Sunday’s blog (see Pipeline Opponents Help Free Cash Flow) drew some interesting feedback. It seems odd to favor constrained growth opportunities, and it’s contrary to how most management teams will assess their outlook. But for many pipeline investors, including your blogger, the pre-Shale years of steady returns were what made the sector attractive. Anti-fossil fuel activists refuse to acknowledge how the world works, but they are making new pipelines cost-prohibitive, just as nuclear opposition has done for that source of power.

Investors have asked about the prospects for the Dakota Access Pipeline, DAPL (listen to Judicial Over-Reach on the Dakota Access Pipeline). Judge Boasberg ruled that DAPL should shut down, and allowed only 30 days for it to be emptied of crude oil even though the owners argued that was too little time. Once shut down, there is a real question as to whether it will ever re-open. Since the pipeline is built and in use, you’d think shutting it would require extraordinary circumstances.

Yesterday evening, a U.S. Appeals Court granted an administrative stay while it considers whether the line, long opposed by local tribes and environmental activists, should be shut.

In this case, the government has been found to have incorrectly issued the permit allowing it to be built. Ludicrous analogies are easily constructed – if you can’t safely build with government approval in hand, nothing much could get done in this country. The courts will decide if Judge Boasberg is correct on the law, but if he is it means the law is wrong and needs to be fixed. We think this is a unique case, and that existing pipelines are not at risk of being shut down.

Even if the shut-down order is ultimately overturned, the Army Corp of Engineers has been told to carry out a more robust environmental study than was originally done. Although the Trump administration could appeal this requirement, it appears that there is insufficient time to do so before the election. One of Trump’s first acts following his inauguration was to direct the Army Corp of Engineers to issue the necessary permit. That legal challenges have outlasted the term of this administration with DAPL’s prospects still not resolved further highlights the challenges of new projects.

Investors have to consider the possibility of a Biden victory, which will lead to a changed emphasis towards climate change in the White House. In this scenario, DAPL’s prospects would be unclear. If it’s been shut down pending a revised environmental study, it may never re-open. The hit to Energy Transfer (ET) is around 3.5% of EBITDA, which we think is already priced in.

Although Biden is calling for $2 trillion to be spent on clean energy, Covid is causing a ballooning Federal budget deficit, currently $2.7 trillion with three months of the fiscal year remaining. As a % of GDP we’re approaching World War II levels. Being better prepared for another pandemic is likely to be more important than in the past, so cheap, plentiful domestic natural gas will continue to gain market share in providing energy to Americans. It’s confidence in this future that underpinned Berkshire recent acquisition of Dominion’s pipeline and storage assets.

.avia-image-container.av-kxzoha-db7a3b261a676a52cd9635d6ca88b560 img.avia_image{ box-shadow:none; } .avia-image-container.av-kxzoha-db7a3b261a676a52cd9635d6ca88b560 .av-image-caption-overlay-center{ color:#ffffff; }

Meanwhile, existing pipelines are more valuable. Dominion and Duke Energy abandoned their Atlantic Coast Pipeline (ACP) even though they had successfully fended off legal challenges and had plenty of customer commitments. So Transco, owned by Williams Companies (WMB) and operating from Texas to New York, is well positioned to meet some of this unsatisfied demand. They may even find a way to bring Appalachian natural gas to customers in North Carolina by building on to their existing network. They’ll have no competition.

Since the ACP cancelation WMB has outperformed the sector, as defined by the broad-based American Energy Independence Index. Both have outperformed the Alerian MLP Index, since investors continue to avoid concentrated MLP exposure.

We are invested in ET and WMB.

We publish the American Energy Independence Index

Several major pipeline developments last week might well represent a key turning point in how the industry operates.

Berkshire Hathaway (BRK) acquired Dominion Energy’s natural gas pipeline and storage assets for an enterprise value of $9.7BN, which included BRK using $4BN of its cash pile. Although some estimated the price on the low side, Buffett clearly sees a long positive future for natural gas pipelines. This was a welcome endorsement.

At the same time, Dominion and Duke Energy canceled their planned Atlantic Coast gas pipeline project (ACP). This has been the subject of numerous court challenges from environmental extremists. The project appeared to be proceeding, with capacity 90% subscribed, and legal challenges successfully rebuffed. However, the possibility of further court proceedings with additional ongoing delays and cost uncertainty led Dominion and Duke to abandon the effort.

In other news, the U.S. Supreme Court over-ruled a lower court, which had blocked a permit program that several pipeline projects were relying on for construction. But at the same time, it rejected a request from the Trump Administration to allow construction of the Keystone XL crude oil pipeline that had been blocked by a Federal judge in Montana.

But the most stunning legal development was the ruling by U.S. District Judge James E. Boasberg that the Dakota Access Pipeline (“DAPL”) must immediately cease operations and remove all the crude in it within 30 days. DAPL’s construction under Lake Oahe, ND, near the Standing Rock Sioux Reservation, drew fierce protests from local Native Americans and others opposed to its construction. The Obama Administration was opposed to it. Following Trump’s election, the Army Corp of Engineers gave their approval and DAPL was completed. It has capacity of up to 570,000 barrels per day, moving crude from the Bakken in North Dakota to Patoka, IL.

The judge’s ruling finds fault with the approval issued by the Army Corps of Engineers, which was given on the basis of an Environmental Assessment (EA). The Court found that, given the controversial nature of the project, a more rigorous Environmental Impact Statement (EIS) was required under the National Environmental Policy Act (NEPA).

In summary, the judge believes the government incorrectly allowed the pipeline to be built.

Whether or not this is the case, ordering the pipeline to shut down defies common sense. The implication is that, even if the government issues a private company a permit, substantial economic risk remains if your opponents can find a compliant judge. DAPL could lose $1.2BN next year if it’s forced to close. Bakken crude production will face higher transportation costs as producers resort to rail, where spills are more likely. It may not even by physically possible to empty the pipeline within the 30 day deadline. The process includes pumping huge volumes of nitrogen into the pipeline to push a bullet-shaped “pig” through it.

There are numerous knock-on effects. Production may now be cut back in the face of higher transport costs, causing layoffs. Landowners who sold the pipeline the right to cross their land won’t get paid. North Dakota royalties on production will fall. One analyst suggested that Judge Boasberg was frustrated that the Army Corp of Engineers had concluded their EA was adequate even after the court told them to review their process. Under this interpretation, the judge is trying to punish the Army Corp of Engineers, although oversight of the Administration is more properly the role of Congress.

The ruling is being appealed, and DAPL may yet continue to operate if a higher court over-rules Judge Boasberg’s order to shut down the pipeline. For the judicial system to work, a more reasonable assessment is needed. But considerable uncertainty about DAPL’s future will remain, and if there’s a change in government in November, the Army Corps of Engineers may decide not to even issue an EIS, which they estimate will take 13 months. DAPL cost $7.5BN, substantially over budget because of numerous delays. It may never restart.

.avia-image-container.av-q4vn99-3215e909a1744ee01912b55c635e76b2 img.avia_image{ box-shadow:none; } .avia-image-container.av-q4vn99-3215e909a1744ee01912b55c635e76b2 .av-image-caption-overlay-center{ color:#ffffff; }

Energy Transfer (ET), who built DAPL and retains a 36.4% ownership stake, has earned a reputation for not backing down when opposed by environmental activists. But the implication of the ruling is that permit issuance by the Federal government can’t be relied upon when deploying capital. Whatever the merits of this particular case, a court shouldn’t be able to impose economic losses on a company that has obtained the necessary permit, just because the permit may have been issued incorrectly. Otherwise the permit recipient needs to review its own regulator for correct procedure. This is not how great nations are built.

The cancelation of ACP, the uncertainty over DAPL and the perpetual struggle to build Keystone XL will cast a shadow over every new pipeline project. Unpredictable legal delays have prevented the construction of nuclear power facilities in recent years – although most costs can be estimated, court challenges can burn up time and money in ways that are hard to anticipate. The private sector has concluded nuclear power is just not worth the trouble, impeding our use of this source of emission-free energy. The pipeline industry is going the same way.

Anti fossil-fuel activists have achieved a great victory. But they’ve also achieved what pipeline investors have failed to – a decreased appetite for new construction. The Shale Revolution has been a huge bust for equity investors in the U.S. energy sector, including midstream infrastructure. The old pipeline business that used to be dominated by MLPs did little new building, invested in maintenance of their existing assets and paid attractive distributions that grew through price hikes and productivity improvements.

Pipeline executives drank the same kool-aid as their upstream customers. Too often, growth projects failed to cover their cost of capital and acquisitions were based on unrealistic assumptions. The pursuit of growth has been, in aggregate, bad for investors. Canadian companies have been more disciplined, but the abject past decade’s performance of the Alerian MLP Index reflects poor capital allocation by management teams constantly building and buying.

Falling growth capex this year is the driver of increasing free cash flow (see Pipeline Cash Flows Will Still Double This Year). Last week’s court rulings are likely to further trim growth projects, which will be lamented by management teams but cheered by investors.

It’s also likely to increase the pricing power of existing infrastructure, especially where additional capacity is needed but unavailable due to growing legal uncertainty. If future customers ultimately can’t access natural gas because needed pipeline capacity wasn’t built, that will be someone else’s problem. Maybe a more predictable legal process will evolve, but for now it is clearly opaque and sometimes capricious.

Don’t let the disappointment that will be heard on 2Q earnings calls confuse you. Many of these companies developed a culture of always building. In the future, growth projects will be more modest additions to existing infrastructure where permit jeopardy isn’t a factor. Buffett is unlikely to pursue controversial new pipeline construction for the business he just acquired, and he sees much to like about its prospects. Climate activists are doing long-term pipeline investors a favor. Few would expect us to admit that! Barriers to entry are becoming insurmountable.

Client meetings for many businesses have had to conform to local Covid-19 restrictions. Most of us have found that working remotely is fine, although I suspect it’ll become increasingly problematic in the months ahead. As Zoom calls suddenly became part of daily life, we were all chatting with people with whom we had recently shared an office. Relationships already existed. But we’ll see how it goes when newcomers have to build a rapport over Zoom. Training is also harder. Remote learning is widely believed to have been a bust (see The Results Are In for Remote Learning: It Didn’t Work). Research is finding that students achieved only 70% of the reading gains compared with a typical year, and less than 50% of the Math. This is why it’s critical that schools reopen in-person in September.

.avia-image-container.av-1ivzvl7-2df7b4cbc1e4f537f78d1a6e6f32597b img.avia_image{ box-shadow:none; } .avia-image-container.av-1ivzvl7-2df7b4cbc1e4f537f78d1a6e6f32597b .av-image-caption-overlay-center{ color:#ffffff; }

Meeting with clients has to take place outside – the photos are from a recent breakfast with two long-time clients and friends, Ron and Jeff Karp from Summit Private Investments. In March all the large investment firms we deal with quickly suspended visits by outsiders. Every contact now carries some risk, and it’ll be interesting to see how much old attitudes are restored once the general population is vaccinated or otherwise immune. It’s likely that the risk of infection disabling an entire department or firm will be a permanent consideration, just as business continuity plans took on added importance following the 2001 attack on the World Trade Center. In finance, we can expect regulators to start looking at how firms protect their employees, as well as their plans if another pandemic occurs.

Nobody misses their daily commute into New York City from the suburbs. Numerous conversations reveal that the 2-3 hours of time previously dedicated to daily travel is highly valued. People will return to the office, but it seems that schedules have permanently changed. Mass transit in the New York area and presumably others is likely to experience a permanent drop in demand, which will pressure finances.

JPMorgan expects to operate with offices only half full, even once restrictions have been lifted. “Hot desks”, available to different users each day will be a used at least temporarily. I understand from a friend that satellite offices are being considered in the suburbs, where enough formerly commuting employees live. Edison, NJ and Stamford, CT are two locations apparently under consideration. Although big corporations will want a more dispersed labor force, they’ll also want their people working in a secure IT environment subject to corporate oversight.

Another friend from Goldman Sachs told me seasoned employees in his department will work from home two days a week, and that such schedules will be fixed — i.e. if Tuesday and Wednesday are your at-home days, you’ll generally be required to stick to that. Interestingly, new hires will be expected in the office five days a week, recognizing that working remotely relies in part on existing professional relationships that have been built through in-person interaction.

I’ve also heard that ground floor office space is becoming more sought after, because workers don’t need to use the elevator. The WSJ noted the other day that some employers, “…can’t figure out how to send people up a 50-story skyscraper.” This is because, “… limiting riders on some elevators would create dangerous crowding in lobbies.”

.avia-image-container.av-195of8r-2bb98d194e4bee9546c0899d37d83362 img.avia_image{ box-shadow:none; } .avia-image-container.av-195of8r-2bb98d194e4bee9546c0899d37d83362 .av-image-caption-overlay-center{ color:#ffffff; }

What does all this mean for energy consumption? U.S. gasoline demand has recovered to around 85% of last year’s levels, a surprisingly strong rebound given the recession. The re-imposition of types of lockdown in some southern states hasn’t yet shown up in the figures. But over the longer term, even when masks and social distancing are mostly a memory, some reduction in demand is still likely.

.avia-image-container.av-tf26tn-002c84d032e76f28e9ef6bdbf51d60ec img.avia_image{ box-shadow:none; } .avia-image-container.av-tf26tn-002c84d032e76f28e9ef6bdbf51d60ec .av-image-caption-overlay-center{ color:#ffffff; }

What receives less attention is the continued robust demand for natural gas. The latest weekly figures show total demand slightly ahead of this time last year, at 80.7 Billion Cubic Feet per Day. Across the midstream energy infrastructure industry, we calculate 58% is involved in natural gas with petroleum products only 26%. Although altered work habits are likely to dampen transportation demand, this is a smaller part of midstream than many realize. Earnings reports over the next few weeks will provide an important update on overall energy demand.

History is about people, and personal connections always add interest. On hearing we’d be visiting Charleston, SC a good friend, Austin Sayre, suggested we stop by his family’s ancestral home. The Colonel John Stuart House is in Charleston’s historic district, where many of the homes have a plaque describing their former owner’s significance. Colonel Stuart is one of Austin’s ancestors.

The plaque and Wikipedia together describe Colonel John Stuart, a Scottish rebel who later represented the British government in dealing with Native Americans. Born in 1718 in Inverness, he arrived in Charleston in 1748. During the Revolution, his loyalty to the British crown meant he had to flee Charleston, and his house was confiscated. Stuart died in Pensacola, FL in 1779. The British Commander-in-Chief in North America, General Sir Henry Clinton, lamented, “The loss of so faithful and useful a servant to His Majesty.”

Charleston is a beautiful old city. Dozens of fine homes in the historic district have been restored, and it’s absorbing to stroll among them while reading about the lives of former residents. The water front is picturesque, and is best experienced on foot wandering down the narrow streets. The city also provided our first meal out in three months (see Having a Better Pandemic in Charleston, SC).

There’s more to the story. John Stuart didn’t just sail for the new world in search of opportunity. He was fleeing for his life. In 1745 Charles Edward Stuart (“Bonnie Prince Charlie”) led the Jacobite rebellion, which sought to overthrow King George II in favor of Bonnie Prince Charlie’s father, who was waiting in France. John Stuart, clearly of the same clan and therefore related, joined the uprising. It was put down at the Battle of Culloden in 1746, where the English won a decisive victory.

.avia-image-container.av-ihtdqc-01f11088f23cc258496ea780890b0744 img.avia_image{ box-shadow:none; } .avia-image-container.av-ihtdqc-01f11088f23cc258496ea780890b0744 .av-image-caption-overlay-center{ color:#ffffff; }

What remained of the Scottish army returned to their homes in the Scottish highlands. But King George II sought revenge against the treasonous officers who had led the uprising. John Stuart was wanted, and likely faced execution if caught. He and his brother Francis left Britain, on a ship that brought them to Charleston. There, John Stuart eventually built the house we had visited, and his descendants ultimately included Austin Sayre.

Incidentally, the TV series Outlander portrays the events around Culloden, including the battle, in a number of gripping episodes.

I contemplated this historical vignette and my connection with it. Part of it didn’t add up. John Stuart had gone to war against the British Crown in 1746, following which he had fled the country. Just 14 years after Culloden, we find Captain John Stuart in the local militia fighting the Cherokee Indians.  He was captured, but later released in exchange for a ransom.  In 1762, Stuart’s familiarity with Native Americans led the British to appoint him Crown Superintendent for Indian Affairs in the South.

During the Revolution, John Stuart’s loyalty to the Crown forced him to flee again, this time from Charleston. Why did this former rebel later pledge fealty to the king?

I asked Austin, who shared the story passed down to him through his family. King George II died in 1760. He was succeeded by his grandson, George III, whose father, Frederick, Prince of Wales, had died in 1751 of a lung injury. Sometime after George III’s accession, John Stuart and his brother Francis sought a royal pardon from the new king. George III was looking for friends in the colonies, and was perhaps also influenced by John Stuart’s service in the 1759-61 Anglo-Cherokee war.  Both brothers were pardoned. This is why the Scottish rebel spent his later years as a loyal subject. What a fascinating twist!

Francis subsequently returned to Britain, but John remained in Charleston until the Revolution. He built his house between 1767 and 1772, by which time he was Colonel John Stuart.

It’s an obscure piece of history. The story was made real for us through visiting the home once owned by our friend’s ancestor, and supplemented with additional information. Charleston felt closer to Britain than does everyday life in New Jersey, because its early history is so vividly British. Our shared histories are why, for this Brit, America has so easily been home for 38 years and will be for the rest of my life.

I am descended overwhelmingly from English stock – my ancestors might even have been on the opposing side at Culloden, although Austin Sayre is too much of a gentleman to retain a grudge. Colonel John Stuart no doubt lamented the 1776 Declaration of Independence, but Austin and I agree that Britain’s loss was the world’s gain. We are a great country navigating a tough patch. We’ll make it to the other side. We always do.

Covid-19 is probably the biggest political issue in America today. Liberals see a worsening situation in need of a slower return to normalcy requiring additional fiscal stimulus. Rising infections in Arizona, Texas and Florida provide plenty of quantitative support for this view. Conservatives reject this argument, presenting their own set of data. The restrictions on movement imposed by most states have offended those who perceive an unneeded loss of freedom – some even put face masks in this category, although masking up when in close contact with others seems a fairly trivial courtesy.

The sensational headlines continue to inspire fear, such as Newsweek’s “Texas’ Largest Hospital Reaches 100 Percent ICU Capacity”. The article goes on to add that 72% of that capacity is being taken up by non-Covid-19 patients, which nullifies the headline. This is why “liberal media” has become a term of disparagement.

.avia-image-container.av-2o2ascp-ad72ff2ade906c1c0c9f060392cbec5a img.avia_image{ box-shadow:none; } .avia-image-container.av-2o2ascp-ad72ff2ade906c1c0c9f060392cbec5a .av-image-caption-overlay-center{ color:#ffffff; }

There is data to support the view that the pandemic continues to moderate, and is far less fatal than originally feared.  A well-run hospital is always at 90-100% ICU capacity.  Hospitals can free up ICU beds  by canceling elective surgeries, and redesignate certain beds as ICUs, allowing them to operate at multiples of normal capacity.

Making an optimistic case shouldn’t imply that the proponent isn’t worried about getting sick. A conversation with a friend who was hospitalized for four days convinced me this virus is better off avoided.

.avia-image-container.av-289noh5-b6fb8a3ff2de2254db850a5667b1980b img.avia_image{ box-shadow:none; } .avia-image-container.av-289noh5-b6fb8a3ff2de2254db850a5667b1980b .av-image-caption-overlay-center{ color:#ffffff; }

Conservatives note that positive test results are going up, but that it’s due to increased testing. We’re finding more infections because we’re counting more. Liberals counter that the percentage of tests that are positive has edged up over 6%, which means it’s not all down to increased testing. However, this is still far below its peak of 21.8% in April. The criteria for testing have evolved, and riskier groups such as nursing home or prison populations will test higher. Because young people represent a bigger proportion of positive test results, some argue that they’re not following social distancing guidelines. While there are lots of photos to support that, hospitalization data continues to moderate, which suggests that people who are testing positive aren’t as sick. This is true even in Texas, where positive tests results are rising. Nationwide, hospitalizations and the fatality rate continue to fall. Doctor visits for flu-like symptoms are down.

The strongest argument that Covid-19 is unlikely to kill millions comes from estimates of the overall infection rate. U.S. fatalities are 120,000 (defined as people who died where Covid-19 was a contributing factor, although it’s now well known that other contributing factors such as obesity are usually present). Older people are far more vulnerable. CDC data shows that just 19% of fatalities are people under 65 years old.

.avia-image-container.av-1h2i6zt-f7e2ca7caf1933e64f3805fa1fc3e6b4 img.avia_image{ box-shadow:none; } .avia-image-container.av-1h2i6zt-f7e2ca7caf1933e64f3805fa1fc3e6b4 .av-image-caption-overlay-center{ color:#ffffff; }

.avia-image-container.av-1anz5k9-eb4149d27b933d39139d53ce6afa0978 img.avia_image{ box-shadow:none; } .avia-image-container.av-1anz5k9-eb4149d27b933d39139d53ce6afa0978 .av-image-caption-overlay-center{ color:#ffffff; }

We referenced a research paper on Wednesday (The infection fatality rate of COVID-19 inferred from seroprevalence data) that estimated an Infection Fatality Rate (IFR) for those younger than 70 years old of 0.04% (see Still Spreading, But Less Deadly). CDC data doesn’t precisely align, because they define age cohorts as 55-64 etc., rather than 60-70. But a reasonable estimate is that 30,000 people under 70 have died.

.avia-image-container.av-kbs7jd-a476abda9907649645d3abb347b4e3a4 img.avia_image{ box-shadow:none; } .avia-image-container.av-kbs7jd-a476abda9907649645d3abb347b4e3a4 .av-image-caption-overlay-center{ color:#ffffff; }

The 0.04% IFR implies that for every 10,000 people under 70 who are infected, four have died. This suggests that 75 million Americans have been infected (30,000 divided by 0.04%). It seems an impossibly high number – and yet, CDC Director Robert Redfield said on Thursday that, “5-8% of the American public has experienced infection, whether they recognized it or not.” This implies somewhere between 16 and 26 million Americans have been infected. With 2.2 million confirmed cases, that means for every positive Covid-19 test, another 7-11 people are infected but not bothered enough to visit a doctor. Redfield’s estimate is for the entire U.S. population, while the 0.04% IFR is for <70. But the two estimates are broadly consistent.

As with much of the data, it can confirm contrasting views. How the Virus Won reflects a Liberal view. Alternatively, for most of this year excess deaths have been below normal, partly because road fatalities are down (usually around 38K annually).  It’s possible that we’ve avoided more deaths from all other causes than Covid-19 has caused, although nobody knows who those fortunate souls are. One Covid-19 death is one too many, but policymakers are responsible for making judgments for society as a whole based on the best data available.

Covid-19 cases are rising, especially in the south. Three weeks ago, my wife and I headed to South Carolina and beyond, where restrictions were limited and nobody we met knew anyone who had gotten sick (see Having a Better Pandemic in Charleston, SC). Masks were scarce, inside dining was permitted and it seemed like the old days. It was a glorious break from New Jersey with its opaque lockdown process and intermittent minor relaxations. However, rising infections in the south are causing some to suggest that people have been too relaxed in their efforts to avoid infection.

Covid-19 has become a political issue, so voting affiliation tends to color people’s attitudes. The New York Times recently posted two graphs that can be harnessed by each end of the political spectrum. The Liberal narrative focuses on the early under-counting of deaths because of insufficient testing (noted below the charts) and the uptick in infections. Covid-19 has killed even more people than we thought, and is spreading.

.avia-image-container.av-1p9gc1m-75bf370472e54ef63165933e8072266e img.avia_image{ box-shadow:none; } .avia-image-container.av-1p9gc1m-75bf370472e54ef63165933e8072266e .av-image-caption-overlay-center{ color:#ffffff; }

The Conservative perspective looks at the earlier understated number of deaths, which are now being more accurately counted because of more widespread testing, and sees an even faster decline in fatalities. Moreover, the increase in infections doesn’t seem to be arresting the decline. This suggests that we’re simply finding more infected people, because we’re testing more, and not that it’s getting worse. Treatments are improving too, leading to better outcomes.

Since it’s become a political issue, both sides can use the data to argue their case.

The median age of those testing positive is trending younger. In some counties in Texas, the majority of the positive tests are now people below thirty. Dr. David Persse, public health authority for the Houston Health Department, said, “It is my current theory that elder persons have become more vigilant in taking precautions,”

This sounds plausible, since older people are far more vulnerable to suffering serious illness or death from the virus. And the rising rate of infections among young people could reflect their confidence that, even if they contract the virus, their symptoms will most likely be mild or even non-existent (asymptomatic). We’re all growing weary of social distancing with its myriad restrictions on life as we knew it. Younger people seem to be increasingly willing to risk infection, since any negative consequences are likely to be mild.

.avia-image-container.av-rw85x6-59e1935423cee6d1e347383e944d26d3 img.avia_image{ box-shadow:none; } .avia-image-container.av-rw85x6-59e1935423cee6d1e347383e944d26d3 .av-image-caption-overlay-center{ color:#ffffff; }

This highlights the problem with requiring low-risk people to follow behavioral rules that protect others that are more vulnerable. It doesn’t seem much to ask in theory, but drinks at a bar with friends can easily seem a long overdue and justified proposition.

San Antonio mayor Ron Nirenberg also believes social distancing is being harmfully ignored, “While they may survive an illness, younger people are going to be stuck with a pretty hefty medical bill at the end of it.” That doesn’t sound like a compelling incentive – hence states like Texas are forced to reconsider how they impose social distancing.

But there’s a problem with this interpretation that age groups are adopting risk-based behavior. For Dr. Persse to be right about older people more successfully protecting themselves, you’d expect to see young people represent a bigger proportion of deaths and older people less. But this data is fairly stable. It looks to us that we are simply identifying more infected people because we’re testing more. Some may argue that deaths are a lagging indicator, but CDC data shows the same stable pattern for hospitalizations too. Although more young people are being counted as infected, the proportion of young people getting seriously ill or dying is not rising.

.avia-image-container.av-15i7wsa-63032d142a52d957971fb8b02d440446 img.avia_image{ box-shadow:none; } .avia-image-container.av-15i7wsa-63032d142a52d957971fb8b02d440446 .av-image-caption-overlay-center{ color:#ffffff; }

Early estimates of the Infection Fatality Rate (IFR) from Covid-19 were in the 3-4% range, based on data from China that assumed no asymptomatic spread. The New York Times article opens with 2.3 million+ cases and 120,345 deaths, implying an IFR as high as 5.2%. Projecting these IFRs across wide swathes of the U.S. population imply many millions of deaths, so it’s easy to see why governments took aggressive steps to protect people. But now we know that asymptomatic spread is high, which has greatly increased the infection rate. The fatality rate has correspondingly fallen as a result.

A recent paper from Stanford University (The infection fatality rate of COVID-19 inferred from seroprevalence data) has not yet been peer-reviewed, following recent practice to publish first with that caveat, in the interests of sharing analysis quickly. Serology tests estimate the infection rate across a population by looking for antibodies in blood tests. The Stanford paper uses data from 23 such studies, and arrives at an IFR of 0.04% for people under 70. This is why young Texans are drinking in bars and failing to follow social distancing. They probably take more risk getting home from the bar than when they’re inside.

Coronavirus approached us like a distant wave earlier this year. Initially it was remote and unthreatening, as we viewed developments far away in Asia. But it soon engulfed us, making our lives unrecognizable and crushing economic activity everywhere. As the first wave recedes, individuals and businesses are adapting to the new normal, while contemplating a second one later this year.

Demand for transportation collapsed, with global crude oil demand down a record 25% in April. Working remotely has been far less disruptive than many expected. While it’s probably now a permanent feature, I suspect most businesses will adopt a hybrid model. In-depth discussions, training and relationship building are all richer in person, when conditions allow.

Brazil’s Petrobras plans to keep half its administrative staff working from home permanently, one of the first big companies to make such an announcement. This will impact over 10,000 employees. A new risk for large businesses is the possibility that an entire department could be incapacitated by a virus super spreader – and even after we’ve vanquished Covid-19, the hypothetical risk of a new virus will remain. Imagine the trading room of a global bank becoming infected. Traders can work remotely, but that presumes they’re not already sick. A dispersed department is a safer one. Downtown real estate owners shudder. In the future, every business meeting will need to be of sufficient value to justify a possible exposure.

.avia-image-container.av-2f66t9-e8b9168ca006357aad43dc9d680fc830 img.avia_image{ box-shadow:none; } .avia-image-container.av-2f66t9-e8b9168ca006357aad43dc9d680fc830 .av-image-caption-overlay-center{ color:#ffffff; }

Aviation is years away from a return to normalcy. Qantas has now pushed back the resumption of international flights until at least October. Passenger volume through TSA checkpoints remains down 83% from a year ago.

Electric vehicles are not immune to weaker demand either. Sales of rechargeable batteries are forecast to fall for the first time in history, by 14% this year.

The energy sector is adapting. After losing over half its value through mid-March, the North American pipeline sector is the new momentum play, easily outperforming the overall market on the rebound. The International Energy Agency recently forecast that crude demand in 2021 will jump by 5.7 Million Barrels per Day (MMB/D), recouping two thirds of this year’s projected drop of 8.1 MMB/D. U.S. shale production, which dropped by 2 MMB/D during the lockdown, is expected to recover a quarter of this drop by the end of the month.

The increase in Free Cash Flow (FCF) at pipelines is a result of lower spending on new projects (see Pipeline Cash Flows Will Still Double This Year). Similarly, upstream investment is also slowing. Goldman Sachs expects capex for big oil projects to halve over the next couple of years, and fall by a third for liquefied natural gas. This structural under-investment will mean less new non-OPEC supply in the coming years, which Goldman argues will cause a multi-year cyclical upswing in commodity prices and better returns on invested capital. As energy investors, the last few years of poor returns have led us to regard almost any reduction in growth capex positively.

BP took a $17.5BN writedown as they expect oil demand to remain on a permanently lower trajectory. They were still able to raise $12BN in hybrid debt, equity-like securities which give BP the option to repay but may be perpetual. With coupons as low as 3.25%, there was clearly strong demand.

Lower crude oil production in the Permian in west Texas has reduced flaring, since less associated gas is being produced as well. The Texas Railroad Commission (RRC) is exploring ways they could limit flaring – since they’ve never rejected a flaring application, they are hardly a vigorous enforcer. Now at least one commissioner is considering the reputational harm flaring causes, which is at least a step in the right direction. We have long called for greater control (see Texas Reconsiders Flaring, listen to Stop Flaring Natural Gas and watch Stop Flaring).

Businesses are adapting, and the brisk recovery in economic activity is helping. The new normal is almost here.

Last week Oneok (OKE) did a secondary offering of 26 million shares. It was priced at $32, and diluted existing shareholders by around 7%. Although a healthy discount from two years ago when they raised $1BN at $54.50, it was nonetheless encouraging that a pipeline company could raise equity. On March 18, when the sector was roiled by desperate selling from incompetent closed end fund managers (see The Virus Infecting MLPs), OKE traded at $12.16.

In reviewing OKE’s recent stock price performance, a good friend of mine recounted some sage wisdom he once heard from a big investor: It’s never a bad thing to let your new investors make money.

Like most of the sector, OKE rallied strongly from late March. Energy led the rebound in stocks, and on Monday, June 8 OKE traded briefly over $48, almost 4X its low in March. This would have been a great opportunity to do a secondary offering, within touching distance of the price from two years earlier.

.avia-image-container.av-guw91-b0b6a04ce57d858b7f42fb0a720d8e41 img.avia_image{ box-shadow:none; } .avia-image-container.av-guw91-b0b6a04ce57d858b7f42fb0a720d8e41 .av-image-caption-overlay-center{ color:#ffffff; }

OKE management may have been thinking about it – judging from the stock’s subsequent fall, they were likely even discussing it, and perhaps injudiciously. But the announcement finally came two days later, after trading last Wednesday, June 10, when OKE closed at $41.98.

OKE quickly sank on Thursday, dropping $4 on the open and closing down $6.65 at $35.33. The secondary was later priced at $32, a third lower than its price at the beginning of the week.

Most of those involved must be very happy. Buyers of the secondary never saw a loss on their investment, and by Tuesday 16th the stock had rebounded to $38. The underwriters clearly did well, and even existing holders who didn’t participate in the offering can draw comfort from OKE’s now improved financial strength. OKE followed my friend’s advice to let its new buyers make money.

Nonetheless, a more adept management team would have been preparing earlier to fully exploit the market’s newfound passion for pipeline stocks. They would have been ready at $48, rather than chasing the market down to $32. Secondary offerings can be executed quite quickly.

.avia-image-container.av-o5umn9-17a2f343b30d7cd32674b1300030844f img.avia_image{ box-shadow:none; } .avia-image-container.av-o5umn9-17a2f343b30d7cd32674b1300030844f .av-image-caption-overlay-center{ color:#ffffff; }

By contrast, consider Tesla (TSLA). Given the trouncing he has handed short selling hedge funds and other skeptics, it’s likely CEO Elon Musk’s photo adorns many dartboards in Greenwich. The case for shorting TSLA was widely made and not that complicated – they were going to run out of cash. It was just a matter of when. Inconveniently for naysayers, this date with financial destiny kept being pushed off, as TSLA’s operating results continued to surprise.

Losses on short positions expanded steadily late last year as TSLA rallied. In January, as the stock exploded upwards like a SpaceX launch, shorts capitulated and joined the indiscriminate buying. On February 4^th, the day TSLA traded at $969. Elon Musk gracefully allowed the shorts an exit, via a $2BN secondary offering of 2.65 million shares. This was priced $200 lower, at $767, but since it was less than 1.5% of shares outstanding the dilution was inconsequential.

Coronavirus subsequently wiped out half the company’s value, which likely caused the embittered hurling of a few more darts at Musk’s likeness in Greenwich. But TSLA, like OKE and the rest of the market, has made a strong recovery since. However, the buyers of OKE’s secondary are probably happier than the buyers of TSLA’s. We think they’ll have more to cheer.

We are invested in OKE

On Sunday we reviewed Vaclav Smil’s Natural Gas: Fuel for the 21st Century. Smil writes about how the world uses energy, well supported by useful facts and figures. Our original review was a brief summary of the book. Below, we highlight some of the fascinating proof statements Smil includes in his book.

For example – as a drill bit advances into a rock formation, the weight of the drill string above it increases such that it would surpass the 6.5-9 tons of weight that is optimal for fast rock penetration. So the block assembly atop the derrick on the drill pad needs to support the weight of the entire drill and string combination.

Computer-generated 3D visualizations of rock formations include large-scale, immersive displays where people can walk inside the imagery.

There are about 3 million miles of mainline and other pipelines that link natural gas production areas and storage facilities with consumers (EIA, 2019, updated from lower figures in Smil’s book).

We often note that pipelines can provide many decades of operational life, depending on construction techniques and subsequent maintenance. Smil quotes a report from The Role of Pipeline Age in Pipeline Safety by Kiefner and Rosenfeld, “…a well-maintained and periodically assessed pipeline can safely transport natural gas indefinitely because the time-dependent degradation threats can be neutralized with timely integrity assessments followed by appropriate repair responses.”

Smil estimated that pipeline transport of oil was 40 times safer than by rail and 100 times safer than by road, something climate extremists should consider since their pipeline opposition often leads to less safe modes of transport. The same analogy isn’t possible for compressed natural gas because rail and road transport are so rare.

Many industries rely on natural gas for heat. The food industry uses pasteurization (heating to 72°C) for virtually all canned and conserved items, as well as dairy products, juices, wines and vinegar eliminate harmful pathogens.

Paper manufacturing requires heat to dry wet paper. Typically 1.1-1.3 lbs of water are removed for every 1lb of paper.

80% of U.S. bricks are made in gas-fired kilns where temperatures reach up to 1,360°C.

Methane (CH4) is the most important input for the synthesis of ammonia (NH3) via the Haber-Bosch process, which has boosted agricultural productivity, without which the world couldn’t feed its current population.

Ethane and propane, both natural gas liquids, are often found in natural gas along with more voluminous methane (known in isolation as dry gas). These are feedstocks for the production of polyethylene, polypropylene and polyvinyl chloride – in other words, plastics. The U.S. petrochemical industry has been a big beneficiary of these cheaper inputs, and the U.S. is easily the biggest exporter of natural gas liquids (of which ethane and propane are the two most important). For a fascinating view of the plastics business, check out Jordan Blum’s terrific piece from 2018 in the Houston Chronicle’s Texas petrochemical plants turn ethane into building blocks of plastic. It shows how ethane from Texas is formed into polyethylene pellets, then shipped to Vietnam where it’s turned into plastic packaging for frozen shrimp. It finally returns to a Houston-area grocery store.

Ethane production is part of the Shale Revolution. If you’re wondering what its growth prospects are, consider that consumption is growing at almost 4% annually, and that per-capita consumption in non-Japan Asia is around a quarter of the developed world. Plastics use rises with living standards – clearly, much more re-use is required given consumption patterns.

The Center for Strategic and International Studies reports that there are 70 cross-border pipelines for natural gas, NGLs and petroleum products between the U.S. and Canada (Smil counted 31 crossing points just for natural gas). When considering U.S. energy security, Canadian-sourced imports are practically riskless.

Although LNG transport has been thankfully safe, back in 1944 a poorly constructed storage tank in Cleveland failed. The resulting explosion killed 128 people. In 2004 an explosion at an LNG plant in Algeria killed 26 people. I grew up 22 miles from Canvey Island in the UK, an LNG delivery point since 1964 with little else to attract a visitor. My childhood was happily free of LNG incidents. Facilities that handle LNG in the U.S. undergo an exhaustive Federal permitting process.

Long before fracking, more quixotic attempts had been made to extract natural gas held tightly in shales. Incredibly, the U.S. experimented with explosions of nuclear devices. Three tests took place 1967-69 in New Mexico and Colorado using devices 3-9 times as powerful as Hiroshima. Full scale production envisaged 40-50 such detonations annually, but the early results were so far below expectations that the project was abandoned.

Vaclav Smil is a prolific writer of books that explain how the world uses energy. Past titles include Making the Modern World – Materials and Dematerialization, Energy Transitions, Energy Myths and Realities, Energy: A Beginner’s Guide and Energy and Civilization: A History. If you want to understand the physics, chemistry and economics of energy, you need go no further. Natural Gas: Fuel for the 21st Century is four years old, but still provides a solid grounding in its importance for many decades to come.

What we call natural gas is mostly methane (CH4), and it’s been produced by the decomposition of organic matter on earth for at least 3 billion years. Rising concentrations of atmospheric methane can be traced back to the expansion of rice cultivation in Asia, thousands of years ago, and didn’t just begin with the industrial revolution. Ethane and propane are often present in the natural gas mix, although methane dominates. Methane is burned in power plants to produce electricity, and is used for heating and cooking in most homes. Ethane tends to be most valuable as a petrochemical feedstock into plastics, while propane is used to generate heat in various industrial processes, in backyard barbecues and in some cases for transportation.

The Shale Revolution in America has been as much about natural gas as crude oil, although it’s the latter that draws more attention. Natural gas relies heavily on pipelines for transportation, so long term purchase agreements are common in order to justify the significant capital investment in necessary infrastructure. One of the most remarkable energy stories in the last decade is how the U.S. switched from planning greater natural gas imports to becoming a major exporter, as domestic production swelled. Greg Zuckerman’s The Frackers recounts how Cheniere Energy turned reoriented Liquified Natural Gas (LNG) terminals from import to export.

Facts and figures are the very essence of Smil’s books, providing support for every statement. Methane has relatively low energy density, which is why it has to be converted to near liquid form before loading onto LNG tankers; otherwise, the economics of shipment would be unattractive. This is also why it’s not used in road vehicles, where propane’s higher energy density makes it preferable although gasoline dominates because it has even higher energy density.

Natural gas storage is often underground, in depleted natural gas reservoirs, porous rock formations or salt caverns. A giant aboveground tank 100 meters in diameter and 100 meters tall would only hold enough natural gas to heat around 500 Canadian homes during a typical winter. Methane’s high combustion efficiency has led modern residential natural gas-fired furnaces to reach efficiencies of 95-97%. No other fuel is this efficient. In power plants it generates less than 60% as much CO2 as coal. Developing technology may bring further, dramatic improvements (see Clean Fossil Fuels May Be Coming). America’s switch from coal to natural gas for electricity generation is why greenhouse gas emissions have fallen. It’s also why getting China and India, the world’s big coal users in the coming decades, to rely more on natural gas is one of the most important ways the world can combat global warming.

Today’s Energy Transition anticipates the global economy’s move from fossil fuels to zero-carbon based energy. The role of natural gas in this transition is hotly debated – as the cleanest burning fossil fuel, Smil believes (as do we) that it’s going to be part of the solution to lowering emissions. The religious zeal of climate extremists makes no distinction between coal and natural gas, or the impracticality of eliminating 80% of the world’s energy sources. Because this is so unappealing to most people, global emissions grow and Greta lectures ineffectively to virtue-seeking audiences (listen to Davos Talks Climate Change).

Smil provides many more useful insights about natural gas, which will be discussed in a later blog. For a highly informative read, pick up a copy of Natural Gas: Fuel for the 21st Century.