Next month VettaFi, which owns the Alerian indices, will announce a rebalancing of the Alerian MLP Infrastructure Index (AMZI). This will impact the Alerian MLP ETF (AMLP) which tracks AMZI. For an index fund it does a poor job of keeping up with its index – ALPS Advisors, who runs it, reports alpha of –3.03% over the past three years. That’s mostly due to the two tax restatements they made (see AMLP Has Yet More Tax Problems). Over the past year AMLP’s NAV has been adjusted down by 6%. ALPS wisely warns that, “…the daily estimate of the Fund’s deferred tax liability used to calculate the Fund’s NAV could vary significantly from the Fund’s actual tax liability.” It’s currently $329MM, around 4.3% of NAV.

AMLP’s fiscal year-end is November 30^th, so investors will be hoping for no further tax revisions like the one that was released that time last year. December 15^th is the next hurdle, because that’s when VettaFi will rebalance AMZI. It could use it. Currently, the top five names are 72% of the portfolio. Energy Transfer (ET) is over 18%. Just ten names constitute 97% of the portfolio.

AMLP is for those who like their market exposure concentrated.

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Morgan Stanley recently pointed out that ET’s weight is more than 6% over the normal 12% cap. It’s not an easy problem to solve. The number of MLPs is declining – ET’s recent acquisition of Crestwood removed another one. Being an MLP-dedicated fund means to love an ever-decreasing number of names.

ET has performed well this year, with a YTD total return of 25%. ALPS didn’t decide to overweight the name, it’s a consequence of their index construction. Morgan Stanley points out that if VettaFi decides to bring ET back to 12% in their December rebalancing, that could put downward pressure on the stock.

AMLP’s distributions are also now classified as 100% income. This is a change from prior years when they were almost always a return of capital, passing through the tax deferred benefit of MLPs to AMLP holders. Evidently the tax review that led to the cumulative 6% NAV adjustment also reclassified the tax nature of their distributions. It’s unlikely many AMLP investors are aware of this, but those holding it in taxable accounts will receive another unpleasant surprise when they file their 2023 tax returns.

There is so much wrong with this fund.

It is a great example of investor inertia. At $7.5BN in AUM, financial advisors who still use AMLP draw false comfort from knowing that legions of their peers are passively accepting a pool of fewer names and uncertain tax treatment. Investment performance and portfolio construction would render this fund unable to pass the most cursory due diligence of any investment firm’s review process. Its longevity and size substitute for careful analysis.

If your financial advisor still has you in AMLP, your portfolio isn’t receiving the attention it deserves. Ask why not.

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Fundamentals for midstream energy infrastructure continue to be supportive. 3Q23 earnings were generally good. The US Energy Information Administration recently noted that North American LNG export capacity is on track to at least double over the next four years, from 11.4 Billion Cubic Feet per Day (BCF/D) currently to 24.3 BCF/D. As well as five additions in the US, Mexico is adding three and Canada two.

US natural gas is among the world’s cheapest. The constraint on selling more is the capacity of the liquefaction plants currently in operation. Ramping up is a slow process, but as the chart illustrates export growth is coming. US natural gas will contribute to reduced global emissions by allowing more LNG buyers to rely less on coal.

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Earlier in November Williams Companies (WMB) confirmed they’d be moving forward with their Southeast Supply Enhancement project which will increase natural gas takeaway capacity out of the Marcellus shale via their Transco pipeline network. This will increase the volume of natural gas able to go south, potentially supplying our growing LNG export capacity along the gulf coast.

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RBN Energy, a research firm that provides many useful insights, noted the trend towards more investor-friendly allocation of cash flow. Last year the 13 biggest midstream companies (seven c-corps and six MLPs) returned 43% of cashflow to investors via dividends and buybacks. Add in retained cash of 6%, and this equaled the 50% share spent on capex and acquisitions.

In 2019 dividends were 48% of cashflow (there were no buybacks). Capex plus acquisitions was 83%. The difference was financed with increased debt (34% of cashflow).

Energy is a cyclical business, but the increasing dedication of cashflow to investor returns is becoming a welcome habit.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Carbon Capture and Sequestration (CCS) faces daunting Math. Mike Cembalest,  JPMorgan Asset Management’s Chairman of Market and Investment Strategy, publishes a well-researched and insightful annual energy paper. In the 13^th edition last March, he provided the sobering CCS math that sequestering just 15% of the US’s annual CO2 output would involve the same volume as all the oil moving through our distribution and refining system. That’s a lot of infrastructure. He has good reason to be a skeptic on the ability of CCS to have much impact – research shows that many projects fail to complete or fail to deliver their promised volumes.

Nonetheless, commercial involvement in CCS is growing, helped in the US by last year’s mis-named Inflation Reduction Act and its tax credits for carbon capture. Because there’s no cap on the 45Q credits, private estimates of their cost are substantially higher than the $3.5BN provided by the Congressional Budget Office. Goldman Sachs projects them to be 10X more costly. The Brookings Institute thinks the overall legislation will cost $1TN in direct spending and tax credits, more than 3X government estimates.

America prefers tax credits to reward emissions reduction, whereas many other countries impose taxes on those who generate them.

Occidental (OXY) is leading the charge to scoop up Federal handouts. They’re spending $1.3BN to build the world’s biggest Direct Air Capture (DAC) facility in west Texas, called Stratos. Blackrock recently agreed to invest $550 million in the project. Stratos is expected to be in operation by 2025. They’ve already sold carbon credits to Amazon and All Nippon Airways and have sold 65% of the plant’s capacity through 2030. Many companies are concluding that it’s more impactful to pay for offsetting carbon credits rather than trying to curb their own emissions.

Stratos will remove 500K Metric Tonnes (MTs) of CO2 annually, insignificant versus US annual emissions of 6.3 billion MTs of CO2 equivalent. But OXY CEO Vicki Hollub has big plans for DAC. She thinks OXY could build up to 100 plants similar to Stratos and by licensing the technology out enable perhaps thousands more.

Exxon Mobil is partnering with Indonesia’s state oil company Pertamina to invest $2BN evaluating a potential storage site in the Java Sea.

The infrastructure challenge Mike Cembalest cited above assumes that CO2 has to be transported to permanent storage, which usually means finding a place underground with the right geology. But CO2 in the ambient air has a fairly uniform concentration throughout the world’s atmosphere of around 417 parts per million (0.04%). This means that DAC plants can be located above the storage location, eliminating the need for pipeline infrastructure to transport the CO2 and improving feasibility. Often the best rock formations are the same ones that held hydrocarbons previously, which creates the beautiful symmetry of returning carbon atoms to their point of origin, just as a different molecule.

Enlink (ENLC) and BKV Corporation just announced the successful sequestration of CO2 in a well in the Barnett Shale in north Texas. The CO2 was captured from a natural gas processing facility where concentrations can be 1,000X or more the 0.04% in the atmosphere.

ENLC plans to build a CCS business in Louisiana, capturing emissions from petrochemical customers supplied with natural gas via ENLC’s pipelines. Given their $6BN market cap, they offer more concentrated CCS exposure than many larger companies in the sector.

Climate extremists, rarely accused of serious thought on the subject, generally oppose carbon capture as prolonging the world’s reliance on fossil fuels. They should welcome anything that cost-effectively removes CO2 from the atmosphere. Instead, they throw paint at priceless art, proving both that they’re Philistines and that the UK criminal code has been hijacked by liberals. You don’t see that behavior in the US, nor the traffic disruption they cause by marching in the road. American drivers so delayed would naturally hit the gas, reducing the odds of repeat offenders. Throw in the disgusting marches in support of Hamas and Britain, where I grew up, is sliding towards left-wing sponsored anarchy.

Following up on last week’s blog (see Will We Use More Hydrogen?), Germany is planning a 6,000 mile hydrogen pipeline network costing around €20BN ($21BN) by 2032. Encouragingly for US natural gas pipeline owners, 60% of this network will repurpose existing natgas pipelines, showing their versatility during the energy transition.

Germany has had a bad energy transition so far, marked by great expense and huge strategic errors (reliance on Russian natural gas; eliminating nuclear power; industry fleeing to cheaper energy such as in the US). They offer little to emulate – the technical adaptability of gas pipelines is the main positive in their hydrogen story. Germany will be producing more hydrogen than they can use domestically so plan to export 70% to neighboring countries. Let’s hope there’s demand.

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Finally, I spent last week seeing clients in Arizona and had the opportunity to play golf with two long-time investors. It was warm, sunny and welcoming. Scottsdale is mercifully free of the homeless drug addicts that disgrace so many downtowns, even though China’s premier is not scheduled to visit. At least one city government has its act together.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Steven D King is not as famous as his namesake, but for an economist can still write a spine-tingling book. Prompted by the inflation that followed the pandemic, King walks us through past episodes of inflation and their causes, and offers some clues as to whether it’s persistent or transitory.  

Moderate inflation of 2% or lower had become so entrenched that by 2020 the Federal Reserve adopted an asymmetric policy of tolerating inflation above target in order to allow the long run average to reach 2%. Policymakers worried about a Japan-style deflation as much as they fretted over inflation, and when Covid uber-stimulus caused it, the Fed maintained that it would not persist. Hence “transitory” became a flip criticism of Fed chair Jay Powell. 

Until the last hundred years or so inflation and deflation were equally likely. Although citizens in the Roman Empire suffered disastrous inflation during the third century CE, over the next fifteen hundred years or so centuries passed with little inflation and sometimes deflation. During the 15th century the British pound is estimated to have gained 11% in purchasing power. The 20th century up until today is more notable for the absence of any serious deflation. Avoiding deflation at all costs “is likely to end up delivering an inflationary bias.”  

The US 1930s depression was the most economically destructive period in the country’s history. By contrast, Germany’s experience with hyperinflation under the Weimar Republic led to the catastrophe of Hitler. Economic policy in both countries is biased to avoid a repeat – hence the Fed targets maximum employment consistent with stable prices while for decades the Bundesbank’s mandate was simply price stability.  

Quiescent inflation from the late 1980s perhaps led to central bank complacency that their credibility largely assured price stability. But some economists think globalization allowed a one-time enormous increase in the supply of cheap labor and improved supply chains. Central bankers were less important than they thought.  

The aftermath of the US Civil War saw the Federal government fear a repeat of the inflation that followed both the US and French revolutions. But northern financiers had provided extensive credit to southern farmers. The debtor benefits from inflation through a devalued obligation as much as the creditor loses out. Therefore, the deflation that followed the end of hostilities had the effect of making the South poorer while the North got richer, “…a mechanism to ensure the economic costs of the war were imposed on the former Confederate states.” 

King draws an interesting analogy with the periodic debt crises in the Eurozone, during which heavily indebted southern countries like Greece and Italy would benefit from inflation while trapped in the same currency as northern creditors such as Germany. A fracturing of the Euro was only avoided when ECB central bank head Mario Draghi pledged to do “whatever it takes” to preserve the Euro, which eventually included buying Italian and Greek sovereign debt.  

Modern Monetary Theory (MMT) receives a brief and disparaging mention, one with which we heartily agree (see The Death Of Modern Monetary Theory). MMT holds that because a government can never default in its own currency, expansionary fiscal policy should be run to maximize employment. This relies on governments constraining themselves only when forecast inflation shows the limits of productive capacity have been breached. The flaw is in expecting any government to honestly forecast inflation. Even the Fed is bad at it.  

Perhaps the biggest change in central banking in our lifetimes has been the granting of independence from political interference, at least over the short to medium term. During the late 1970s and early 1980s high inflation was a political issue and elected leaders accepted that it was their responsibility to tame it. Paul Volcker could never have driven interest rates to 21%, helping cause two recessions, without support from President Reagan and Congress. 

Central bank independence frees monetary policy from political interference, but it also frees governments from responsibility. The massive fiscal stimulus following the pandemic soon turned out to be excessive. The Fed and other central banks were rightly criticized for reacting late, but few called for the fiscal drag of spending cuts or tax hikes to offset the earlier mistake. Quantitative Easing has blurred that independence. Even wildly imprudent fiscal policy can always rely on the QE bailout. Now that excessive government debt is increasingly financed by central banks, the conduct of monetary policy is more complicated. The unfortunate milestone of $1TN in annual interest expense on Federal debt was brought two years closer, from 2030 to 2028, because the Fed raised rates.  

King offers a four-point test to see whether an uptick in inflation will be persistent or not. The Fed’s asymmetric tolerance for higher inflation, attributing it to external shocks such as covid and Russia’s invasion, and trade tensions that are constraining supply chains are three indicators of persistence. The absence of monetary excess (M2 has been shrinking for over a year) is the only one to provide comfort. King concludes that recent inflation “has been the most worrying since the 1970s.” 

His lessons from past bouts of inflation and warnings about the future make this a book worth reading for every investor.  

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Investors often ask what are the prospects for hydrogen as an energy source. In spite of Jeff Sommer’s conclusion that the market doesn’t think much about the future (see Priced For A Pragmatic Energy Transition) we think about it all the time.

Hydrogen is appealing because when it burns it combines with oxygen to release harmless water vapor. There’s no CO2. There’s a place for hydrogen in industries such as steel and cement where production requires fossil fuels – although electric arc furnaces are increasingly used for certain types of steel, and 43% of planned new capacity will use this method. Currently steel production generates 7-9% of CO2 emissions.

Hydrogen is difficult to handle and expensive to produce. Prolonged contact with steel tends to make the pipeline and welds brittle. Hydrogen molecules are small enough to permeate the steel itself, which over time can cause leaks. Solutions include building pipelines with fiber reinforced polymer, and also blending it in with natural gas to run (up to 15% hydrogen) through our existing pipeline network. Since hydrogen has about one third the energy density of methane (natural gas), delivering the same energy content with a hydrogen blend requires the pipeline to operate at higher pressure, which may require modifications to the pipeline. There are currently 39 pilot projects across the US exploring the hydrogen/methane blend for natural gas distribution. Dominion Energy’s plant in Utah is an example.

There are currently around 1,600 miles of hydrogen pipeline in the US. For reference, we have 305,000 miles of natural gas transmission lines with a further 2.2 million miles of distribution pipes to customers.

Air Products, Linde and Air Liquide produce most of the US’s 10 million tons per annum (MTpa) of hydrogen. It’s produced via Steam Methane Reforming (SMR), which reacts methane with steam at high temperature, producing hydrogen and carbon monoxide, which then combines with oxygen and is released as CO2. If the CO2 is captured this is called Blue hydrogen.

Although hydrogen burns cleanly, its current production requires more energy than the resulting hydrogen contains and generates emissions.

The US recently awarded $7BN in grants to help fund hydrogen hubs that will produce green hydrogen. This will be produced via electrolysis that separates hydrogen from water, and if the power is derived from renewables there are no emissions. The aim is to produce 10 MTpa, (ie double what we do now) by 2030. This is equivalent to around 3 Billion Cubic Feet per Day (BCF/D) of natural gas on an energy equivalent basis, roughly 3% of US production. If this was all blended into our natural gas supply, we’d theoretically reduce emissions from burning natural gas by 3%.

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Cleveland Cliffs has tested using hydrogen in steel production and is planning to use some of the green hydrogen that will be produced from one of the aforementioned hydrogen hubs.

The world uses fossil fuels for around 80% of our primary energy because they’re convenient and not subject to interruption from cloudy or calm days like renewables. They’re dispatchable, as is hydrogen, meaning they’re available whenever needed. Directing the electricity from solar panels and windmills towards the production of green hydrogen seems to me a better use than connecting them to customers via the grid, because the intermittency won’t matter much.

Cost estimates of hydrogen vary widely, but on an energy-equivalent basis green hydrogen is 5-10X the cost of US natural gas. As is often the case with the energy transition, it’s technically possible to reduce emissions but expensive. Climate extremists and liberal politicians continue to assert that renewables are cheaper – meanwhile fossil fuel use keeps growing, as if the world is stubbornly denying itself the opportunity to get more energy for less.

The UN projects oil production will reach around 114 Million Barrels Per Day (MMB/D) by 2030 and 116 MMB/D by 2050 versus 102 MMB/D today. This is based on analyzing the twenty largest producing countries. The International Energy Agency sees demand peaking within a few years. Their forecasts look increasingly political and less grounded in reality.

There are many policies and technologies available today that can be harnessed to reduce emissions. These include phasing out coal in favor of natural gas, dramatically increasing nuclear power, carbon capture and deploying hydrogen as described above. Anybody who describes themselves as worried about climate change but doesn’t support these isn’t interested in solving the problem. Claiming the world should fully rely on solar and wind because they’re cheaper betrays an absence of thought about how we use energy.

We feel pretty good that natural gas infrastructure will continue to support a substantial part of America’s energy needs.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

The other day a NYTimes columnist contrasted the relative outperformance of oil stocks with plunging solar and wind. He concluded that the stock market is oblivious to the threat of climate change whereas the UN and other scientists believe we must reduce Greenhouse Gas (GHG) emissions to zero by 2050. The writer, Jeff Sommer, briefly contemplated who was right – the market’s apparently sunny outlook or the scientists’ dour one. He quickly concluded that the market was wrong. Well, he is a journalist. At the NYTimes.

Sommer thinks energy investors are focused on the short term and ignoring climate change. I’m an energy investor, and I think about the energy transition all the time. If you invest in this sector you have to have a perspective on how the world’s use of energy will evolve. The International Energy Agency believes the world will eliminate GHGs by 2050, but all the data points to global energy consumption increasing and emissions maybe falling by then but certainly not reaching zero. It’s the difference between what some people think should happen and what others think will likely happen.

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Energy stocks began pricing for the risk of climate change and the energy transition many years ago. The fear that crude oil reserves and natural gas pipelines would become stranded assets, abandoned well short of their useful lives, has been steadily gaining importance for at least the past decade.

The S&P Energy index, which is dominated by Exxon Mobil and Chevron who together represent 45%,  has lagged the S&P500 for seven of the past ten years and three of the past five. Along with the American Energy Independence Index (AEITR), both have underperformed the market over ten years but are approximately even over the past five. This reflected investors’ discounting the impact of the energy transition.

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In 2020 investor excitement about the prospects for renewable energy peaked. The S&P Clean Energy index (“S&P Renewables”) had a huge year but has since lost half its value. That’s because many of these companies aren’t doing that well. Orsted, one of its top ten holdings, is likely to book a $5BN+ loss on its US offshore wind business. First Solar swung to a $281MM operating loss last year on revenues of $2.6BN. Over the past five years, an investment in pipelines has outperformed renewables.

But it’s not true to suggest energy investors aren’t considering climate change. It’s foremost in the thinking of most who have exposure there, and one of the top reasons for those who avoid the sector.

This is most visible in valuations. Midstream energy infrastructure corporations yield over 6% with a Distributable Cash Flow (DCF) yield of 11%, forecast to rise to 12% next year (JPMorgan). Large MLPs yield 8% with DCF yields of 14%. These are attractive valuations by most historical standards, and they’re only available because many investors still assume fossil fuels are going away within the next decade or so.

Political soundbites matter. Just over four years ago, candidate Biden said, “I guarantee you. I guarantee you. We’re going to end fossil fuel.” He wasn’t specific about when, and in a more sober moment during February’s state of the union he conceded, “We’re still going to need oil and gas for a while.”

The market is priced for his first statement and only warily acknowledges the second.

S&P Renewables soared on the election rhetoric and has plummeted on the financial results, reflecting Ben Graham’s quote that in the short run, the market is a voting machine but in the long run it is a weighing machine.

Renewables stocks have continued falling this year, even though the 2022 mis-named Inflation Reduction Act provided huge subsidies. First Solar (FSLR), the biggest component of S&P Renewables, is down by a third since March. It trades at around 18X 2023E earnings, modestly less than the S&P500 at 19.8X, so even now hardly looks out of favor. JPMorgan rates it “Overweight” calling it a “safe haven”. They have a $220 one-year price target, which is up 50% from here, and forecast 2024 EPS at $14, up from $8 this year.

Wells Fargo rates FSLR overweight with a $215 price target. They expect EPS to double next year.

This does not look like a stock short of love from sell-side analysts.

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Often long term energy forecasts confuse aspirational with likely. This natural gas chart shows both. The IEA Net Zero is not in our future. Their Stated Policies one is plausible. Making such projections objective draws the ire of climate extremists. You have to screen out the hyperbole.

Jeff Sommer of the NYTimes is confusing recent market performance with valuations. Energy stocks, especially midstream, are cheap. They’ve been cheaper to be sure, especially during the first few months of the pandemic in 2020. But they are still priced defensively in our view.

The FSLR example shows a bullish outlook for solar panels. It’s just no longer priced as if Biden’s election rhetoric was anything more than a soundbite to pick up some gullible far-left votes.

The energy transition is clearly priced into energy stocks. What’s not priced in is the certainty of the world eliminating GHGs by 2050 (“Zero by 50”). That’s an extreme forecast, and while theoretically possible it’s becoming steadily less plausible every day. By their actions, people around the world are showing concern about emissions while stopping short of economic suicide by following the most extreme policy prescriptions.

Zero by 50 is intended to limit global warming related to human sources of GHGs to 1.5 degrees C above 1850. Temperatures today are already 1.1 degrees warmer than that benchmark. We’re living with it, not yet extinct.

Cost-effective emissions reduction looks like smart risk management of our only planet. Reducing living standards around the world with impetuous choices does not.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Targa Resources provided one of several bright spots among pipeline earnings last week with a 50% increase in their dividend planned for next year. Their cashflows are increasing strongly. JPMorgan projects a Distributable Cash Flow (DCF) yield of 14% for this year, rising to 16% in 2024 and almost 18% in 2025. The new $3 per share dividend yields 3.3%. The company also bought back $132MM in stock during 3Q. Both JPMorgan and Wells Fargo see around 25% upside over the next year.

Irrational exuberance has been missing from midstream energy infrastructure for almost a decade. 25% 12 months’ upside on a stock that’s returned 32% over the past year may remind grizzled MLP veterans of 2014, when the structurally flawed Alerian MLP ETF (AMLP) peaked. It currently trades at half its value back then, missing stocks like TRGP which long ago shed the MLP structure in search of a broader investor base. The years that energy has been out of favor have served to improve the valuations of TRGP and its peers. Leverage of 3.6X Debt:EBITDA this year is projected to decline to 3.3X next year. Along with Its dividend coverage and buybacks, TRGP reflects the lower risk profile and improved shareholder returns that continue to propel the sector higher.

Energy Transfer (ET), widely owned among financial advisors we talk to, has been repaying that faith with a 26% total return YTD. 3Q23 EBITDA beat expectations handily by 7%, and they raised full year guidance (midpoint went from $13.25BN to $13.55BN). Management is still negotiating with the US Department of Energy (DoE) over a permit extension for their Lake Charles LNG project. They reported that some potential buyers have been lobbying the DoE directly to let it go ahead. It’s unclear why the DoE won’t extend an approval they previously issued. But they should. Exporting cheap US natural gas will improve energy security for our friends and allies around the world as well as offering a cleaner substitute to coal for power generation.

Cheniere expects to be at the high-end of guidance for 2023 and more importantly now expects first LNG production from Train 1 of Corpus Christi Stage 3 by the end of next year, six months ahead of prior expectations. This creates the potential for their marketing arm to sell into an elevated spot natural gas market in 2025 before contracts start.

Other good news came from MPLX which beat EBITDA expectations, Pembina who raised full year guidance by 4%, Western Gas who repurchased another 5.1 million shares from Occidental and Enlink who spent $50MM buying back shares during 3Q23.

Oneok raised 2023 guidance and expressed optimism about identifying further synergies from their recent acquisition of Magellan Midstream. Equitrans, owner of the perennially delayed Mountain Valley Pipeline (MVP), said they expect most construction to be completed by year’s end and to be in service by January.

It was another solid quarter of earnings to soothe the purchase decisions of investors committing capital to the sector.

Your blogger spent last week traveling across the southeast US seeing clients. Stops were made in Dallas, Houston, New Orleans and Miramar Beach, FL. As always, it was thoroughly enjoyable to reconnect with old friends and make some new ones. The pipeline sector’s fundamentals have been relentlessly positive. This continues to move stock prices higher which is overpowering skepticism around traditional energy.

Houston’s Red Lion British Pub serves that quintessentially English dish – Chicken Tikka Masala. Fellow Brit Geoff Lanceley and I both enjoyed it. This Indian dish is now more popular than fish and chips in the UK.

In New Orleans I saw Keith Laterrade, a long-time investor with us who in the late 1990s played professional (English) football in England. This included one game as goalkeeper for current Premier League champions Manchester City. He progressed substantially farther than me in the world’s favorite sport, and we always compare notes on the latest results before moving on to pipelines.

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Keith suggested dinner at Bayona which is owned by his long-time client Regina Keever in the French quarter just a block from Bourbon Street. It must be New Orleans dining at its best. If you can visit, you won’t be disappointed. Keith doesn’t just manage money for clients, he supports them across a wide range of financial interests. He’s currently helping Ms Keever who, after 30 years of providing a high-end dining experience is looking to sell.

If you’re interested in buying a restaurant at the top of its game, let me know and I’ll connect you with Keith.

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Miramar Beach in Florida’s panhandle is known as the Emerald Coast because of the color of the water which beautifully offsets the white sandy beaches. Long-time client Rob Coletta suggested  Bijoux for dinner. This similarly beat expectations, just like the pipeline companies that occupied our convivial dinner together.

Throughout my meetings everyone was pleased with how the fundamentals are playing out and surprised that retail buyers have not yet warmed to the sector. Although our investor base tends to vote Republican, there is an appreciation if not gratitude towards the climate extremists whose opposition to new projects has improved free cash flow, helping create the positive circumstances for today’s investors in reliable energy. My admonition to “Hug a Climate Extremist” always draws a smile.

It’s not just tongue in cheek. By investing in natural gas infrastructure, we’re supporting the source of America’s biggest success in reducing CO2 emissions by displacing coal. By investing in LNG export terminals, we’re helping provide the same opportunity to buyers around the world. Practical solutions are the best.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

“I want to go make that happen” was twenty-one-year-old Elon Musk’s thought in 1992 on California mandating a 10% market share by 2003 for Electric Vehicles (EVs). Or rejecting a job building videogames, which he loved, because “I wanted to have more impact.” As a young man he wanted to colonize Mars to ensure human consciousness could outlive Earth and prepare for the end of fossil fuels with EVs. He’s always been a big thinker.

This becomes clear early in Walter Isaacson’s biography of Elon Musk, a gripping story that draws you to read just one more chapter (there are 95) each time you sit down with it. Those around Musk learn to live with his (self-diagnosed) Asperger’s, which makes him a harsh critic with no empathy for others. He tells those opting to remain at Twitter after three rounds of layoffs to be prepared to work “long hours at high intensity.”

Musk lives that way himself, apparently sleeping little and rarely vacationing, powering through days of problem solving with Red Bull. Somehow, he runs multiple companies that each could justify their own CEO. He demands impossible deadlines. He demands simplification in production lines and product design (“delete, delete, delete”), ignoring the warnings of engineers that his goals are impossible. Mostly, teams of employees rise to accomplish what they thought was out of reach. Sometimes they don’t, and occasionally Musk revises his opinion with new information. He instills a culture of extreme urgency, preaching that the future of humanity is at stake.

Musk embraces risk, and crises. Like many overachievers he’s never content. He’s highly analytical, yet his mood swings can trigger sharp pivots. He runs through key employees at a dizzying pace. Some burn out on the job’s demands and Musk’s mercurial temperament. Others are fired when he deems them no longer at peak productivity. There are very few who have remained, and at times he turns to close family members who are the only people he trusts. Many find it exhilarating to be around someone who is changing the world, accepting the lost family time and unpredictability as worth it.

A physically violent childhood in South Africa made Musk a fighter. His father routinely berated and belittled him. He was rarely happy and never content. He credits videogames, which he plays obsessively for a diversion during a crisis, with teaching him strategies that work in business.

An unconventional family life is part of Musk’s story. At one point he decides not to own a home, regarding possessions as unseemly for a billionaire changing the world. He enjoys good relations with nine of his ten surviving children as well as their mothers. One son transitioned to a daughter and rejects him, a source of great sadness. Odd names (one toddler is simply “X”) should surprise no-one. X is often with Musk, and learned to count backwards from ten by watching SpaceX rocket launches before he could count forward.

The acquisition of Twitter combined Musk’s restlessness and risk appetite in an impulsive gamble. As usual he threw himself into endless long days of crisis management while slashing employment by over three quarters. He slept on a couch in a conference room. Twitter the service still operates – whether it will be a financial success is less clear.

You can understand why people bet against him. Even Bill Gates shorted Tesla because he calculated there would be a surplus of EVs. His losses apparently reached $1.5BN. It’s unclear how this ultimately played out but it caused Musk to sour on Gates. “Why make money on the failure of a sustainable energy car company?” he asked.

Yet Musk routinely faces down one looming catastrophe after another. He pushes himself and others to the brink of failure, but so far has won every time. Isaacson adds up the value of the four companies Musk had founded and financed by April 2022 – Tesla ($1TN), SpaceX ($100BN), The Boring Company ($5.6BN) and Neuralink ($1BN).

Isaacson’s book presents a compelling portrait of a consequential and complex figure. Musk granted unfettered access for two years, providing rich material that is never dull. Watching Musk from afar is to see an impending train crash repeatedly averted. Somehow the world’s richest man got that way while focused on bigger goals. We should want Musk to continue pulling off miraculous victories because the changes will likely be positive.

Bill Gates said, “There is no one in our time who has done more to push the bounds of science and innovation than he has.”

There are still many more chapters in the story of Elon Musk.

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For our entire careers the US budget deficit has hung over markets like the sword of Damocles. It was a political issue in 1992 when Bill Clinton beat George Bush, a victory enabled by Ross Perot siphoning off Republican voters with his warnings of fiscal catastrophe.

Under Clinton we briefly ran a budget surplus, part of an improving trend Bush had started by reneging on his pledge to not raise taxes (“Read my lips. No new taxes”). That cost Bush the election, and as the Clinton surplus melted away so did popular concern about the deficit. Today there are no fiscal hawks, because they can’t get elected. The bull market in bonds that started in 1982 lasted almost four decades. But it’s over.

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When investors consider America’s ballooning debt, they shake their heads at the looming disaster and then forget about it as they select asset classes and securities. Few consider what it might mean for their portfolios.

In the 1970s bond investors suffered negative real returns as inflation rose faster than interest rates. Paul Volcker famously crushed inflation, but bond investors soon demanded higher real returns that briefly touched 10% as compensation for the risk of inflation’s return. Nominal and real yields steadily fell as inflation remained quiescent.

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Yields on ten year Treasury Inflation Protected Securities (TIPs) have declined more or less continuously since their first issuance in 1982. Because investors care about returns net of inflation, the decline in real returns has affected all asset classes. The drivers are complex and the subject of much academic research. Inflation uncertainty can cause investors to demand higher returns, which is why the Fed is so focused on restoring it to 2%. Broad technological advancement can improve productivity, driving realized real returns higher, as can an increased need for capital. Central bank buying of bonds, Quantitative Easing, has depressed real returns.

There’s no accepted method for forecasting what real returns will be. But it’s clear that investors want them higher.

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TIPs have provided a reasonable forecast on future returns. The third chart overlays ten year TIPs with the subsequent ten year bond return. The 1992 trailing ten year bond return was 8%. In 1982, ten year TIPs yielded 7%. The forecast reflected in this yield was within 1% of what bond buyers realized over the following decade.

It’s in this context that we should consider today’s rising TIPs yields. The downward trend is over. Real yields, which were inexplicably negative during the early stages of the pandemic in 2020, have moved up through 2% and are close to 2.5%.

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Treasury Secretary Janet Yellen believes it’s because of the strong economy. US GDP rose 4.9% in 3Q23, driven by a 4% increase in consumption expenditures. Other factors could be at work. Bonds have benefited from substantial buying by the Fed and other central banks who aren’t return oriented. The Fed is now letting its balance sheet shrink. China is reducing its exposure. Perhaps they’re worried about these assets being frozen if at some point we’re at conflict over Taiwan.

The fiscal outlook could be another consideration. As non-commercial buyers are withdrawing, the return-oriented investor is the marginal buyer. Three month t-bills at 5.5% look attractive. But are thirty year bonds at 5% offering sufficient compensation for the chart at the beginning of the blog? The Fed’s commitment to 2% inflation is only as strong as the desire in Congress to support them. Taming inflation caused by the pandemic has brought forward by two years the point at which interest expense equals 3% of GDP (from 2030 to 2028). Higher rates have a deleterious effect on our fiscal outlook, because we owe so much money.

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At some point over the life of the new thirty year bond the US Treasury will sell next month, the constraint posed by interest expense on discretionary spending is likely to become a topic of Congressional debate. The fealty to 2% inflation will be considered alongside other worthy goals.

Populism continues to promote deceptively simple solutions to today’s complicated problems in both political parties. We may endure another government shutdown as the new Republican speaker, whose views are right of his predecessor, pursues the facile and incorrect path of refusing to pay for what you said you’d pay for.

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Populists aren’t a good credit risk.

Naturally a blog on midstream energy infrastructure will express the belief that it offers protection from the reckoning of decades of fiscal incontinence. Meaningful cash returns now will be preferable to the delayed gratification of future growth when the purchasing power of those deferred cash flows is uncertain.

Rising TIPs yields may just reflect the dawning realization of what investors already know – that our fiscal future is unlikely to be pain-free.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Financial advisors need no reminding that performance this year has been heavily influenced by how much you invested in the Magnificent Seven (Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia and Tesla). Not only have the remaining 493 stocks substantially lagged the S&P500, but the MSCI All-Country World index of nearly 3,000 companies would be down this year if not for the seven.

In other words, it’s been hard to beat the S&P500. And yet, midstream energy infrastructure continues to close in on a third successive calendar year of outperformance.

The American Energy Independence Index (AEITR) has its high flyers too. Magellan Midstream was up 45% YTD until it stopped trading following its acquisition by Oneok. We were not happy with the deal (see Oneok Does A Deal Nobody Needs). Nonetheless, we’ll grudgingly accept the profit while remaining dismayed at the recapture of deferred taxes that the transaction creates.

Equitrans (ETRN) is +43% YTD thanks to Joe Manchin insisting on the Mountain Valley Pipeline’s (MVP) inclusion in the recent legislation to raise the debt ceiling. MVP’s completion suffered another delay last week when ETRN disclosed challenges hiring workers to finish the job. It turns out that the constant risk a judge will issue a construction halt in response to one more challenge from an environmental extremist makes those jobs less appealing.

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Plains All American (PAGP) is +37%. The M&A activity in energy hasn’t hurt. Exxon’s acquisition of Pioneer (see Exxon Buys More Of What The World Wants) is estimated to increase crude production out of the Permian by 350 thousand barrels per day over the next four years, which is good if, like PAGP, you own and operate crude pipelines there. Chevron’s deal with Hess is another example of capital being allocated on the premise that oil has a bright future ahead of it.

The International Energy Agency expects global crude oil demand to flatten out within the next five years before declining (see The Super Cycle Or Peak Oil?). That’s clearly not what Exxon or Chevron expect. The WSJ cheekily suggested that weakness in electric vehicle sales suggests they could peak first, before crude oil consumption (see Chevron Bets on Peak Green Energy).

Energy Transfer (ET) is +24% YTD. With a 17% 2024E Distributable Cash Flow yield (according to JPMorgan) and 7.1X Enterprise Value/EBITDA, it is the cheapest large business in the sector. It always is. ET is the most commonly owned pipeline name when we talk with financial advisors who pick individual stocks. Years ago management cemented their reputation for abusing their investors when they issued dilutive and very attractive convertible preferreds to management (see Energy Transfer: Cutting Your Payout, Not Mine from 2018 and Is Energy Transfer Quietly Fleecing its Investors? from 2016).

ET’s issuance of these offending securities led to a class action suit in Delaware which the company won. Even though they enjoyed a victory in court, they still didn’t do the right thing. Ever since, the stock has traded at what we’ll call a “Kelcy discount” (Kelcy Warren is Executive Chairman and former CEO) to its peers.

But ET knows how to run a business. Their casual relationship with fiduciary responsibility hides behind well-honed commercial instincts. When Texas suffered widespread power outages during Winter storm Uri in 2021, ET enjoyed $2.4BN in windfall gains by providing natural gas to a market that was short (see Why The Energy Transition Is Hard).  Many financial advisors are drawing some satisfaction that this long-time holding is finally rewarding their faith.

The midstream energy infrastructure sector may not have the Magnificent Seven leading the market higher. But we have these Fab Four that have all handily beaten the averages. Since we’re down to three, Enterprise Products Partners (+20% YTD) can take Magellan’s place.

The laggards this year are the Canadians. TC Energy (TRP, -10%), Enbridge (ENB, -13%) and Pembina (-11%) share the stability of utilities, a quality investors don’t value with rising rates. Their Canadian Presbyterian conservatism is being challenged. ENB is leaning against the trend in buying three utility businesses (see a comment on this in Fiscal Policy Moves Center Stage). ENB and TRP are both projected to have leverage above 5X Debt:EBITDA through the end of 2025, meaningfully higher than the 3.0-3.5X that prevails among their investment grade peers. TRP has the more pressing need to shed assets to fund their capex program, but both companies are comfortable that their debt levels are manageable.

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Here I’ll switch to briefly indulge in a personal anecdote. My wife and I recently met John Cleese after watching him on stage. Americans are most familiar with Cleese through Monty Python but Fawlty Towers is among the greatest comedies of all time. Cleese plays Basil Fawlty, the irascible hotel owner constantly berating the guests whose presence is often an inconvenience or worse. Quotes from these twelve episodes have featured in our family discourse for decades. Since Cleese has been an enduring source of laughter for us, it was my great pleasure to tell him personally. True to form, he was charming and then told us to “buzz off” as there were others waiting to shake his hand.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

It’s always interesting to learn how financial advisers use our energy infrastructure investments in their portfolios. Often, it’s for income, because the 6-7% yields are well covered by cash flow, growing and supported by continued reluctance to boost growth capex. America has the pipeline network we need. New construction gets held up by court challenges from climate protesters, with the delays increasing costs. Equitrans with their Mountain Valley Pipeline project is an example. They announced a further delay because hiring is hard. Their recent 8K SEC filing noted, “multiple crews electing not to work on the project based on the history of court-related construction stops when there’s the risk of another court order stopping work.”

Canada’s federal government probably owns the record for cost over-runs, with a 4X increase since they acquired the TransMountain expansion from Kinder Morgan five years ago (see Governments And Their Energy Policies). Developments like these are dissuading growth projects, which is why pipeline sector dividends are growing. A dollar not spent on capex is a dollar coming back to shareholders, through a dividend hike or stock buyback. It’s hard not to love climate extremists.

Because of the prospect of rising payouts and buybacks, we think pipelines offer income with growth. Who says you can’t have both?

Some financial advisors like energy because it’s relatively uncorrelated with other sectors. We think this makes a lot of sense (watch Will Geopolitical Risk Effect the Energy Market?).

I was with one such investor last week who uses midstream energy as a hedge against more conventional equity exposure. He’s very happy with the results, and his business is growing strongly because of this and doubtless many other good calls for his clients.

The American Energy Independence Index (AEITR) handily beat the S&P500 for the past two years. Pipeline companies are not popularly linked with AI so have lagged the market this year. However, the gap has begun to close as Israel has responded to the shocking terrorist attack by Hamas, ratcheting up tensions across the region.

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By mid-July the S&P500 was 13% ahead of the AEITR. As of Friday the gap had shrunk to 2.6%. Dividends help – the S&P500’s dividend yield is a paltry 1.6%, less than a quarter of what pipelines pay. Enbridge (ENB) yields over 8.1%. Its C$3.55 dividend has grown annually for 28 years, a record management has pledged to continue. It represents an extreme case of the contrast between energy infrastructure and the overall market. ENB still looks like a good pairs trade with a short S&P500 position. Notwithstanding your blogger’s substantial overweight to the sector, I recently put that trade on too.

Stocks had a bad week. But they still don’t look that cheap. Six months ago (see Inflation vs Regional Bank Crisis) valuations were just average compared with the past couple of decades. Since then, the S&P500 has risen 4%, 2023 forecast earnings are flat and declining, and the ten year note has risen 1.5%.

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Today’s Equity Risk Premium (ERP) of 0.3 is the lowest in two decades. Even using 2024E EPS, at 0.9 it’s still unattractive. Moreover, earnings forecasts have been declining in recent weeks, with few upward revisions likely other than for the defense sector.

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We’ve also included the ERP for the NASDAQ 100. This is an unconventional way to evaluate the tech sector, and your blogger long ago concluded that he felt more comfortable with value stocks. Over the years I have carefully avoided expensive investments with high growth rates, and such omissions have not always been to my advantage.

Nonetheless, it’s hard to resist publishing the Tech sector ERP chart. Rising bond yields are doubly bad here, because as well as offering a relatively stable return they mean a higher discount rate/lower NPV on those far bigger, far away profits.

Tech stocks lost three quarters of their value during the dot.com collapse. Even during the 2008 great financial crisis they were down by half. Today’s ERP for the sector is around the same level.

This blog doesn’t promise to get you into tech stocks at the low. But they don’t look cheap.

Electric vehicle (EV) sales are flattening out. Everyone I know who owns a Tesla loves it, but also has another car for long drives. But my circle of friends is not representative of America. A journalist on the NYTimes Climate desk recently reported on an EV trip he made in South Dakota that ended with his Volvo C40 being towed because it ran out of juice.

We still worry about our phone batteries going dead.

EVs seem like fun, but compared with much of the world, in the US we (1) drive farther, (2) drive bigger cars, and (3) enjoy relatively cheap gasoline. EV penetration looks as if it’ll be slower than many fans expect.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

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