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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Big spending is a bi-partisan strategy.

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

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

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

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

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

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

We are short December 2022 eurodollar futures.

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

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

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

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

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

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

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

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

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

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

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

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

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

Although we generally write about investing in midstream energy infrastructure, we find macro subjects interest our readers too. In April, not long after the market low, The Stock Market’s Heartless Optimism was popular, as any guide to the market’s direction was eagerly sought. We regularly use the Equity Risk Premium (ERP) to illustrate the relative value of stocks versus bonds. Earnings forecasts never fell as far as the market, which is what propelled its rebound for the remainder of the year.

Full year S&P500 EPS is currently forecast by Factset to come in at around $140 once 4Q20 reports are out. For 2021, analysts are forecasting S&P500 EPS of $170. The 21% increase looks impressive, but a year ago the 2021 EPS forecast was $197. Despite this 14% drop in forecast earnings, the market returned 18%. It’s been cheaper. Lower bond yields helped, but relative value has clearly deteriorated. At 3.6, the 2021 ERP shows stocks are attractive compared with the past 50 years, but mid-range for the past decade.

A 1% jump in bond yields would likely expose the market’s lofty valuation. This has been true for years without result. Investors need to consider the possibility of such, improbable though it seems. Recent M2 money supply growth of 26% has eclipsed the inflationary ‘70s and ‘80s. Taming the deficit is a quaint hobby with few votes, and the Fed wants to see inflation above its 2% target for a period of time before acting. This doesn’t mean inflation is about to jump, but the mismatch between investor positioning and the odds of such a surprise appears significant.

We wrote on this topic recently (see A Cheap Bet On Inflation), drawing a good number of emailed comments. One friend and client generously described it as “post of the year”.

Inevitably, we wrote on Covid, as reasonably numerate non-medical people trying to figure it out. Opinions are strong on both sides, and the most reasoned responses came from those who believed we were underestimating the threat. Our morning meetings often include a discussion, and there isn’t complete agreement even within SL Advisors on certain elements. What is unarguable is that life won’t return to normal until people feel safe, regardless of whether they’re over-estimating their risk or not.

For my part, in New Jersey in March and April of last year we endured a loss of personal liberty I never thought possible in America. Even a solitary walk in the woods was banned. As soon as we could, my wife and I escaped for a trip south, where infections were lower and society more open. This was briefly chronicled in Having a Better Pandemic in Charleston, SC, which many enjoyed.

Climate change will continue to be a dominant driver of energy sector returns. Anything linked to the energy transition draws fund flows (see Hydrogen Lifts an LNG Company).

Valuations defy fossil fuels’ 80% share of global energy, and the relentless growth in developing countries’ consumption to support rising living standards. We have long thought natural gas a better bet than crude oil. 2020 highlighted the former’s resilience as the collapse in transportation demand was mostly felt in oil markets (see With Energy Uncertainty, Natural Gas Offers Stability and Natural Gas Demand Still Stable).

The election result means energy companies will continue cutting growth spending, a welcome development. Next week’s Georgia runoffs for the Senate will determine whether Goldilocks Gridlock or a razor-thin Democrat majority prevail. The former is better, but pipeline free cash flow is growing in either scenario. Why Exxon Mobil Investors Might Like Biden explained how we thought politics would affect the sector.

Our podcasts have developed a growing listener base too. Among the most popular were Joe Biden and Energy, Climate Change Was Never Our Biggest Threat, Exxon’s Bet Against Renewables and Democrats Mean Higher Energy Prices.

As always, we invite your feedback whether positive or negative. We aim to produce what you want to read or listen to.

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