “recipe for disaster.” It’s not political orthodoxy for either party, although progressive Democrats see in it a way to finance their liberal agenda. But you could also envisage Republicans relying on MMT to justify tax cuts.

While economists like Paul Krugman and Larry Summers are debating the merits of MMT, practically speaking the debate is over. In Kelton’s book, she doesn’t argue that deficits never matter – if government spending exceeds the economy’s non-inflationary productive capacity, inflation will rise. That’s how you find out where the limit is.

As the bond market shows, we’re not there yet.

What isn’t receiving enough attention is that our fiscal policy is steadily adopting the MMT framework. Persistently low interest rates have removed the last remaining bulwark against fiscal profligacy. Spending hawks have gradually retired from Congress or been voted out. Holding such views is a thankless task. You don’t need to be an MMT advocate to ask why we don’t borrow huge sums at such low rates. The deficit was already growing under Trump because of tax cuts, before Covid relief took it higher still.

Last March, Trump tweeted, “With interest rates for the United States being at ZERO, this is the time to do our decades long awaited Infrastructure Bill. It should be VERY BIG & BOLD, Two Trillion Dollars, and be focused solely on jobs and rebuilding the once great infrastructure of our Country! Phase 4”

Biden’s $1.9TN package is to be financed fully with debt as opposed to taxes – for now anyway. And it doesn’t include anything from the Green New Deal (see The Bovine Green Dream). Or for infrastructure.

Big spending is a bi-partisan strategy.

What seems increasingly likely is that we’ll keep pushing our deficit higher until we generate inflation. To fail to do so is to needlessly leave people worse off. The government should spend, and provide jobs for all, because as Kelton writes in her book, “…poverty strips people of the opportunities to flourish and to participate in the American dream.”

Bernie Sanders, who will chair the Senate Budget Committee once the Democrats take control of the Senate next week, has Stephanie Kelton as an adviser. His platform during his run for the presidency last year included $30TN for Medicare for All, $16TN for the Green New Deal and $7.5TN in Federal job guarantees. Any complaints he may have on Biden’s spending plans are likely to criticize their lack of ambition.

Worrying about the deficit has been a fool’s errand for decades. Betting on higher inflation has been a losing trade for the entirety of most investors’ careers. That could remain the case this year too, although there are signs of price pressure. Hot rolled steel has doubled in price since October. Money supply (M2) is growing at 26%, faster than even the inflationary 1970s and 80s.

Protecting against inflation is incredibly cheap. December 2022 eurodollar futures yield 0.29%, only 0.06% more than today’s three month Libor, with almost two years to go. Pipeline stocks, which often have inflation escalators embedded in their tariffs, yield over 8%.

Inflation may stay quiescent, but the cost of protection is very low.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

We are short December 2022 eurodollar futures.

The U.S. Energy Information Administration (EIA) is generally apolitical – they’re not championing any single energy source. That may change under the new Administration, and they may become a shrill for renewables, but so far, they largely report data.

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Yesterday their website carried Renewables account for most new U.S. electricity generating capacity in 2021, highlighting that 70% of the 39.7 Gigawatts (GW) of new capacity to be added is solar and wind.

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Recently they also ran with Nuclear and coal will account for majority of U.S. generating capacity retirements in 2021. The continued drop in coal is good news – its elimination is the fastest route to reduced emissions globally. This trend is unfortunately moving in the opposite direction in China and India, but at least in the U.S. we’re getting it right.

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The drop in nuclear is not helpful in terms of lowering emissions, since it produces none. A realistic path towards fighting climate change includes using more nuclear, rather than relying fully on solar panels and windmills.

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What’s notable is that we’re adding 39.7GW of generating capacity while retiring 9.1GW, for a net gain of 30.6GW. Total U.S. power generating capacity is 1,100 GW, so we’re adding around 3%. But U.S. power consumption for the past decade is flat. Energy intensity, the amount of energy consumed per $ of GDP, has been falling for decades in developed countries, reflecting ongoing energy efficiencies and the steady decline of manufacturing’s share of economic output.

So why is the U.S. increasing its energy capacity?

The 39.7GW being added is certainly expected to be used – otherwise the capital wouldn’t have been invested. Most likely, it reflects the lower utilization of renewables, which typically runs 20-30%. By contrast, baseload natural gas power plants run at 90% of capacity, with nuclear higher still.

The dismal truth that, for all the excitement about solar and wind, it takes more than 1 GW of solar capacity to decommission 1GW of coal power. This lower utilization is beginning to show up in the figures. The U.S. is net adding capacity while consumption is flat. Maybe enormous growth in electric vehicles will shift energy consumption from petroleum to electricity, but it’s likely we will gradually utilize less of our power generating capacity as the mix shifts.

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Comparing the cost per GW of different power sources doesn’t account for differences in utilization, which therefore flatters renewables. The need for back-up power to offset their intermittency is also normally overlooked.

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Germany has pursued renewables aggressively, adding capacity even while demand has been falling. Because of this, they also have among the highest electricity prices in the world. More of their power generation sits idle than in the past, because the windpower they’ve been adding has lower utilization. Watching the “Energiewend” (Energy Transition) has been instructive for the rest of us (see It’s Not Easy Being Green).

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At least they’re not as bad as California, the state with America’s most expensive and least reliable electricity (see California’s Altruistic Carbon Policy).

Outside of California, electricity is cheap in the U.S. Some may believe there is plenty of room for prices to rise. If we are serious about climate change, prices should rise. Germany’s example shows where this can go. It’s not yet part of the climate change debate in America. It should be.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

The cold winter currently being endured in north-east Asia isn’t just a boon for those hoping the planet isn’t burning up. It is setting a fire under local prices for Liquified Natural Gas (LNG). Because of the relatively high cost of moving LNG by tanker, regional price differences can be far wider than for crude oil, where transportation costs are a much smaller portion of the overall shipment.

February LNG prices for the JKM benchmark used by Japan and South Korea eclipsed $17 per thousand cubic feet (MCF) last week, with reports of at least one individual cargo trading at above $33. Wholesale electricity prices touched 100¥ per KWh. By contrast, U.S. February natural gas is at $2.70 per MCF.

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$3-5 per MCF is generally the cost to ship LNG from the U.S. Gulf coast to Asia. With regional prices until recently around $7-9, the differential was already boosting LNG exports from the U.S. and elsewhere.

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The low temperature in Beijing on Thursday was -3F, not seen since 1967. China’s electricity demand is likely to set a new high this winter, with manufacturing rebounding strongly from the Covid slump. China stepped up its LNG imports last year, seeking to moderate its reliance on coal, where it consumes half the world’s output.

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The EIA estimates that 58% of China’s total energy consumption comes from coal, with natural gas just 8%. Cheniere, the biggest operator of LNG export facilities in the U.S., estimates that China will double its natural gas pipeline network, to 163,000km, by 2025. South Korea, Taiwan, India, Vietnam and Thailand (i.e. most of developing Asia) similarly intend to increase natural gas consumption. During the first three quarters of last year, China’s LNG imports increase by 4.4 Million Tonnes, equivalent to more than half the increase in U.S. LNG exports over the same period.

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It’s why Cheniere’s stock is up over the past year, handily beating the energy sector.

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China’s motivation to switch from coal to natural gas for power generation is to reduce local pollution, a much bigger domestic concern than global warming. While the region around Beijing has largely eliminated coal power, China is building almost as many new coal plants as the U.S. currently has operating (see Fighting Climate Change Is Hard).

Japan relies almost completely on imported LNG for its natural gas. Around 30% of this comes from the U.S. Japanese power generation relies on coal and natural gas for almost two thirds of its output.

The Fukushima nuclear disaster led to sharp reductions in nuclear power, which increased the need for fossil fuels. Although this has been partially reversed over the past couple of years, natural gas remains vital and its superior carbon footprint is likely to give it an edge over coal for some time.

If our incoming Climate Czar John Kerry wishes to offer Japan and China some advice on the subject, he might suggest emulating the U.S. in using more natural gas to reduce emissions. It would be a pragmatic way to pursue the fight against climate change while also benefiting the U.S. economy.

High LNG prices in Asia are good for our domestic natural gas business through increased exports. After dipping in the summer, volumes increased to 9 BCF/D (Billion Cubic Feet per Day) in November, beating the prior monthly record of 8.1 BCF/D set last January. Last month, feedstock to LNG export facilities was 11.2 BCF/D. As additional liquefaction capacity becomes operational, LNG exports will rise further.

U.S. natural gas is among the cheapest in the world, and our exports are the fastest growing. The opportunity for America to provide cheap, clean-burning natural gas to developing Asia is enormous. Increased energy consumption to drive rising living standards is assured in non-OECD countries. Let’s see if John Kerry is sensibly pragmatic or perversely progressive.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

The S&P500 (SPTR) had a strong decade, returning 13.6% p.a. from 2011-20. By contrast, MLPs had a lousy ten years, delivering –1.2% p.a. The reasons have been well documented on this blog and scarcely need repeating. The Shale Revolution induced overinvestment which led to excessive leverage. Distribution cuts followed, driving away many traditional MLP investors.

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But midstream energy infrastructure didn’t do nearly as poorly as MLPs. The broad-based American Energy Independence Index (AEITR) returned 7.5% p.a. MLPs have dragged down the overall sector for several years. The Alerian MLP Index (AMZX) does a poor job of representing the pipeline sector nowadays, with most of the industry having dropped the MLP structure in search of a wider set of investors.

Pipelines lagged the S&P500 to be sure, but much of the miss occurred last year.  In the nine years prior to last year (I.e. 2011-19) annual returns are 13.1% and 10.1% respectively. Covid hit the energy sector hard, but strongly growing free cash flow and rising commodity prices offer reasons for optimism this year.

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There’s also evidence that income-seeking buyers, long a core investor base for MLPs, are less relevant. For a couple of decades there existed a clear intra-year seasonal pattern around MLP returns. Because of the high yields, sellers would often wait until just after a quarterly distribution to sell. Buyers would similarly invest just prior to a distribution. This created a quarterly pattern in which the first month of the quarter, typically the record date for quarterly distributions, saw higher than average returns.

Holding a stock so as to receive the dividend is a pointless strategy, unless there are tax considerations. Stock prices, including MLPs, adjust for the payout once they go ex-dividend. It’s an example of some retail investors misunderstanding this. Clearly, over 1995-2015, sales timed just before a distribution would have generated better returns, as would purchases just after.

The K-1s also give a January boost – if you’re planning to buy an MLP in December, waiting a month avoids a K-1 for the year, just as selling in December avoids one for the following year.

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But in the last five years, higher volatility and distribution cuts have reduced the importance of quarterly distributions as a factor in timing buys or sales. Because 2020 was so volatile, it distorts average returns by month over the past five years; however, the median shows a similar result. The overall sector, as represented by the AEITR, shows a more muted pattern than MLPs, probably because of its broader, institutional investor base.

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The result is that only January and April now show reliable above-average returns. Returns are positive 70-80% of the time, depending on the index. July and October no longer stand out. Trading around quarterly distributions has lost importance – that the effect remains visible in January/April could be random, or at least not related to payouts. The S&P500 has a modest January effect too, likely reflecting year-end portfolio decisions by investors.

What the data shows is that pipelines haven’t been nearly as bad an investment as MLPs alone indicate. Corporations, especially the Canadians which are prudently managed, have made the difference. And individual investors focused on distributions are a diminishing part of the overall investor base.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.