In March we wrote about start-up Liquified Natural Gas (LNG) exporter, NextDecade (NEXT) (see Making LNG Cleaner). As with Tellurian (TELL) and Cheniere (LNG) before them, NEXT needs to sign up buyers of its LNG before obtaining the financing to complete the liquefaction infrastructure. The rolling global energy crisis which has seen European and Asian buyers paying over $35 per Million BTUs (MMBTUs) for shipments has improved the outlook for US LNG exports. The $25 per MMBTU regional difference with US domestic prices is testament to the constraints posed by limited LNG export capacity. NEXT aims to partially solve that – foreign buyers are eager, although US customers will wind up paying marginally more as increased exports push up prices.

French utility Engie pulled out of discussions with NEXT late last year because they were unhappy at buying Texan natural gas given the prevalence of flaring. Regulators in Texas have interpreted their oversight of methane flaring very broadly, with the result that flaring permits are routinely granted. In 2019 a dispute arose between Exco, a natural gas driller, and Williams Companies over Exco’s application to flare natural gas rather than pay the tariff Williams demanded for pipeline transportation (see Texas Reconsiders Flaring). It showed how Texas’ ready approval of flaring had abandoned the original intent, which was to allow the flaring of associated gas where no infrastructure existed in order to allow crude oil production. Williams argued that the natural gas infrastructure was available, but that Exco didn’t like the price. In September, a judge ruled in Williams favor but that may not be the conclusion.

European LNG buyers are likely to share Engie’s sensitivity to how their product is produced, so NEXT created a “carbon solutions” unit to capture the CO2 associated with their LNG activities. Last week SL Advisors partner Henry Hoffman chatted with management during Cowen’s 2021 Energy Summit.

We think NEXT is under the radar for most investors. They do have some sell-side coverage though. Credit Suisse raised them from Neutral to Outperform in March, which gave the stock a boost. The company has a firm offtake deal with Shell to deliver 2 million tons per annum (MPTA) of natural gas for 20 years. NEXT needs agreements on 9 MPTA more in order to fully sell out capacity for Phase 1 of their proposed Rio Grande facility in south Texas. They are optimistic that they’ll reach this goal next quarter, reporting discussions on volumes well in excess of what’s needed.

The Administration’s Build Back Better legislation, which is currently with the Senate, may boost revenues at Next Carbon Solutions if the CO2 tax credits are sufficient to stimulate additional demand for the new unit’s services.

NEXT is aiming to provide “green” methane, whose production is certified to have resulted in minimum methane leaks along with the capture and sequestration of the CO2 generated in its processing and eventual liquefaction for transfer to LNG tankers.

Henry Hoffman also held discussions with Tellurian’s (TELL) management. TELL’s founder and CEO is Charif Souki, whose weekly Youtube videos have developed a following among retail investors. We like TELL too, but Souki has an unpredictable, risk-seeking streak. He was forced out of Cheniere by Carl Icahn who opposed Souki’s plans to expand into natural gas trading. Why complicate a business with years of cashflow visibility not exposed to natural gas prices?

Last year Souki suffered a margin call on his personal holdings of TELL when the stock collapsed during the Covid rout. He has a healthy risk appetite. We also didn’t like the August secondary offering which was done at a substantial discount to the prevailing price. TELL has a business model that incorporates exposure to LNG prices, which is probably making it harder to finance but allows greater upside if LNG prices remain firm, as Souki believes they will.

TELL told us they were in discussions with private equity investors, which we think could be good as it will improve corporate governance, and get the company closer to having enough financing to begin construction of their LNG facility.

Natural gas remains the most impactful way for the world to lower emissions, by reducing reliance on  coal. Recently an overly hasty effort to transition to renewables in Europe has exposed weaknesses in their energy strategy and created further demand for natural gas. Although $35 per MMBTU is likely unsustainable, the long term demand for LNG is clear.

NEXT and TELL both offer the opportunity to invest in continued global demand growth for natural gas. We are invested in them.

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

Please see important Legal Disclosures.

Please sign up here for our webinar, Making Sense of Rising Inflation and the Global Energy Crisis, on Thursday, December 16 at 12 noon Eastern.

The Administration’s explanation for the less than transitory inflation relies on supply bottlenecks and a faster than expected rebound in energy demand. Both are wrong. The Wall Street Journal recently made an interesting argument that inflation will persist (see Another Reason Inflation May Be Here to Stay).

Personal Consumption Expenditures (PCE) on all goods (i.e. both durable and non-durable) is running well ahead of the long-term trend. March’s $1.9TN covid relief plan marked the end of Joe Biden’s presidential honeymoon. Critics of this and other elements of excessive fiscal stimulus point to the reason goods purchases are so strong with consequent higher inflation. Apparently, government planners expected prior spending patterns to be repeated, but services expenditures don’t show the same above trend trajectory.

In short, more of this $1.9TN was channeled into goods purchased online, and less than expected on services, reflecting that a portion of the population remains wary about going out to dinner, movies and other entertainment.

Services represents two thirds of PCE and goods only one third. So it might seem plausible to assume goods inflation will moderate, reinforcing the discredited transitory narrative.

However, as the Wall Street Journal points out, housing and healthcare make up over half of services PCE. With the government largely picking up the cost of Covid-related healthcare on top of Medicare and other Federally-financed programs, this sector is distorted.

But the Housing and Utilities component is dominated by rents – both actual and imputed. The WSJ notes that leases come up for renewal infrequently, and that eventually the buoyant real estate market will translate into higher rents.

This may be true – but the WSJ overlooks the fact that two thirds of American households own their homes. For them, the cost of shelter is based on Owners’ Equivalent Rent (OER), the often criticized estimate of the value of the shelter (a service) their home provides. This shows up in the services PCE.

For those unfamiliar with the distortions caused by OER, inflation is all about the cost of goods and services, not assets. A home is an asset that provides shelter, a service. Inflation statistics try and separate the two, by surveying home owners on what they think they could rent their house for. This is the estimated value of shelter. Because home ownership is so common in the US, a large chunk of estimated housing costs are based on OER. (for a more detailed explanation, see Why You Can’t Trust Reported Inflation Numbers). The Bureau of Economic Analysis published a revised explanation of housing costs earlier this year.

OER is a creation only a Bureau of Labor Statistics economist could love. It’s not supported by any cash transactions, but it’s used to estimate around $2TN of PCE. As the chart shows, it bears little relationship to the Case-Shiller index which tracks actual house prices – probably because most homeowners are puzzled when confronted with the survey question about rent. A defense of OER is that, over very long periods of time (i.e. a decade or more) it tends to track home prices – and sure enough since the last peak in home prices prior to the 2008 Great Financial Crisis the two series’ have similar returns.

Where next for OER? It’s hard to forecast since it’s drawn from survey responses and not actual transactions. But it’s unlikely to decrease its growth rate, and at least some homeowners might be expected to raise their imputed rent estimate in response to the strong housing market.

A rising OER will drive the services PCE higher, causing its trajectory to return to its prior trend or even exceed it. Although there won’t be any increase in cash receipts as a result, calculated spending on services will be higher and so will inflation, since CPI also derives its housing methodology from PCE.

Easing supply constraints may allow goods inflation to moderate, although there are no signs of that yet. Whether it does or not, services inflation seems likely to move higher. This will maintain the pressure on the FOMC to respond to inflation, even though OER doesn’t impact household budgets in the same way that, say, rising gasoline prices do.

It may even cause some at the Fed to comment about the weaknesses of OER, although strength in this metric would simply be a delayed reflection of the actual appreciation in home prices we’ve all seen.  Either way, inflation is likely to remain persistent not transitory, a term Fed chair Powell retired at his Congressional testimony yesterday.

Join us on Thursday, December 16^th at 12 noon Eastern for a webinar where we’ll provide an update on the midstream sector during rising inflation.

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

Please see important Legal Disclosures.

On Monday the Energy Information Administration (EIA) announced that 27.3 Gigawatts (GW) of natural gas power plants will be added to the US fleet over the next three years, representing a 6% increase from current capacity. The US is blessed with abundant supplies of natural gas, sufficient to power the country for many decades.

Many US states are pursuing sensible energy policies designed to maintain reliability and affordability, as well as diminish our reliance on coal. The map below shows where these power plants are being added – generally close to existing natural gas supplies. New York state is conspicuously not taking advantage of this opportunity, since its energy agenda has been hijacked by progressives.

The COP26 in Glasglow revealed the divide we’ve often chronicled between OECD countries who want lower CO2 emissions and emerging economies that are focused on raising living standards, which requires more energy. The inability of COP26 to produce anything meaningful exposed the ambivalence of countries like the US to an overly rapid energy transition. Higher crude oil has brought solicitations to OPEC to increase supply and now sales from the Strategic Petroleum Reserve (SPR).

The first failure of climate extremists is their inability to convince consumers that they should give up reliable fossil fuels and opt for higher-priced intermittency.

The most important development this year in US power generation is the resurgence of coal demand at the expense of natural gas. After several years of losing market share, domestic demand for coal has rebounded because of improved relative pricing.

US natural gas for January ‘22 delivery touched $6.50 per Million BTUs (MMBTU) a month ago, before retreating to its current level of around $5. US consumers are not immune to the policy errors in other countries (see Why The Energy Crisis Will Force More Realism) but are thankfully being spared from the type of Greta-inspired outcomes endured in the UK (see U.K. Power Prices Soar Above £2,000 on Low Winds). The new natural gas power plants noted by the EIA are an example.

By contrast, nothing newsworthy is happening with US solar and wind. They continue to grow — since January 2018 solar’s market share of US power generation has increased from 1.2% to 2.2%, and windmills have gone from 6.0% to 7.5%.

It’s possible to create some impressive numbers from this – solar output has a Compound Annual Growth Rate (CAGR) of 20% since January 2018, and wind has 9%. But as the charts show, if both disappeared tomorrow, we mostly wouldn’t notice. Coal use is up 12% in the past year, and currently generates almost twice the power of solar and wind combined. Vaclav Smil has shown that energy transitions play out over decades. Renewables will be small with a high CAGR for many years to come.

US energy-related CO2 emissions are forecast to be +7% this year – not just because energy consumption is rebounding from covid-depressed levels, but also because of this adverse fuel mix. Next year is forecast to be +1%, in part due to a shift back towards natural gas by utilities.

This leads to the second failure of climate extremists – their refusal to differentiate among fossil fuels has impeded their effectiveness. Had they pushed public policies that encouraged utilities to switch from coal to natural gas, perhaps with a carbon tax, the trend towards natgas would have continued this year and CO2 emissions wouldn’t have jumped as much. Instead, their purist approach has left market forces through cheap natural gas to drive most of the reduction in CO2 emissions the US has achieved.

The US even declined to join 40 other countries in pledging to phase out coal within two decades. This puts us alongside China, the world’s biggest emitter and consumer of half the world’s coal.

American voters want to reduce emissions as long as it doesn’t lead to higher energy prices. Administration efforts to jawbone crude oil prices lower reflect that reality. High gasoline prices should incentivize switching to electric vehicles (which are more likely to rely on natural gas power plants than any other fuel). Instead, the White House is trying to diminish this incentive with sales from the SPR. Foregoing the coal pledge is another example of pragmatism over-ruling progressives.

Pragmatic policies in many states and the White House’s incoherent energy strategy are helping us avoid the poor planning of the UK, Germany and California. Many states such as Florida are adding natural gas capacity in order to preserve reliability. It’s one more reason why migrants from New York state with its poorly conceived energy policies will continue to move to the sunshine state.

Join us on Thursday, December 16^th at 12 noon Eastern for a webinar where we’ll provide an update on the midstream sector during rising inflation.

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

Please see important Legal Disclosures.

We often get questions on the correlation between pipeline stocks and crude oil. Most investors intuitively believe they are linked – and inconveniently they seem especially so when prices are falling. March of last year is a recent example.

Pipelines are a volume business — the “toll model” has often been used to describe the fact that it’s volumes passing through the pipelines, not the value of the commodity, that drive midstream economics. To the extent that high prices imply increased production it can appear that they should be related.

This year pipelines and crude oil have both marched higher, propelled by the strong economic recovery from covid and restrained investment in new output by energy companies. US oil production remains 1.5 Million Barrels per Day (MMB/D) below its pre-covid peak. The volume-driven pipeline industry ought to be suffering with less crude oil passing through its infrastructure – except that the industry’s new financial discipline has driven free cash flow higher.

Lower volumes are a result of constrained growth capex, both among the upstream customers of pipelines as well as the midstream sector itself.

Although visually crude oil and pipelines (defined here as the American Energy Independence Index, AEITR) move together, the correlation isn’t that high. Over the past decade the average 90 day rolling correlation of daily returns is 0.41. As the table shows, year by year it doesn’t stray too far from that.

In 2015 when crude oil and pipeline stocks were falling, some clients asked us if we’d considered hedging by shorting crude oil futures. It was a reasonable question, since the sector seemed to follow oil prices relentlessly lower. But the correlation shows that it’s really a weak relationship. And the devil is in the details – any hedge would require a hedge ratio. How much crude oil should a portfolio short in order to hedge its equity exposure? The unstable relationship means that the choice of hedge ratio would depend on the past time period examined, revealing it to be a somewhat arbitrary choice.

Unable to identify a reliable hedging strategy we rejected the suggestion. In mid-2017 such a fund was launched (see Oil-Hedged MLP ETF Launches at Propitious Time) but it’s since closed, confirming how hard it is to get the hedge ratio right.

Natural gas is a more important source of cashflows for pipeline stocks than crude oil, but here the correlation is non-existent. The US is fortunate to possess decades worth of reserves of natural gas. Moreover, because exports of Liquified Natural Gas (LNG) are limited by the availability of specialized infrastructure to chill it down to 1/600^th of its volume so it can be pumped onto an LNG tanker, US consumers have been mostly insulated from the energy crisis sweeping through Europe and Asia. EU governments and the UK have committed a series of policy errors in recent years. These include: becoming too reliant of intermittent solar and wind; cutting back local production and storage of natural gas; and relying too heavily on Russia’s capricious supply schedule.

Unexpectedly quiet weather in the normally blustery North Sea has once again cut electricity generation from windmills (see U.K. Power Prices Soar Above £2,000 on Low Winds). The £2,000 price per MWh cited should be compared with the $75-$140 range that US customers pay. Converted to US$, UK electricity is being sold for as much as $2,700, 20-36X times as much as American wholesale prices. Even the policymakers in California haven’t been able to screw up as badly. The UK government is subsidizing prices to avoid the political outcry that would quickly follow, so in effect the entire country is paying for past energy policy blunders.

Lowering CO2 emissions is a worthy goal, but examples of the folly of pursuing the agenda of climate extremists keep piling up.

One of the most positive developments of the year for the pipeline sector has been the steady recovery in natural gas volumes. High crude prices have buoyed investor sentiment, but the return of domestic natural gas output to its pre-covid high represents a tangible benefit that has boosted earnings at companies such as Williams and Cheniere.

COP26 showed that emerging economies such as China and India continue to value raising living standards over reducing CO2 emissions. India’s per capita GDP is $1,900, compared with the US at $63K. Hundreds of millions of Indians live in poverty. Fighting global warming isn’t resonating with them or their government. The US can help by encouraging India and other countries to buy more natural gas and use less coal. That’s the pragmatic solution, and America is well positioned for it.

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

Please see important Legal Disclosures.

Democrat policies have so far been more positive than many expected for the energy sector. Those regions and countries that have aggressively pursued renewables have demonstrated the challenges that arise when power is too reliant on unreliable, weather-dependent sources. Crossing a 20% share from solar panels and windmills seems to be the threshold at which problems occur.

Liquified Natural Gas (LNG) shipments continue to change hands at $35 per Million BTUs (MMBTU) in Europe. Underinvestment in natural gas supply and storage is one of the reasons.

The infrastructure bill that passed the House last week includes $73BN to upgrade the nation’s power grid, along with $7.5BN each for electric vehicle chargers and low-emission buses and ferries. Shifting transportation to run on electricity rather than gasoline is key to lowering CO2 emissions.

Natural gas provides 36% of America’s electricity. This is down from 39% last year, mostly because higher natgas prices have caused utilities to switch to coal, whose share has risen from 20%-24%. It’s not a trend that climate extremists will welcome, but every protester against pipelines and natural gas production has helped make this happen. Non-hydro renewables are slowly picking up market share, and are expected to reach 15% next year. Notably, the US did not join more than 40 countries in pledging to phase out domestic coal consumption. On this we joined with China, revealing the ambivalence of US climate policy and the importance of Joe Manchin (D-WVa). The White House needs Manchin’s support and West Virginia produces more coal than any other US state other than Wyoming.

Although natural gas has lost some ground in electricity generation, rising LNG exports have made up the difference. Moreover, the US Energy Information Administration sees continued growth in domestic consumption, driven by increased demand from the power and industrial sectors. Although it’s not obvious to a casual follower of renewables developments, in three decades natural gas is still projected to provide twice as much energy to Americans as renewables.

This doesn’t take account of exports, which are virtually certain to grow as emerging economies use more energy to raise living standards. Cheniere provided confirmation of this trend in recent weeks with several announcements of long term LNG supply agreements with foreign buyers (see It Takes Energy To Keep Up With Inflation). On most forecasts the world’s energy needs are likely to increase faster than renewables generation, so although solar panels and windmills will gradually pick up market share we’re likely to use more of everything. The COP26 doesn’t seem to have done much to change that.

The infrastructure bill has supporters on both sides. Investing in transportation through fixing roads and bridges and improving the rail system. The Build Back Better bill, whose passage is still not assured, includes home energy tax credits and up to $12,500 for electric vehicles manufactured by US union workers. My partner Henry once noted that conventional automobiles using an internal combustion engine are in effect built around a small generator. If we were designing personal vehicles today, we might start with battery-powered instead.

The bottom line is that increased focus on electrification of transportation looks very positive for natural gas and the infrastructure that supports it. The energy transition is going well for the energy sector.

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

Please see important Legal Disclosures.