The Keystone XL pipeline extension (KXL) became a political football years ago. Canada has long struggled to transport its crude oil from Alberta to markets overseas. Three years ago Kinder Morgan (KMI) found themselves embroiled in an inter-provincial dispute, when British Columbia refused to allow added capacity to the TransMountain Pipeline (TMX) that links Edmonton, Alberta with Vancouver and the Pacific. Having concluded the project had become too political, KMI fortuitously sold TMX to the Canadian federal government just weeks before a court issued a ruling that added further substantial delay (see Canada’s Failing Energy Strategy).

The Keystone Pipeline System runs from Alberta to Cushing, OK and on to the Gulf of Mexico. In 2008 planning was started for KXL, which was needed to add 830K barrels per day of additional capacity, albeit following a different route which would have allowed it to pick up oil in North Dakota too.

KXL’s size made canceling it a goal of environmental extremists. Because it was to cross the US-Canada border, the State Department was involved in its approval. Obama imposed delays for several years, but in 2017 newly-elected President Trump approved it. TRP brought in Alberta as a partner, so as to share risk with the government entity best positioned to benefit. Court challenges caused further delays, but in March 2020 TC Energy (TRP), the owner, announced plans to proceed with construction.

In January on his first day in office, newly-elected President Joe Biden issued an executive order canceling the permit for KXL. Last week TRP announced they’re suing the US for $15BN under the United States-Mexico-Canada Trade Agreement (USMCA) that replaced NAFTA.

It was a dumb move full of theatrics to play to progressive Democrats. Most of the oil that KXL was going to transport will still get to market, albeit by rail and truck which are (1) more expensive, (2) worse for the environment, and (3) not as safe as pipelines. KXL opponents presumably expect that the higher transportation cost will result in less crude being produced. That may be true, but given the second and third considerations listed above we may have higher emissions and more spills than if KXL had been built.

While environmental extremists hailed Biden’s decision, they may come to hope that TRP prevails in court. Capital investments whose timeline extends beyond a single presidential term need certainty that permits issued under one administration can’t be revoked under a later one. Just as an individual can’t simply change his mind over a prior legal commitment, neither can a country.

TRP’s lawsuit revolves around whether the US was permitted to change its mind about KXL. The concept that a permit lawfully obtained under a prior administration is nonetheless subject to subsequent revocation is not free. If allowed to stand, the capricious flexibility so allowed would inject uncertainty into a wide range of capital projects. Investors would need to consider the possible impact of an election, which would increase the required IRR to justify an investment. Corporations would become more deeply involved in elections in order to protect their investments.

Moreover, it’s entirely possible that a new Republican administration in 2025 could rescind Biden executive orders that were intended to support investment in infrastructure to support renewables. If TRP loses its lawsuit, capital commitments in support of the energy transition that rely on today’s executive orders will ultimately deliver more expensive energy than otherwise – if they even reach completion.

The US has adopted an arrogant stance to its northern ally on this issue, something easily done for a superpower. KXL and oil exports were always going to be more important to Canada, and Americans famously care little for their northern neighbors’ feelings anyway.

But there’s a lot more at stake than a lost pipeline investment in TRP’s lawsuit, which if they were to be awarded the full $15BN would amount to over $100 per US household. If the US prevails, required IRRs will rise on many projects, including renewables that could become political flashpoints. NIMBY opposition is already growing to the onshore placement of solar farms, windmills and the high voltage power lines necessary to move power from rural areas to population centers.

It may turn out that seeing TRP prevail in court will be more beneficial to the goals of the Sierra Club, flawed though they are, than uncertainty over the longevity of future presidential permits. If so, maybe their members will pay towards the $15BN they’ll have cost the rest of us.

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

Voters have a history of blaming the president for high gasoline prices, even if the White House has limited power to change them. When OPEC tripled oil prices following the Iranian revolution in 1979 it was one blow too many for Jimmy Carter, who was swept aside by Reagan in 1980. The Arab world’s opposition to US foreign policy in the Middle East was one of the causes of high crude.

Although Joe Biden wasn’t at the OPEC meeting that just collapsed over the UAE’s insistence on an increased production quota, the continued bull market in oil which got a further boost can be partly traced back to his policies. Goaded by the progressive wing of the Democrat party, the Administration has a hostile attitude towards new oil and gas production.

Growing political pressure on energy companies to cut back oil and gas production is having an impact. Large publicly traded companies are especially vulnerable to such pressure. Exxon Mobil and Chevron both recently had to modify their spending plans in response to shareholder pressure, while Royal Dutch Shell was ordered to do so by a court (see Profiting From The Efforts Of Climate Extremists).

One consequence is that OPEC’s influence over oil prices is growing, as non-OPEC producers have less spare capacity. Demand is currently running at 97 Million Barrels per Day (MMB/D) and looks set to reach 100 MMB/D by year’s end. There’s no reason to expect demand to stop increasing at that point, as rising living standards in emerging Asia are likely to push it above pre-Covid levels.

The US energy industry’s newfound financial discipline is also helping. Domestic production is not rising nearly as much as in past cycles. This is all great news for energy investors. Having endured excessive capex with low prices, the pendulum is now swinging back the other way. Morgan Stanley expects the group of independent US shale producers under research coverage to boost Free Cash Flow (FCF) by a third over the next year, where they’ll have a FCF yield of 15%. We expect North American pipeline companies to generate $49BN in FCF this year, up 27%, and $56BN in 2022.

Environmental extremists are very happy with rising oil prices. There will be no energy transition unless renewables are competitive, and this helps. They tend to be more city-dwellers than rural, so gasoline prices don’t have much impact.

Energy investors are also happy, as the unlikely alignment of interests with the liberals has led to a mutually desired outcome. But what about the rest of America? Gasoline prices are now higher than at any time during the Trump presidency. This is yet another incongruity with continued fiscal and monetary support for the economy which clearly no longer needs it. Biden can quietly turn to the disillusioned progressives who think he’s abandoned them and claim credit for the high oil prices they want.

So far the energy transition has had limited impact on consumers. Apart from power outages in states where renewables have risen to an unwieldy share of electricity generation (see California and Texas), disruption has been minimal. Rising gasoline prices will eventually test society’s willingness to pay more for energy. We should pay more. The energy transition is expensive. If lowering CO2 emissions was easy we would have already done it. If it’s a worthwhile endeavor, it’s worth paying for.

The problem is that the energy transition hasn’t been marketed as such. Candidate Biden promised us green employment opportunities that would be well-paying union jobs. It’s all been disingenuously promoted as an exciting opportunity. Instead it’s an eternal slog to avoid carpeting the landscape with intermittent solar panels and windmills until pragmatism dictates the adoption of new technologies: carbon capture and sequestration to allow increased use of natural gas (see Carbon Capture Gains Momentum); blending of hydrogen into the natural gas supply (see Europe’s Nascent Hydrogen Industry); and perhaps one day we’ll revisit nuclear, if society truly wants to solve the problem.

Although Biden gasoline prices are higher than at any time under Trump, they reached $4 a gallon in 2014 under Obama. It wasn’t much of a political issue back then, because the president hadn’t done much to cause it. That was also the peak in the energy cycle, since the Shale Revolution’s supply shock followed and prices duly fell.

This suggests that the pain threshold for rising gasoline prices is above where they are today, which is good news for energy investors. It means environmental extremists can continue shifting oil supply to foreign governments and privately held firms, continuing the publicly traded industry’s virtuous cycle of reduced capex and growing FCF. Biden’s vulnerable on gas prices because his policies are intended to push them higher, but we’re not there yet. Pipeline stocks still have plenty of upside.

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

The red-hot housing market is a topic of cocktail conversations, at least among those comfortable to take that step back to normalcy. The S&P/Case-Shiller U.S. National Home Price Index (C-S) sports a 14.6% year-on-year increase through April. Residential real estate benefits from numerous sources of government support. Property taxes are tax-deductible up to $10K (although in NY and NJ the benefit is derisory because taxes can be 2-3% of a home’s value). Mortgage interest is also tax deductible, and the Federal government underwrites the credit risk of conforming mortgages which lowers their interest rate. Add to that the $40BN in monthly MBS purchases, part of the $120BN in long term bonds the Fed is buying which acts to further depress rates. So on top of the various tax subsidies and guarantees, the Federal government is lending almost half a trillion dollars a year to home buyers. It’s no wonder home prices are rising.

The Fed measures housing inflation by relying on a survey by the Bureau of Labor Statistics on what monthly rent homeowners think their home could command if rented. It’s safe to say that Owners Equivalent Rent (OER) is not the subject of the abovementioned excited cocktail chatter because it’s a theoretical concept – the only element of the inflation statistics not derived from actual transactions. Its weaknesses are well documented and we won’t belabor them here (for more detail, see Why You Can’t Trust Reported Inflation Numbers). Suffice it to say that OER doesn’t reflect the cost of housing for the two thirds of households who choose to own their home. The S&P/Case-Shiller U.S. National Home Price Index has risen at an annual rate of 4.4% over the past two decades, versus 2.6% for OER. The Fed’s use of OER means it has persistently ignored inflation in the biggest expense households face.

Although the FOMC is more in thrall to progressives than bond vigilantes nowadays, their full-on spiking of the punch bowl is making some increasingly uneasy. Boston Federal Reserve Bank president Eric Rosengren is worried that a housing “boom and bust cycle” will threaten financial stability. It’s hard to find any serious support for the Fed’s continued buying of MBS in the financial community. Even the liberal wing of the Democrat party must conclude that few beneficiaries of housing inflation are likely to be found among their core supporters.

The continued strong housing market speaks to the imminent conclusion of at least this element of the Fed’s $120BN monthly bond buying. Expect the FOMC to curtail it during the third quarter, as a growing chorus of economists and investors warns of another housing bubble. Eurodollar futures priced in earlier monetary tightening following Powell’s press conference a couple of weeks ago, so that the yield curve now more closely resembles the forecasts from St. Louis Fed president James Bullard than Jay Powell (see The Fed, Thinking Fast Or Slow). But there’s still more downside price risk than upside for futures.

Switching to energy markets, those of us outside California will appreciate this priceless headline:  California Asks Residents to Avoid Charging Electric Cars Amid Power Grid Strain. The Golden state is pursuing altruistic energy policies – swearing off everything but solar and wind, yet unable to provide reliable power. One problem is they’re ahead of most of the world in shifting as quickly as possible to largely renewable power (2018 was 34%). Global greenhouse gas emissions continue to rise, mostly due to rising living standards and energy consumption in developing countries. To the extent that climate change is responsible for the heatwave across western states, Californians are enduring both the results of global warming and the costs of mitigation without any visible benefit.

Of course renewables aren’t directly responsible for California’s power shortages, although had they redirected solar and wind investments to modernizing their existing grid and boosting conventional power sources they’d be in a better place.

The energy transition is a multi-generational marathon. It’s not an endeavor that lends itself to a declaration of victory, although defeat will be recognizable. This will be a problem for politicians, but it’ll be interesting to see how enduring popular support is to phase out fossil fuels in California and elsewhere. The effort will need to last decades while the connection with changing weather will remain tenuous. Few other states will see much to emulate in their approach.

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

Recently Pembina and TC Energy announced a joint venture for Carbon Capture and Sequestration (CCS), aimed at CO2 emissions generated from Canada’s tar sands oil extraction activities. Canada has an ambivalent stance on climate change policies. Like all signatories to the Paris Accord, they claim to have set aggressive targets for emissions reductions. Canada also has a carbon tax, a sensible measure to place a price on emissions that has little support in the US.

But Canadians also have one of the highest per capita rates of energy consumption in the world – almost a third higher than Americans, who are often regarded as the world’s energy gluttons. A Canadian’s emissions are about the same as an American’s, because of their greater access to hydropower. But Canada’s emissions have been stable, not falling as in the US where coal to natural gas switching has been the main source of reductions in the past decade. 2020 emissions fell everywhere because of lockdowns, but are rebounding.

Part of Canada’s struggle with emissions is a result of its long winters. But tar sands oil production is another. This is an energy-intensive process that involves heating bitumen with natural gas to separate out the crude oil. It’s fair to say that Albertan energy workers are less concerned about climate change than their liberal neighbors in Ontario and Quebec, even though western Canada supplies eastern provinces and generates substantial tax revenues.

Images of tar sands production facilities were sufficiently emotive to sustain extremist opposition to the proposed Keystone XL pipeline for a decade, until Biden finally killed it off last month.

Canada will continue to produce oil from tar sands, even though transportation to market has become a chronic problem. Its crude will move by rail, instead of cheaper and safer pipelines. But the Canadians recognize they have an image problem, hence the recent announcement on carbon capture.

The Alberta Carbon Grid (ACG) will initially capture CO2 generated from the extraction of crude from tar sands. But there are also plans to connect with areas of industry elsewhere in the province and to power plants as well. It will use existing oil pipelines that will be retrofitted to transport CO2, and will add new infrastructure on to it.

Estimates are that the initial system will capture and sequester underground 60-80,000 metric tonnes (hereafter “tons”) of CO2 daily. One advantage of Canada’s cool climate is that it’s easier to inject the CO2 underground into porous rock when daytime summer highs are typically in the 60s. The JV has identified an underground reservoir near Saskatchewan with capacity to eventually store over 2 Gigatons of CO2, which will take several decades to fill.

The projected annual volumes equate to around 4% of Canada’s total 2019 CO2 emissions of 730 tons, which seems quite impressive for a single project. By contrast, Exxon Mobil’s planned CCS in Texas is projected to sequester 50 million tons annually beneath the Gulf of Mexico. This is 60% bigger than the ACG but less than 1% of US 2019 emissions.

CCS is drawing more attention. Its appeal to the fossil fuel industry is that it offers a way to continue today’s energy mix while reducing emissions. Climate extremists oppose such thinking because they’re passionate about a world of solar panels and windmills. But when you work through the math, the cost of capturing all the CO2 emitted from the combustion of natural gas is not an insurmountable figure. Its implementation is also much more plausible than carpeting the landscape with intermittent renewables along with the extensive high voltage power lines required to move it from rural areas to population centers. Massachusetts can’t even buy hydro-electric power from Quebec because New Hampshire won’t allow the necessary power lines to be built in their state.

The tax code already pays a $50 per ton credit for permanently sequestered CO2. The Clean Air Task force thinks it should be higher, and has estimated the cost of capturing CO2 from different sources – ranging from as little as $39 per ton for CO2 produced in gas processing to $100 per ton in cement production. Industrial emissions with more concentrated CO2 allow for cheaper separation of the CO2.

The table shows that even at a substantially higher cost of $150 per ton, the CO2 emitted from burning natural gas could be captured with an increase in our overall energy spend of less than 20%. A new CCS industry would create jobs just as the president promises ramping up renewables would. Anyone truly worried about global warming and not simply proselytizing for renewables would surely embrace this as worth the cost.

The energy transition is about economics, not technology. The solutions are mostly known. Costs can be reduced through scale and innovation continues, but it’s about society’s willingness to pay for the cost. The point of the table is not to try and persuade climate extremists, but to show that substantial emissions reductions are possible without our power supply failing us when most needed, as in California for example.

Today’s energy companies have a lot riding on the outcome, which is why CCS is gaining more attention. As their solutions become more visible, the sector will continue its recovery.

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