SL Advisors Talks Markets

The Transatlantic Energy Trade

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For years the center of gravity for global LNG trade was in Asia. China, India, Japan and South Korea were routinely over 60% of global LNG imports. Asia-Pacific was often over 70%, reaching a high of 75% in 2018. Australia and Qatar were geographically better suited than the US to meet this demand, and our exports were in any case inconsequential until 2017.

Two events of great geopolitical importance followed. The US rapidly grew its LNG exports and is now the world’s #1. Meanwhile Germany’s energy strategy, built on fantasy rather than realpolitik, collapsed. Today Europe is 31% of global LNG trade, a share that has doubled over the past seven years.

Western Europe has adopted policies more oriented to reducing Greenhouse Gas (GHGs) emissions than any other region. Over the past decade, CO2 emissions from fossil fuels declined at a 2.2% annual rate, almost twice the 1.2% rate of the US. Recently they’ve been rather too successful: 2023 was –6.2% versus 2022, but it’s mostly because the high energy prices caused by climate policies have caused GDP growth to slump. The German economy is headed for a second straight year of no expansion in 2025.

Six years ago President Trump famously criticized German leaders for relying on Russian gas imports via the Nordstream pipeline while US troops were stationed in Germany protecting them from Russia. Trump often causes conventional political leaders to squirm with his outspoken attacks, but it’s a pity past presidents hadn’t been so forthright. Germany’s reliance on Russia collapsed spectacularly following the invasion of Ukraine.

Europe relies on renewables for 15% of its primary energy, more than double the rest of the world which is at 7%. It’s an unappealing example to follow given their moribund economies.

In negotiating long term LNG import agreements, European policymakers have clung to the notion that their energy systems will be free of hydrocarbons. So they’ve often balked at the 20+ year deals LNG exporters need to justify their fixed investments in liquefaction terminals.

Meanwhile, incoming President Trump who is our de facto president already, just said,”I told the European Union that they must make up their tremendous deficit with the United States by the large scale purchase of our oil and gas. Otherwise, it is TARIFFS all the way!!!”

This followed the US Department of Energy’s (DoE) report on the advisability of increased US LNG exports, which it warned would raise domestic prices by 30% over 25 years. It’s a ridiculous forecast, because with natural gas at $3 per Million BTUs versus $12 in Europe and Asia, a $1 increase is inconsequential and a 25 year price forecast is useless. We waited 11 months since the permit pause in January for a weak political document that is the parting gift of Energy Secretary Jennifer Granholm.

There are reports that she sought to ban LNG exports entirely. The only plausible explanation is that she’s taking a stand that will cheer left wing progressives when she runs for public office* again one day. It’s similar to NJ governor Phil Murphy and his pursuit of offshore wind that is widely opposed by the NJ residents who live on the Atlantic coast where the turbines will be situated.

For America, Jennifer Granholm’s retirement can’t come quickly enough.

Some have speculated that opponents of increased US LNG exports could rely on the DoE to persuade the courts to block increased exports.  It’s more likely that incoming DoE head Chris Wright will correctly consign the report to the dustbin and focus on what’s in our national interest.

It’s hard to think of a set of circumstances more likely to favor the energy sector at the expense of others. The US is threatening most of our trade partners with tariffs unless they (1) impede illegal immigrants entering from their country, which applies to Canada and Mexico, or (2) buy more American goods, which for the incoming administration means US oil and gas.

According to the US Bureau of Economic Analysis, shipments of crude oil, natural gas liquids, natural gas, fuel oil and other petroleum products were $262BN for the year through October, 15% of all our exports. Pharmaceutical preparations ($90BN) is the next biggest category, followed by civilian aircraft and engines ($80BN).

Europe wants to avoid tariffs and is pursuing green policies that are impeding their economy. At the same time they are reliant on US natural gas, and we have a president who wants them to buy more, which will provide them with reliable, secure energy and maybe even arrest Germany’s industrial decline.

It looks like a good time to be invested in US energy.

*An earlier version of this blog post suggested Jennifer Granholm might decide to run for US president one day. Thank you to a regular and diligent reader who noted that as a Canadian citizen she is ineligible.

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

SL Advisors Talks Markets

Measuring The Midstream Mood

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Last week my partner Henry Hoffman attended the 23^rd Annual Midstream, Energy, and Utilities Symposium, held by Wells Fargo. The mood was understandably upbeat, underpinned by strong fundamentals and the more coherent regulatory framework expected following the election.

Given our focus on natural gas, we were naturally interested in this element of the energy story. Data centers in support of AI are driving power demand sharply higher. Randy Fowler, CEO of Enterprise Products Partners, noted that ERCOT which runs the Texas electricity grid is forecasting 150GW of power demand by 2030, up from 85GW currently. We heard other reports that demand may even double by then.

Grid expansions of this magnitude typically take several years. Therefore, it seems unlikely existing infrastructure will be able to meet the increased demand from data centers, which will lead to “behind the meter” solutions whereby a data center builds its own power source or buys it directly from a provider without going through the grid. The several announcements involving nuclear power contemplate this. However, the widely reported Microsoft deal to restart a reactor at Three Mile Island has run into problems with FERC as this power supply wouldn’t be totally separate from the grid.

Cheniere is planning to take advantage of the more co-operative regulatory environment to “permit it all”, which in their case could bring their total permitted LNG capacity to 90 Million Tons per Annum (MTPA), around 12 Billion Cubic Feet per Day (BCF/D). This would give Cheniere alone more export capacity than any other country. Cheniere’s CFO Zach Davis expects the global LNG market to grow from 400 MTPA to 600 MTPA by the early 2030s. He also noted 1,200 MTPA of global regassification capacity, indicative of robust demand.

Anticipation of an improved regulatory environment has pushed midstream stocks higher since the election. Some of this can be achieved by the new administration through executive actions, but building any type of US infrastructure nowadays is too often tied up in legal challenges. Climate extremists have learned how to use the courts to slow hydrocarbon projects but just about anything can suffer interminable delays. Williams Companies’ (WMB) general counsel highlighted four areas that require attention:

• Limiting challenges to approved permits.
• Reducing state-level authority to block projects based on technicalities.
• Streamlining water-crossing permits under FERC jurisdiction.
• Imposing stricter time limits on federal reviews.

A bipartisan effort to pass legislation reforming permitting was moving forward until the election. Some attendees felt the political winds were shifting. WMB reported more frequent discussions with members of Congress. A handful of Democratic governors have suggested that shifting more oversight of infrastructure to the Federal level could ease political pressure they sometimes face.

NextDecade, a company we’ve followed closely as they’ve moved forward with their plans to build the Rio Grande LNG export terminal in Brownsville, TX, expressed confidence that robust demand would support adding further capacity beyond their Stage One project. They also expect any outstanding permit issues to be resolved by November next year.

There’s very little evidence that the animal spirits of 2016 will offer a reprise of “drill baby, drill” with its subsequent poor investment returns. Most management teams were singing the same tune, which is to maintain strong balance sheets, prioritize accretive investment opportunities and focus on growing free cash flow per share.

Kinetik’s CEO Jamie Welch was more bullish, saying, “On January 21st, don’t be surprised if animal spirits take over.”

In other news, we recently made a small investment in New Fortress Energy (NFE) across our portfolios. NFE provides natural gas using floating terminals called “Fast Liquefied Natural Gas’ or FLNG. Accessing offshore reserves speeds delivery to customers, a significant advantage given the 3-5 years it typically takes to build an onshore LNG export terminal. The company has endured some cost over-runs and recently raised additional equity which enabled them to refinance their debt. It’s currently a small position but we think it’s attractively priced at current levels.

My wife recently retired as a pre-school teacher at our local church. She didn’t do it for the money, which is fortunate because their compensation structure might kindly be described as parsimonious. But she did receive a form of payment which is priceless, in the form of hand-drawn cards from five year old students saying I love you, a reward rare in investment management as I often noted.

However, several years of strong performance in midstream has stimulated warm feelings among countless clients, and I have felt the love this year as I’ve met with and corresponded with many of you. The 2020 pandemic was a miserable period in so many ways. But there were sparkling rewards for those who retained their conviction.

One investor cited a tripling of the value of his investment (excluding dividends) which yields over 14% from his original cost. He called it, “a good result for sticking with things when your hands are bloody from the pain.”

Another long-time investor called me and read off similarly rewarding figures from client accounts.

We appreciate the continued support of so many investors, who are overwhelmingly long term and not just in for a quick trade. Some have been with us since the firm’s founding in 2009. We never forget that you’re the reason we are in this business.

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

SL Advisors Talks Markets

Lemming Leadership

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Sometimes this blogger stumbles across a phrase that begs to be used as the title for a blog post. Who better to be the subject of this one than the far-left climate extremists whose policies have led to higher energy prices, deindustrialization and job losses.

Start with Germany. Ryanair’s CEO Michael O’Leary recently described Germany as being run by “a government of idiots” because they followed the “stupid solutions” pushed by the Green Party. No doubt O’Leary’s perspective is the narrow one of the airline executive. He criticizes airport fees of over €50 per passenger which he believes will relegate Berlin to “a regional airport at best.”

Germany imposes some of the highest aviation taxes in Europe, partly to curb CO2 emissions. Lufthansa CEO Carsten Spohr agrees with O’Leary, commenting that, “More and more airlines are avoiding German airports or canceling important connections.”

More broadly, Europe’s energy policies are driving de-industrialization. The auto sector represents 7% of EU GDP, far higher than in the US. They’re having to build EVs the market doesn’t want using energy that’s priced too high. No wonder Volkswagen is planning factory closures, lay-offs and pay cuts.

Angela Merkel, German chancellor 2005-21, bares as much responsibility as anyone for these failures. She led the country to depend heavily on Russian natural gas and endorsed Green policies including shutting all their nuclear plants and diving headlong into windpower.

Appeasement of Russia following its 2014 annexation of Crimea led to the 2022 invasion and Germany’s current scramble to reinvigorate its military following decades of dependence on the US for defense.

But such poor leadership isn’t only across the Atlantic. Angela Merkel has her fans among the Democrat establishment in the US.

Five years ago Harvard awarded her an honorary degree, citing, “shrewd resolve and pragmatism” and sensible policies including the nuclear phaseout. She’s on a book tour and was recently feted by Barack Obama at an event in Washington, DC.

Merkel endorsed Kamala Harris for president, which for voters aware of Germany’s penchant for economic self-harm likely cemented the Democrat as too liberal.

Last month’s election sent a clear message against progressives on a range of issues including energy policy. America’s big enough to accommodate varying approaches to energy, so we can see which states are managing climate change without widespread collateral damage.

Texas is the biggest user of windpower and second in solar. Sunny Florida is third in solar. Both states are adding jobs, people and investment because they provide cheap, reliable energy in a regulatory environment that promotes new business formation.

California is #1 in solar and has expensive electricity provided on a creaky grid. Diablo Canyon, a nuclear power plant, was almost shut down prematurely due to pressure from environmental extremists.

German voters have been led lemming-like over the cliff into energy purgatory and economic malaise. American energy policies have generally been enlightened with a few exceptions such as liberal Massachusetts which imports LNG because it won’t allow gas pipeline infrastructure linking it to the Marcellus shale in Pennsylvania, and New York which forbids new natural gas hook-ups.

The Sierra Club and its peers have been an irritant but largely inconsequential, which is why the US economy continues to do so well.

Fund flows into the MLP sector have been negative for years. From 2018-23 there were five years of outflows. For much of this year the pattern continued. Meanwhile equity funds have seen almost $140BN in inflows since the election as investors assessed the market’s prospects with generally less regulation.

My friends in Naples may not be fully representative of the overall electorate (ie wealthy, white, older and male). But they’re certainly cheered by the election and consequent market reaction.

Energy including midstream is a clearer election beneficiary than any other sector. In November MLP funds saw their strongest monthly inflows in almost eight years. 2024 is suddenly on track to be the best year since 2017. We do a lot of calls with clients and for that reason generally gain assets. But there’s still no FOMO, no irrational exuberance, at least among the new investors we talk to.

Wells Fargo noted that midstream’s correlation with crude oil prices has weakened significantly to 0.23 this year versus 0.53 over the past five years. During periods of market weakness this has been a common topic for clients wondering why their toll-model investments are moving lower with oil prices.

AI data center demand for natural gas has been an important driver of recent performance, but with leverage averaging around 3.3X Debt:EBITDA, pipeline businesses are just less risky than in the past. We think the low correlation with commodity prices will persist.

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

SL Advisors Talks Markets

November Was A Great Year

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Like millions of families across America, on Thanksgiving we gave thanks for being with friends and family, along with “…sunny days and that we’re all together.” I added a silent appreciation that left-wing climate extremists were resoundingly defeated on November 5th.

The market’s realization that the election had ushered in sensible, pro-American energy policies took the American Energy Independence Index +15% for the month, a return that in different circumstances would be satisfactory over a full year. The YTD performance is +52% the best of four consecutive up years.

President-elect Trump seems to be in the Oval Office already. His pronouncements from Mar-a-Lago on tariffs, illegal immigration and drugs carry more weight and press coverage than anything emanating from the White House.

In preparation for transactional foreign policy, Mexican President Claudia Sheinbaum asserted that migrant caravans are no longer reaching the US-Mexico border. Why is that only happening now?

European Central Bank chief Christine Lagarde has said the EU should embrace a “checkbook strategy” and increase imports of US LNG and defence equipment. They sorely need both. Seeing the fast response of foreign leaders to the election simply highlights how weakly the current Administration has promoted US interests.

It’s likely Europeans will be buyers of LNG next year anyway. Northwest Europe has endured colder than normal weather recently, and North Sea windspeeds have been inconveniently low. As a result, storage withdrawals have been higher than usual, although overall levels remain ample.

European natural gas futures markets reflect increased European demand. Buying more US LNG should be an easy way for the EU to deflect Trump’s promised tariffs.

UK power generation has relied on natural gas more than usual over the past month, given the calm, cold weather. The prospects for the cleanest hydrocarbon are diverging markedly from the outlook for crude oil, where its role in transportation is changing. The International Energy Agency (IEA) is little more than a renewables cheerleader and has long forecast an imminent peak in oil demand.

Greg Ebel, CEO of Enbridge, argues that we’re going through an energy transformation, not transition. On a podcast series called Energized: The Future of Energy he classifies the 19^th century as being about coal, the 20^th about crude oil and the 21^st about natural gas. North America’s biggest pipeline operator rejects climate orthodoxy that all hydrocarbons are going away, arguing instead that natural gas is a vital partner to increased reliance on intermittent solar and wind.

The UK is a case in point. Although windpower is on average their biggest source of electricity, roughly half the time natural gas provides the most.

Meanwhile China’s growing EV market is likely to dampen one source of demand growth for crude oil.  They recently reached a milestone in that half of new auto sales now run on batteries. This often fools people into thinking that China is making substantial progress in decarbonizing their economy, ignoring that their EVs, like China itself, run principally on coal. They’re regressing towards a 19^th century fuel because energy security is what drives policy in Beijing.

China’s energy deficit needs to close before they can take a more confrontational approach over Taiwan. It’s still some years away. Friends of mine with a military background, and therefore better placed to have an opinion, say their military isn’t yet ready.

But China’s heading in that direction, building up their military capability while reducing their dependence on imported energy. Increased power generation from coal and renewables helps because they’re both sourced domestically. This is why the Chinese government has pushed EV adoption.

Nonetheless, moderating crude imports from the biggest driver of demand growth is likely to weigh on prices and global consumption.

Although “drill baby, drill” is widely expected to have a limited impact on E&P behavior, some increased production is likely at the margin as the new administration opens up more public land for drilling. 90% of oil and gas production is on private land and so not much impacted by the White House. However, an improved regulatory environment will encourage some increase.

Barron’s recently wrote about the impact of AI on oil drilling in the Permian, where it’s lowering break evens and driving energy sector productivity higher than any other industry, delivering 60% more oil a day with 40% fewer workers over the past decade. This is bearish for oil prices although not for industry profits.

If we do see lower crude prices it will stimulate demand, delaying any potential peak in oil consumption.

Whichever way crude moves, midstream investors are unlikely to care. The sector has shown little connection with oil prices this year and there’s every reason to think that will continue to be the case.

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

SL Advisors Talks Markets

Pipelines Are Cheap; Stocks Are Not

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Market strategists often point out that valuations aren’t a good timing tool, but it’s still worth staying on top of whether the market is cheap or not. Stocks were having a good year leading into the election, and the Republican sweep took the market another leg higher. Residents of Naples, FL, our winter home, are politically right of center with a demeanor that is unfailingly cheerful, for good reason because it’s a beautiful place.

So, my friends at the golf club are nowadays exhibiting even more good cheer than normal, with happiness from the election and with their portfolios easily offsetting the clean-up cost of two recent hurricanes. My hope is that their sunny disposition continues indefinitely because they’re so much fun to be around. But I’m also watching the Equity Risk Premium (ERP).

With both the S&P500 and bond yields rising at the same time, valuation was never going to be compelling. What’s striking is that the ERP (defined here as the yield spread between  S&P500 earnings and the ten-year treasury) is the least attractive in at least twenty years. This blog has noted that stocks aren’t that cheap to bonds for at least the past year, which is why we don’t employ a market-timing overlay across any of our portfolios.

The Cyclically Adjusted Price Earnings (CAPE) model popularized by Robert Shiller also shows stocks to be expensive. This has been true for several years, demonstrating the weakness in valuation as a timing tool. Nonetheless, CAPE has a good record in predicting future ten year returns from stocks, as shown in this article from 2020. Since then the market’s continued strong returns have discredited the analysis somewhat, but a tool with a robust history going back 80 years or so is still worth considering.

Markets can remain expensive for a long time. Factset is forecasting earnings growth of 15% next year which would be the best since 2021 when profits rebounded from the pandemic. The current optimism is well founded. But it’s hard to make a case for declining bond yields given the outlook for the deficit, tariffs and deported illegal immigrants.

By contrast, midstream energy infrastructure remains cheap, and to this blogger offers a good chance of continuing to outperform the broader market as it has done for the past five years. A recent Bloomberg article noted that labor productivity in oil and gas extraction has improved faster than any other sector over the past decade. Continued innovation in shale has led to increasing output per well and fewer rigs employed while production continues to reach new highs.

Finally, some notes from my partner Henry Hoffman who attended the TD Energy Conference in New York last week:

The conference featured an insightful discussion between John Miller of Washington Research Group and Dustin Meyer, who oversees Policy and Regulatory Affairs at the American Petroleum Institute.

A key point of discussion was the impact of energy policy on recent elections. Meyer noted that while the primary concerns were immigration and inflation, he attributed part of the inflation issues to the Biden Administration’s climate initiatives. He criticized the increased regulatory burdens and climate mandates, highlighting their contribution to rising costs and inefficiencies.

Meyer expressed concern that industry professionals are unclear about compliance expectations under the current EPA, describing the administration’s approach as disjointed with extensive, yet unclear, directives. He also touched on the Inflation Reduction Act, labeling it as a partisan effort that indiscriminately funnels funds into various clean energy projects without a clear strategy. Meyer mentioned a division within the Republican Party over whether to repeal the act or retain elements that are gaining GOP support, such as the tax credit for carbon capture, known as 45Q.

On the topic of U.S. LNG, a representative from Cheniere’s Investor Relations conveyed optimism about the growth prospects for U.S. LNG. He underscored Cheniere’s significant role, accounting for half of the U.S.’s LNG 15bcf/d of exports, equivalent to two LNG tankers daily from their facilities alone. He highlighted Cheniere’s consumption of 7-8% of all U.S. natural gas and affirmed the company’s capability to continue expansion at their target of 7x EBITDA build multiple. He anticipated that the halts on issuing non-FTA licenses by the DOE would be quickly reversed under a new Trump administration.

In a separate session, NextDecade’s CFO, Brent Wahl, shared optimism about U.S. LNG export growth.  Specific to RGLNG, he expects no hurdles from FERC for a SEIS by next year and hopeful for a reversal of the DCCCA’s 3-judge panel’s vacatur sooner. Wahl also noted strong support from stakeholders for continuing with Train 4 once permitting challenges are addressed.

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