MLP Yields Look Better Than Cash

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MLP Yields Look Better Than Cash
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Your blogger is routinely critical of the Alerian MLP ETF (AMLP) — for good reason, as its narrow universe and tax-paying structure offer ample points of weakness. They’ve even struggled to calculate taxes owed, which resulted in two downward NAV adjustments in 2022-23 (see AMLP Fails Its Investors Again).

At times I’ve even been critical of MLPs, wondering if the tax deferral on distributions adequately compensates for the complexity of a tax return with multiple K-1s.

I’ve suggested that few MLP holders can even state with confidence how much that tax deferral saves them. At such times my good friend and tax expert Elliot Miller intervenes, usually through a comment on this blog, to assure that MLPs are truly worth the trouble.

But only those with a pathological aversion to reliable income can ignore the MLP yields on offer today. Midstream earnings for both MLPs and corporations have as usual offered few surprises while generally confirming the positive outlook. As this blog noted recently (see Debt Monetization And Pipelines), if these companies were private, we’d conclude that operating performance was satisfactory and that would be the end of the matter.

However, public market prices have been interposing a lugubrious overlay on an otherwise agreeable situation.

MLP yields are approaching levels that demand justification for holding cash, where returns remain adequate but perhaps not for much longer.

Start with Energy Transfer (ET), yielding 8.1% and with a Distributable Cash Flow (DCF) yield twice as high. Some mutter about Kelcy Warren putting his own interests ahead of unitholders, as he did nine years ago (see Will Energy Transfer Act with Integrity?).

Although ET won the subsequent Delaware lawsuit, the stock’s persistent cheapness since then shows that their reputation as fiduciaries has not been restored. Nonetheless, 2016 is a long time ago. Today ET is led by co-CEOs who regularly demonstrate their skill at running the business.

MPLX reported earnings that were in-line. Its payout is up 12.5% year-on-year, yields 8.5%, and has a 2026 DCF yield of 11.5%. They raised their full year guidance.

Hess Midstream’s payout is +10.3% yoy and yields 9%.

Enterprise Products Partners’ payout is +4% yoy and yields 7.4%.

It’s not just the MLPs that have attractive yields. Pipeline corporations do as well. Oneok yields 6.6% and has raised its payout 4.4% over the past year. Kinder Morgan, a persistently poor allocator of capital but well positioned for the needs of data centers for gas-generated power, yields 4.6%.

Cheniere spent $1BN repurchasing stock during 3Q25 and a further $300MM in October.

The reason operating performance is good for midstream companies is because volumes are growing. Both oil and gas production hit new records this year, with 13.8 Million Barrels per Day of crude output and 109 Billion Cubic Feet per Day of gas output as of August. Once the indefensible government shutdown is over we’ll get more recent data.

In brief, this is a good environment for midstream companies.

However, the consequent pressure on oil prices has weighed on energy sentiment. By contrast, US gas prices are already so low that the increased production has not hurt. Moreover, it’s come in time to provide more feedstock to our growing LNG export capacity.

Global crude prices drive sentiment more than regional gas prices. Oil-focused Oneok is –34% YTD. The synergies from their acquisition of Magellan Midstream look likely to reach $700MM, which is pretty good for a merger few analysts, us included, were happy about. Weak oil is making energy investors miserable.

The knock-on effect on midstream is at odds with their operating results. If anything, increased volumes should be creating investor enthusiasm. That it’s not is creating an opportunity for those looking beyond the next hot AI trade.

Cash provides the option to do something when prices are attractive. Your blogger’s investments are overweight towards pipelines and t-bills with very little else. But the case for less cash and more dividend-paying securities is gaining strength as the Fed does Trump’s bidding by reducing short term rates.

The futures market is priced for a 3% Fed Funds rate in a year’s time. The need for investment income will be no less urgent by then. Buying these high yielding securities now means in our opinion you’ll beat the rush that is assuredly coming in the months ahead.

It’s happened before. The Fed’s rock-bottom rates coming out of the pandemic were a cause of inflows into midstream. Compelling valuations helped. Several years of strong returns followed. Many of our investors were initially drawn to midstream because of the stable income.

The market is setting up for a repeat performance.

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

Energy Mutual Fund Energy ETF

 

Debt Monetization And Pipelines

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Debt Monetization And Pipelines
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I just finished reading Andrew Ross Sorkin’s new book 1929, which relies on a lot of previously unpublished material to tell the story of the Great Crash through some of the protagonists. For those who enjoy economic history or even a good story, this will not disappoint.

Benjamin Strong ran the Federal Reserve until his untimely death in 1928, and some historians think the collapse of the stock market’s speculative bubble might have been better handled had Strong been around.

During the 2008-09 Great Financial Crisis (GFC) we benefited from insightful financial leadership from Hank Paulson at Treasury, Tim Geitner at the New York Fed and then Fed chair Ben Bernanke, as Ross Sorkin chronicled in Too Big To Fail.

Bernanke used the Fed’s balance sheet to great effect, initiating Quantitative Easing (QE) under which the Fed bought far more treasury securities than it needed to conduct monetary policy, with the goal of forcing long term rates down. Many thought this would be inflationary, but QE turned out to be a vital tool to compensate for a near-paralyzed financial system.

QE should have been a one-off measure, reversed via Quantitative Tightening (QT). But somehow the time has never been quite right for the Fed to exit the long term bond market.

It took the Fed until 2017 to start to unwind the original QE, and that was soon derailed by the pandemic, which took their balance sheet to $9TN by April 2022. It was then allowed to decline until last week when Chair Jay Powell announced an end to QT. He said, “At a certain point, you’ll want . . . reserves to start gradually growing to keep up with the size of the banking system and the size of the economy,”

The Fed’s current holdings are six times bigger than in 2008 while the economy is twice as big.

A permanent holding in excess of what’s needed for monetary policy is simply debt monetization. On this basis, the Fed has monetized at least $4TN of our $36TN outstanding and plans to do more. It is a monetary narcotic, a habit we can’t kick.

The next financial crisis will take it higher still. All the political pressure is aimed at keeping rates low and risking price stability. 3% inflation remains more likely than 2%. Midstream energy infrastructure with its PPI-linked contracts offers some protection in our opinion.

Midstream energy has been a passive bystander to the AI-fueled excitement of the S&P500.

If they were private companies not subject to constant revaluation, as investors we’d feel the macro outlook remains positive and operating performance has been good.

But we’re burdened with a public opinion of that view on a continuous basis, and this year’s mood does not match last year’s. Oil-linked names such as Oneok (OKE) have sagged with oil prices, even though domestic crude oil production reached a record 13.8 million barrels per day in August – we’ll have more recent data once the Federal government re-opens. Exxon and Chevron both increased output in 3Q25.

OKE’s 2024/2025 YTD performance is +48%/-31% respectively.

Targa Resources has built a vertically integrated business for hydrocarbons that allows multiple opportunities to touch a molecule. Its 2024/25 performance is +111%/-12%.

Energy Transfer (ET), perennially cheap in part because it’s an MLP but well positioned to profit from the build out of data centers in Texas, is +53%/-10%.

Cheniere Energy (LNG), our leading exporter of natural gas, continues to expand its capacity under budget and ahead of schedule. Many analysts are warning that global LNG export capacity will flood the market, depressing prices and volumes. Oddly though, the futures market is more sanguine than the more dire forecasts weighing on the sector.

Moreover, Cheniere operates with 95% of its capacity pre-sold through 2035, giving it unparalleled cash flow visibility. In 3Q they repurchased $1BN of stock. Its performance is +28%/-1%.

NextDecade (NEXT) reached final investment decision on Trains 4 and 5 with much better economics than on the first three and has plans for further expansion. Its story improved. Its performance is +54%/-25%.

Maybe these stocks and others outran their positive fundamentals last year. Their outlook and operating performance have only improved. Or perhaps it’s a growth year, and AI exposure is where investors want to be.

In any event, long term investors in the sector, which very much includes your blogger, are enjoying 5% yields with growth, strong balance sheets and inflation-linked pricing power on pipeline fees. Our president is a fan of energy exports and easy money. Pipelines offer the opportunity to compensate for fiscal profligacy. It’s the place to be.

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

Energy Mutual Fund Energy ETF

 

Inflation Protection From Pipelines

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The link between inflation and fee increases for liquids pipelines doesn’t draw much attention, but it proved to be valuable to midstream investors three years ago when the Biden administration’s excessive stimulus drove the Producer Price Index (PPI) up 13%.

Maintaining purchasing power is the goal of most long-term investors. Inflation is reasonably close to the Fed’s target, but our dire fiscal outlook is well known. The White House is likely to maintain pressure for low rates for the remainder of Trump’s term in office, and through relentless criticism plus the choice of co-operative FOMC appointments when given the opportunity, he’ll probably get his way.

Last week the WSJ reminded us that during and after World War II, the Fed co-operated with the Treasury in maintaining low rates while “…inflation rose into the teens” (see How Federal Reserve Interest Rates Could Get Stuck on the Floor).

We’re heading into a period of political constraints on the Fed to raise rates in response to higher inflation.

With US Debt:GDP approaching the levels of 1946 when the war ended and assuredly heading higher, it’s worth reviewing the pricing power embedded in pipeline contracts.

It’s generally estimated that around half the EBITDA of the midstream sector is subject to automatic price hikes linked to PPI plus a margin set every five years by the Federal Energy Regulatory Commission (FERC). The purpose is to ensure that pipeline owners can maintain an adequate profit margin that incentivizes continued investment in the sector.

The chart from RBN Energy shows the startling yet lucrative impact of this in 2022-23, which coincided with and partially drove some sparkling returns for the American Energy Independence Index (AEITR).

FERC sets an adjustment factor, which is usually positive, every five years. It was last set in 2020 at +0.78% when FERC was under Republican leadership. However, in 2022 when FERC was under Democrat leadership, the adjustment factor was changed from +0.78% to –0.21%.

The industry sued and last year the U.S. Court of Appeals for the D.C. Circuit vacated the order.

FERC is now under Republican leadership again, and next summer will set the adjustment factor for the five-year period beginning July 1, 2026. Pipeline companies are pressing for the adjustment factor to compensate for the two and a half years when it was incorrectly low. Pipeline customers understandably hold an opposing view.

If FERC does what the pipeline companies want, it will benefit liquids-focused companies, including names such as Oneok and Targa Resources, which have both been weak this year.

The twin drivers of demand for natural gas haven’t done much to help gas-oriented pipeline companies this year. The AI boom is so widely described as a speculative bubble that one must assume it’s not a secret. Goldman Sachs has estimated that generative AI needs to produce $1TN in annual revenue for the capital invested to earn an adequate return, roughly equal to our defense budget or interest on Federal debt.

Morgan Stanley thinks this could happen by 2028, up from $45BN last year.

Midstream companies providing Behind The Meter (BTM) direct hookups to gas supply for dedicated gas turbines aren’t exposed to the returns on equity earned by the data center owners. Buyers of gas turbines are facing a three-year backlog. A turbine is unlikely to be installed and not used, just as a gas pipeline is unlikely to be laid without a secure contract guaranteeing a return for the owner.

Williams Companies (WMB) announced a strategic LNG partnership with Australia’s Woodside Energy to own an interest in the Louisiana LNG facility. This is the project that Charif Souki originally launched with Tellurian, but it was sold to Woodside after Souki failed to obtain financing (see Tellurian Drifts Into Stronger Hands).

WMB’s stock dropped 5% on the news, confirming that the market fears a looming LNG glut and dislikes exposure to it. Total CEO Patrick Pouyanne has been warning of overcapacity among liquefaction terminals, with global capacity expected to rise from 425 Million Tonnes Per Annum (MTPA) to 600 MTPA by 2030.

Meanwhile, Total has restarted construction at its Mozambique LNG project after halting work in 2021 following a terrorist attack in nearby Palma town. If there is a glut they’ll be part of the reason. A slower build-out of competing facilities would suit Total.

New regasification continues to match the growth of liquefaction, maintaining a roughly 2X ratio between the receiving versus the sending side of LNG trade. The world’s buyers of LNG continue to prepare for increased shipments.

Although the precise terms of WMB’s investment with Woodside weren’t published, it’s likely that the perception of a glut would have been incorporated. In a form of vertical integration, WMB will be able to offer its customers gas transportation from its pipeline network and onto an LNG tanker. It looks like good timing on their part.

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

Energy Mutual Fund Energy ETF

 

Bullish News On Gas

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Last week there were two pieces of news that confirmed the bullish long term outlook for natural gas. On Thursday the WSJ reported on the Behind The Meter (BTM) arrangements that are becoming common (see AI Data Centers, Desperate for Electricity, Are Building Their Own Power Plants). This is faster than connecting with the grid and by allocating the costs directly to the data center avoids fueling the developing political debate about how hyperscalers are driving up household electricity prices.

There were some powerful statistics in the report: data centers are expected to represent 12% of US electricity consumption by 2028, up from only 2% in 2020. Texas expects peak load to be 62% higher by 2030. Natural gas will be the energy source of choice because it’s available, reliable and cheap.

Also on Thursday the Energy Information Administration (EIA) updated their forecast for US Liquefied Natural Gas (LNG) export capacity, noting that it could double within four years.

LNG names have been weak. Venture Global remains under a cloud following their loss in arbitration to BP (see Gassy Isn’t Happy). Witholding expected LNG shipments in 2022 to exploit high spot prices following Russia’s invasion of Ukraine netted a big windfall that’s now at risk to further adverse arbitration decisions (see Nothing Ventured, Nothing Gained). But in our judgment the market has more than priced in that worst case outcome.

NextDecade announced Final Investment Decision and the close of financing on Train 5 of their Rio Grande LNG terminal, notably without issuing any new equity. They expect to start shipping LNG by 2027 although Train 5 will be operational four years later. This will bring their export capacity to 30 Million Tonnes Per Annum (MTPA).

Market leader Cheniere has current capacity of 45 MTPA although this will likely increase by 30 MTPA within five years. Their market cap is $48BN. VG expects to reach 100 MTPA by 2030 and is worth $22BN. NEXT has a market cap of $1.6BN.

Nonetheless, five plus years is a long time to wait for full cashflows from NEXT and the stock, most of which isn’t publicly traded, will likely be subject to periodic swoons in the meantime as has happened twice this year. But we think ultimately the return will be attractive.

I’ve been traveling through the southeast US this week visiting clients, from DC via Richmond, and on to Fort Mill, Columbia and Charleston all in South Carolina. Sector performance has been disappointing, but I’ve enjoyed many interesting conversations with long-time investors, and I can report that this group is comfortable with their midstream investments with some considering adding.

We’ve also been doing a lot of calls with clients, answering questions they may have, and reinforcing that we believe current prices represent an interesting opportunity. One investor told me we communicate more than any other investment manager he knows, which was a nice thing to hear. If you’d like to learn more, feel free to reach out.

We also held a webinar on Thursday – if you missed it, here’s a link to the recording.

I once again joined U-Vest’s Financial’s annual conference, held this year in LPL’s offices in Fort Mill, SC. U-Vest are long-time investors with us and it’s been wonderful to watch their growth over the years as they add new advisors and offices across Florida, Texas, Georgia and South Carolina. Mike Davino, Dustin Johnson and Nick Brinson are building a terrific business.

Progressives have always argued that power generation should rapidly shift to renewables. But solar and wind struggle with intermittency, land use, and grid integration. The current Administration’s hostility to both has added to these challenges, on top of which costs have been rising. Political risk around the quadrennial presidential cycle will temper enthusiasm for renewables for many years to come.

Consequently, we often get questions on nuclear power and whether that can meet some of the new demand for electricity from data centers, reducing the demand for natural gas. We’d invest in nuclear power if it offered visible recurring cashflows comparable to hydrocarbon infrastructure. Today it doesn’t, and the costly delays on the Vogtle plant in Tennessee, which was finally completed last year, are enough to dissuade any full-scale projects for now.

There’s lots of R&D into small modular reactors, but the timeline for these initiatives doesn’t match the urgency of hyperscalers in the AI race. However, supportive executive orders and legislation in areas such as tax credits and streamlined permitting are improving the odds that nuclear power will eventually play a larger role.

The US Army announced last week it is planning to add small nuclear power generation reactors on its bases around the world. The US Navy has for decades operated nuclear-powered aircraft carriers and submarines. But this isn’t a model for the civilian sector because they use weapons-grade plutonium, which no country uses for civilian purposes because of the risk of terrorists. The Army will rely on non-weapons-grade uranium, and it’ll be encouraging if this plan offers lessons that eventually benefit civilian use.

The prospects for reliable US energy look good.

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

Energy Mutual Fund Energy ETF

 

Gassy Isn’t Happy

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The last few weeks have been challenging for the bullish story on natural gas. On Thursday evening Venture Global (VG) disclosed that they’d lost an arbitration case with BP over their Calcasieu Pass LNG terminal. The International Chamber of Commerce (ICC) found that VG had breached its obligation to make a timely declaration of the start of commercial operations.

BP and other buyers had signed Sale and Purchase Agreements (SPAs) that would start delivering LNG once VG decided the terminal was “operational.” When Russia invaded Ukraine in February 2022, global LNG prices soared as Europe struggled to replace lost pipeline imports of natural gas from Russia.

VG interpreted their agreements as giving them enough latitude to delay fulfilling LNG shipments under their SPAs, which allowed them to sell the LNG the terminal was already producing into the high-priced spot market (see Nothing Ventured, Nothing Gained).

Shell, BP and other expectant recipients of LNG cried foul and took VG to arbitration, claiming that VG’s windfall gains of $3.5BN were rightly theirs. VG plowed the cash back into their business, building the Plaquemines terminal, reducing their reliance on debt markets.

In August, VG won a similar arbitration dispute with Shell, also before the ICC. It’s unclear how the same facts and circumstances were interpreted differently by the same tribunal. It seems arbitration can be arbitrary. Following the August victory, VG not unreasonably said they expected similar outcomes in other cases. In an SEC filing submitted just before the Shell ruling, VG warned of $6.7-7.4BN in exposure if all the arbitration cases were lost.

On Friday, investors reacted to the news by wiping over $7.5BN from VG’s market cap. Assuming the market was 100% sure of positive arbitration outcomes prior, this exceeds the worst case they warned of in August since the Shell ruling was found in their favor. Wells Fargo estimates the worst case including damages of $5.5BN. JPMorgan thinks $4.8BN.

VG is on track to generate over $6.4BN in EBITDA this year, growing by perhaps $300MM next year. If arbitration awards reduce EBITDA by $1BN annually over the next five years, the company is at around 11.8X Enterprise Value/EBITDA. Cheniere is at 12.4X. The ruling was a big surprise and disappointment, but it leaves the stock fully priced for the worst case.

We avoided buying at the January IPO and even after Friday’s collapse, the stock is only modestly below our entry point. Since its IPO VG is –60%.

I’m going to be traveling to see clients over the next two weeks. A year ago, at one client’s annual conference, I received applause before even beginning my presentation. Four years of sparkling returns were warmly received, but this year has been tough. This time around I anticipate a friendly but less exuberant welcome.

NextDecade (NEXT), whose Rio Grande LNG terminal should start shipping LNG in 2027, recently lost their CFO, an event that algorithms duly interpreted as a reason to sell. It’s been a volatile stock, losing almost half its value following Liberation Day in April. It recovered in the summer, then swooned again when it announced Final Investment Decision on Train 4 with a modestly lower projected EBITDA.

NEXT doesn’t generate any cash today, but $800MM of Distributable Cash Flow (DCF) in 2030 discounted to today at 15% pa is worth about $400MM, which is a multiple of around 4X on today’s $1.7BN market cap. It looks cheap.

YTD it is -16%.

Energy Transfer (ET) has disappointed the many financial advisors we know that own it directly. Its 7.8% distribution yield is almost 2X covered by DCF. YTD it is –12%. It looks attractive to us.

Midstream as defined by the American Energy Independence Index (AEITR) is –1% YTD. Natural gas exposed names have lagged. Gas demand for data centers was last year’s story. Concerns about excess LNG capacity have weighed on exporters this year. The AI-laden S&P500 is +13%.

Over the past twelve months relative performance is better than YTD, but the calendar year is typically how investors assess outcomes.

The possible resumption of a trade war with China dominated Friday’s news. Even Trump’s biggest critics have praised the peace agreement between Israel and Hamas. It looks as if we’re moving from that victory to more capricious “slapping” of tariffs.

The AI bubble is so commonly referenced that it’s hard to believe anyone is unaware of the circular deals identified by Morgan Stanley. As former Citigroup CEO Chuck Prince memorably said in 2007 shortly before the Great Financial Crisis, “As long as the music’s playing, you’ve got to get up and dance.” You’ll probably see that quote remembered elsewhere before too long.

If either or both of these stories cause a further unraveling, midstream infrastructure will still be generating growing cashflows, untarnished by the froth of this year’s market.

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

Energy Mutual Fund Energy ETF

 

BP Navigates Politics With Its Outlook

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BP recently published their 2025 Energy Outlook. When big oil producers make projections about consumption it becomes a political document. Climate extremists are quick to accuse companies of opposing the energy transition and consigning the world to ruinous warming.

Yet capital commitments need to be based on rational expectations, not aspirational ones. Earlier this year BP slashed planned investments in renewables by $5BN because of poor returns. Its stock price has languished, leaving it vulnerable to a takeover from one of its less renewables-focused peers.

Unsurprisingly, BP protects itself from political fallout by saying in the opening paragraph that they’re not making predictions or stating what BP would like to have happen. The Current Trajectory scenario is where we’re likely going.

The Below 2 Degrees scenario plots what’s needed to reduce emissions enough to limit global warming by that amount (Celsius) by 2050. Most observers have given up on the original 1.5 degrees target. The main use of the Below 2 Degrees scenario is to show that reducing global energy consumption enough to reach it renders even this goal impractical as well.

Current Trajectory offers the more interesting slides. Forecasts of peaking oil consumption are built on increasing EV penetration. But the petrochemical industry is the biggest area of growth for oil, for production of plastics as living standards improve across developing economies.

Benjamin Braddock, the recent college graduate played by Dustin Hoffman nervously resisting Anne Bancroft’s attempts to seduce him in the 1967 movie The Graduate was told to dedicate his career to plastics. It’s not a new story.

One of the many implausible outcomes in the Below 2 Degrees scenario shows petrochemical feedstocks roughly flat out to 2050. Rising living standards across non-OECD countries will drive growth for decades. A peak in the global population will probably be required to trim energy consumption including petrochemical feedstocks.

An interesting recent article in The Economist (see Humanity will shrink, far sooner than you think) examined declining birthrates as living standards rise and suggested peak population could occur within a couple of generations by around 2060. That could finally spur a drop in energy consumption, helping drive emissions lower.

The EV chart assumes a sharp increase in EV penetration throughout the world. China may follow that path, but I’m skeptical that the US will see a tripling of EV usage within five years. 1H25 EV sales in the US were 607K, +1.5% year-on-year. The third quarter saw a big jump but with the Federal tax credit of up to $7,500 now ended we’ll see how much that ate into 4Q sales. GM recently cut EV production, citing weak demand.

BP expects natural gas demand to keep increasing for the next couple of decades. LNG demand will soar in emerging Asia as regional production falls. As regular readers know, we are optimistic about the long term outlook for US gas exports.

Power demand from data centers is the other growth driver for natural gas. One impediment might be the availability of gas turbines, since demand is outpacing available production capacity.

Energy Transfer (ET) is the most owned individual pipeline stock among the investors we talk to. The MLP discount keeps it perennially cheap, but that’s no reason to avoid it. Like Williams Companies (WMB), it is well positioned to provide natural gas to data centers, especially through Behind The Meter (BTM) arrangements.

BTM takes gas directly to a power plant that’s dedicated to the data center. Avoiding the highly regulated grid speeds implementation. Both companies have reported dozens of such discussions are under way.

ET’s weak performance this year surprises us. Their 7.6% dividend yield is more than 2X WMB’s 3.1%. ET’s Distributable Cash Flow (DCF) yield is a whopping 14.5% vs WMB’s 6.4%. And yet YTD WMB is beating ET by 31%.

Moreover, ET’s exposure to Permian gas in west Texas is probably better than WMB’s in Appalachia, because adding takeaway pipeline capacity within the energy-friendly Lone Star state is a lot easier than building in blue states like Virginia to reach the world’s data center capital, for now anyway. The interminable delays and huge additional cost in building Mountain Valley Pipeline from West Virginia to Virginia will dampen enthusiasm for new pipelines in that region for years to come.

For ET to be down on the year shows investor preference for bubble stocks. Cash flow and valuation will return to fashion at some point. We like both ET and WMB but have roughly double the exposure to ET that we have to WMB reflecting the former’s superior prospects and valuation.

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

Energy Mutual Fund Energy ETF

 

Getting Cheaper By Moving Sideways

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The energy sector is leaving investors unimpressed. YTD the American Energy Independence Index (AEITR) is +5% and seems to be marking time. The S&P500, increasingly dominated by tech and AI exposure, is +13%. Long-time clients, having enjoyed several strong years, hope the better days will soon return. More recent investors demand to know what’s gone wrong.

Time period matters. Roll the start date back three months, and the trailing one-year return for the S&P500 is +17% and the midstream sector is +19%. 4Q24 makes a big difference.

The perennially underperforming Alerian MLP ETF (AMLP) is only +8%.

Operating performance is beating sentiment. 2Q earnings contained few surprises and mostly confirmed the positive trend for cash flow growth. More recently, Hess Midstream revised their guidance lower but the outlook for crude, where Hess operates, is weaker than for gas. Upstream capex is declining because of soft oil prices (see The Energetic Outlook For Energy) while midstream capex is increasing to meet growing gas demand for data centers and LNG exports.

The contrast between moribund price performance and dynamic operating results is demonstrated by the Wells Fargo EV/EBITDA chart. The midstream sector has become cheaper, having pulled back almost halfway to the lows of late 2023, from which it delivered last year’s +45% total return. The problem, if a trailing one-year return of 19% deserves that characterization, is more with overly cautious investors than with how the companies are doing.

Modest price performance with growing EBITDA has left the sector more attractive than it’s been all year.

Leverage continues to drift lower with a median Debt:EBITDA of 3.5X according to JPMorgan, who also sees dividends growing at 5-7% next year. Distributable Cash Flow coverage ratios for the large cap names listed are at a median of 1.9X. We’ve omitted the LNG exporters Cheniere and Venture Global because they pay small dividends so would distort this metric higher.

The demand picture for natural gas remains robust, with hundreds of $BNs being invested in data centers that will need reliable electricity and LNG exports growing strongly. Below average sea temperatures in the Pacific near Peru meet the criterion for La Nina, meaning the odds of a warmer than average US winter are low. Natural gas prices rose accordingly on this news.

Although we’re rarely accused of insufficient enthusiasm towards pipelines, it does seem that for those underweight the sector, which would be most investors, current valuations offer an opportunity to rectify.

My wife and I were in Italy recently. When we travel, I’m always interested to learn more about how other countries use energy. Americans use more energy per capita than any other developed country except Canada, where the winters are long and cold.

The typical Italian uses only 37% as much energy as an American. There are many factors for this – Europeans rely less on air conditioning than we do in North America. They like to open the windows, since summer heat rarely matches the US.

The cars are smaller, with two-seater and even one-seater models that would fit in the back of a Ford F150. Hotels often require you to put your key in a slot to activate the room’s power, ensuring no wasted electricity when guests are out.

The EU is a leader in adopting policies to reduce greenhouse gases, which has led to some of the world’s highest electricity prices and a slow de-industrialization of the region. Living standards and energy consumption are symbiotically linked. Italian GDP per capita is only 71% of the US, down from 95% twenty-five years ago. Per capita energy consumption has declined 0.8% annually over the past decade, faster than the US at 0.5%.

The setting for Frances Mayes’ Under the Tuscan Sun is populated by many who care little for such analysis. It’s true that sharing a bottle of Chianti in a picturesque village overlooking rolling vineyards can generate thoughts beyond GDP. But to live like an American in Italy you need to have made your money elsewhere.

The inescapable conclusion is that relative living standards in much of Europe are sliding along with energy use. One can debate cause versus effect, but not the outcome. One of the saddest charts I ever look at is the ratio of UK to US GDP per capita, which has dropped quite sharply in the past decade. Brexit, no productivity growth and widespread use of expensive windpower have all contributed. But it does pain me to see my old country making bad choices while also confirming my 1982 decision to emigrate.

Trump’s jibe at the UN that European countries were “going to hell” in part because of energy policies was hyperbolic as usual but directionally correct. He’s wrong in denying the risks in elevated atmospheric CO2, but right in criticizing the belief that the world will run on renewables. It won’t. Fortunately, in America, we know that.

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

Energy Mutual Fund Energy ETF

 

Get Your Foreign Exposure In America

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Investors are routinely advised to incorporate some international exposure into their portfolios. This can be to add diversification or, in the case of emerging markets, to participate in faster-growing economies. For a US-based investor, this is at best a waste of time. Worse, it can introduce unneeded complexity, cost and poor returns.

By investing in countries that are developing quickly, the hope is that faster growth in GDP and incomes will translate into higher equity returns. This approach has provided years of disappointing results. It’s been good for investment managers who charge high fees to provide specialized access to such markets, but not for their clients.

The first mistake is to confuse GDP growth with equity returns. Take those famous empty, unfinished apartment buildings across China. Their construction generated economic activity and boosted GDP, but they’re not generating returns for the capital that financed them. Capex that fails to generate a return above its cost destroys equity value and isn’t limited to profit-seeking enterprises. Governments are equally capable of poor investment choices.

In fact, for many countries the transmission mechanism linking GDP growth and equity market returns is weak. There is ample literature on this point, such as Triumph of the Optimists (2001) which examined a century’s worth of data. The analysis was updated in 2021 with similar conclusions. An academic paper from 2022 (What Matters More for Emerging Markets Investors: Economic Growth or EPS Growth?) provided confirmation.

Moreover, direct investing in foreign markets incurs risk to foreign concepts of property rights, disclosure, accounting standards and fair markets. Many countries aspire to American standards, but few achieve them. I remember visiting India years ago to meet with local hedge fund managers and being told by a regulator that there was no insider trading in their markets. In such cases the only plausible approach is to invest with inside information or not at all. We never invested in Inda.

Then there’s the quandary of which foreign markets to choose and what allocation to make. Done properly, this requires substantial research of relative valuations, investor protections and economic prospects. This level of analysis is way beyond all but the most sophisticated institutional investors.

The S&P500 contains most of the world’s biggest companies. Almost all of them do business overseas. Investors are often surprised at the portion of revenues these 500 companies generate outside the US, which Factset calculates at 41%. It’s not just the Technology sector either – all eleven sectors have some exposure outside the US, although not surprisingly it’s low for Utilities and Real Estate. But the figures should provide comfort to any S&P500 investor who fears his holdings are too parochial.

What’s the right allocation? 500 boards of directors and executive teams have considered the opportunities from Argentina to Morocco to Vietnam and have invested accordingly. Their blended exposure to different countries represents the aggregate best thinking of this group. It’s crowdsourcing – the result of so many independent opinions is likely to be better than the informed view of an individual investor.

In addition, these companies have navigated through local regulations, taxes, property rights, accounting standards and politics in making those choices. Put another way, if the American Widget Company listed on the NYSE decides to create a subsidiary in Brazil, you’re better off getting your exposure through them than trying to identify a Brazilian widget company listed in Sao Paulo.

Instead of trying to identify Indian companies that will give you exposure to that country’s growing middle class, why not let Apple do it for you.

The Wall Street Journal recently advised its readers to allocate around a third of their portfolios internationally. Ironically this is less foreign exposure than the S&P500 currently provides. An investor who followed this advice would wind up with more than half their exposure outside the US, an imprudent choice for someone living in America.

The WSJ article ignored the abovementioned research and instead noted that, “Overseas equities are beating domestic shares for one of the few times in 15 years…” Most of the market advice from the media is on trading. Investors don’t hop into a sector on the basis of a few good months. So much energy is spent on timing rather than strategy.

The S&P500 offers ample diversification and a more efficient, safer way to access investment opportunities beyond our borders. Shun the advice of the poorly informed adviser who wants to make your portfolio more complicated and therefore renders his advice harder to evaluate.

Simpler can be better.

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

Energy Mutual Fund Energy ETF

 

Thoughts On NextDecade

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SL Advisors Talks Markets
SL Advisors Talks Markets
Thoughts On NextDecade
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I’m traveling in Italy and am not so distracted by the cultural and culinary delights to have overlooked the news on NextDecade (NEXT). I’ve watched the subsequent stock price fall with disappointment. They lowered EBITDA guidance on Trains 1-5 from $1.1BN (midpoint of prior $0.9-1.3BN) to $1BN, starting in 2030. Distributable Cash Flow (DCF) is estimated at $0.8BN according to Morgan Stanley, whose $15 price target is now $10.

The stock fell from $10.69 to $6.84 last week and is down 43% from its July 18 high of $12, ironically reached on the back of Morgan Stanley’s earlier upgrade. NEXT is a volatile stock, with no prospect of generating any cashflow for five years. It dropped 40% from its previous high of $9.43 in the Spring following Liberation Day and subsequently recovered.

This is not an investment for leveraged investors or for those seeking short term profits.

But $800MM of DCF in 2030 discounted to today at 15% pa is worth about $400MM, which is a multiple of around 4.5X on today’s $1.8BN market cap. This excludes any potential cashflow from further expansion of their Rio Grande LNG terminal, which we think is likely over the next couple of years, where their economics ought to be better than on Trains 1-5.

There’s a lot of optionality here.

NEXT is a cheaply priced investment with adequate compensation for the execution risk. It’ll remain a volatile stock and with a history of losing nearly half its market value at least once a year is not a holding for those who rely on skill at market timing.

We don’t count ourselves in that group and see attractive upside from here.

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

Energy Mutual Fund Energy ETF

 

Adapting To America’s Low Rate Policy

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SL Advisors Talks Markets
SL Advisors Talks Markets
Adapting To America’s Low Rate Policy
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President Trump continues to heap pressure on the FOMC to cut rates, to the alarm of every economist and bond analyst. Central bank independence is the gold standard for western nations, the only way to assure that politicians don’t seek to juice growth synchronized with the election cycle.

Fed chair William McChesney Martin Jr, who served in that position longer than anyone (1951-1970), was credited with describing the Fed as, “…independent within the government, not independent of the government.”

Central bank independence really means immunity from short term political pressure. Few argue that cental banks shouldn’t be politically accountable. The Fed’s twin mandate of maximum employment with stable prices is set by Congress and could be changed by Congress.

Trump isn’t the first president to call for lower rates, but as with most issues that get him exercised he is a relentless opponent willing to break norms to achieve his goals. The market is beginning to price in a Trump-managed rate cycle. It seems likely to me that his steady pressure on the Fed will tend to force short term rates lower for the rest of his term, as he finds more ways to change some FOMC members and intimidate the rest.

We are heading into a period of increased inflation tolerance. Whether or not actual inflation moves sustainably higher, few would confuse Trump with a hard-money man. If you’re excessively worried about preserving your purchasing power, arrange your investments appropriately into sectors that will respond well to rising prices – such as midstream energy infrastructure. Don’t rely on the president to help.

I increasingly run into people who differentiate between Trump’s policies and their implementation. Tariffs have turned out to be a national sales tax on imports. The Congressional Budget Office estimates they’ll generate $4TN over the next decade. Everyone who wrings their hands over our fiscal outlook and criticized the deficit increase in the One Big Beautiful Bill should welcome this new source of revenue to the Treasury.

Taxes aren’t inflationary. The prices of affected goods undergo a one-time increase. Tighter monetary policy in response would be exacerbating the headwind to consumption. Most states have a sales tax, and you’ve never heard that a monetary policy response was required.

Tariffs may not be that bad. But their implementation has been tactical and capricious.

The conventional wisdom supporting central bank independence is that it promotes low and stable inflation. There’s nothing magic about 2%. The FOMC disclosed their 2% inflation target in 2012 but for years previously had gravitated towards that level without formally adopting it. Many economists have argued that stable inflation is more important than the actual level, since it aids long term capital planning. Stability is more easily achieved around a lower number. Barry Knapp of Ironsides Economics argues that capex has historically been strongest during periods of low inflation volatility, such as from the 1960s-90s.

Our dire fiscal outlook is beginning to intrude. When the Fed raised interest rates in 2022 to combat the inflation caused by the Biden Administration’s fiscally profligate pandemic response, it drove up the cost of financing our Federal debt. With $37TN outstanding, we can no longer be oblivious to interest expense, which will exceed $1TN this year.

Trump has repeatedly accused Fed chair Jay Powell of costing us “hundreds of billions of dollars” by not cutting interest rates. As with much of Trump’s policymaking, his approach is combative and violates conventional norms. But it is reasonable to consider the Fed’s appropriate mandate given our fiscal outlook, the improvement of which both parties have concluded offers no political upside.

Federal debt has an average maturity of around six years and an average rate of 3.3%. If the Fed slashed short term rates to 1% immediately, it would take several years to meaningfully impact our interest expense. But eventually it would. If we targeted stable inflation of 3% and funded ourselves at 2%, a –1% real (i.e. inflation-adjusted) cost of financing would, over time, lower the real value of what we owe.

Mild currency debasement is a time-honored way for governments to repay less than they borrowed when adjusted for purchasing power, as I wrote in Bonds Are Not Forever; The Crisis Facing Fixed Income Investors.

The right way to do this is for Congress to debate the Fed’s dual mandate, to hold hearings and consider whether it should be changed. The world being what it is, the Administration is pursuing a different approach.

It’s easy to criticize the threat to the Fed’s independence. It’s also likely that for the balance of his term Trump will get his way. Because he’s willing to take some risk with inflation, investors should position accordingly. Unsurprisingly, we believe midstream energy infrastructure, with its inflation-linked business model, can be part of the solution.

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

Energy Mutual Fund Energy ETF

 

 

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