Oil Markets Price In Higher For Longer

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Since the Iran War began at the end of February, oil analysts and industry professionals have been warning that the price of crude was increasingly likely to move sharply higher. Storage is depleted. Tanker traffic through the Strait of Hormuz fluctuates with the success of Iranian attacks.

Spot crude was recently back at the highs of March, but no higher. Reported flows through the Strait of Hormuz have approached pre-war levels. Headline oil prices fall on optimistic presidential tweets and rise again on drone strikes. Oil is high but somehow enough supply seems to reach the market that the most dire forecasts have so far been wrong.

Military activity has been eerily quiet. The removal of US dependents out of the Middle East is another sign that a major strike on Iran is coming after the mid-terms. At that point diesel prices will have lost their influence. The rally in spot crude on Friday reflects this shifting expectation.

With little attention, longer term crude prices have been moving up, and for a different reason. Jeff Currie, formerly of Goldman Sachs and now with Carlyle, recently pointed this out. For example, the June 2027 Brent futures contract is now well above the highs of March.

The two price points represent very different perspectives. Spot crude is acutely sensitive to unexpected changes in supply and demand. It is the headline price, responsive to every tweet and missile. It’s more correlated with the prices of gasoline, diesel and other refined products.

By contrast, an Iranian strike on a tanker or a Houthi drone hit on Saudi infrastructure have limited impact on the June 2027 price, which moves with less urgency. Spot conveys the emotion of the market, while the price next summer reflects the result of more thoughtful analysis by market participants.

The steady ascent of the June futures contract hasn’t made headlines but should be of more concern to policymakers. For months the market has priced oil as if supply disruptions would soon be resolved. What’s happening now is a growing acknowledgment that we won’t get back to a pre-war state for some time, if at all.

The resilience of Iran’s capability to strike at shipping suggests that traders are pricing in their more permanent influence over the Strait. While flows from the Persian Gulf have in recent weeks approached the levels that prevailed before February 28, the market is showing that the risk of a setback is going up.

It’s subtle; plain to see for energy executives and policymakers who follow such things, but not front page news. Refined products’ prices are high. The market structure suggests they may become the new normal.

We continue to believe that the stock prices of LNG exporters don’t reflect their long term boost from the closure of the Strait. Even after it re-opens, the threat from Iran will remain indefinitely, or at least as long as the country is run by religious fanatics. The reliability of US energy exports isn’t fully incorporated in the prices of exporters.

However, it is recognized by Qatar, who signed a deal with Cheniere last week to buy 4 Million Tonnes Per Annum (MTPA) of LNG through 2054. What could be a more powerful statement about the relative attractiveness of US supplies than one of our biggest competitors committing to buy from us for almost the next three decades?

How does a new Asian buyer considering a choice between Qatari and US supplies opt for the former under such circumstances?

Will Qatar even go ahead with their planned expansion of their Ras Laffen complex when they themselves are opting for the reliability of US supplies?

Qatar is also in negotiations to buy 3 MTPA from Venture Global.

The threat of a glut of LNG in coming years must be receding for even the most bearish analysts. Qatar, once expected to be a source of the glut, is committing to long term purchases from America to ensure they have sufficient supplies. Qatar regularly buys shipments on the open market to make up for their own inability to honor commitments due to the closure of the Strait.

The less thoughtful observers have not previously considered the change in Qatar’s competitive position.

Last week we traveled across the southwest, to Arizona, New Mexico and Texas seeing friends and clients. Mike Osland in Scottsdale has been a long-time investor in midstream energy, to the undoubted benefit of his clients. Every time I see him he graciously hosts me for a round of golf where the strokes our relative handicaps afford me are always inadequate.

Aaron Irving in Carlsbad, NM counts many energy sector employees among his clients. Aaron even managed to arrange a visit to an oil rig, a memorable day that will be chronicled in next week’s blog.

Later that day we attended the Carlsbad Mayor’s Energy Summit and met Tyler Romans who recently joined Aaron’s business. New Mexico’s regulatory approach to the energy sector is often compared unfavorably with pro-energy Texas, a common topic at the dinner.

Bill Edwards in San Antonio was my ski instructor in Vail for nearly 25 years and has been a client almost as long. Any skiing ability I have is due to Bill. We’ve had many wonderful trips together.

We enjoyed dinners with each, and their charming wives.

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

Energy Mutual Fund Energy ETF

 

The World Keeps Buying More American Energy

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An investor asked me the other day what’s the most interesting theme across our portfolios. It has to be the export story. This blog often chronicles the outlook for US exports of hydrocarbons. Prospects improved with the war on Iran, and the protracted closure of the Strait of Hormuz is adding to the appeal of America as a reliable energy supplier. Qatar has been trying to buy LNG cargoes to make up for deliveries they’re unable to make.

Oil dominates the energy headlines, but the big story is elsewhere.

A decade ago we were net importers of natural gas. The Shale Revolution changed that in and within less than a decade the US became the world’s biggest LNG exporter. Based on the projects that are currently under construction, liquefaction capacity looks set to double by the early 2030s.

The Natural Gas Liquids (NGL) export story is often overlooked. Volumes have tripled over the past decade. Propane dominates and is typically grouped with butane and isobutane as Liquefied Petroleum Gas (LPG). Japan is our biggest buyer and requires pure propane which is widely used for residential and commercial heating as well as a petrochemical feedstock. China also uses propane primarily as a feedstock.

Blended LPG can be cheaper than pure propane, and developing economies tend to be the buyers. Over half of US LPG exports go to Asia.

Five years ago China was our joint top destination along with South Korea for LNG exports. Evidently concluding that less US trade exposure is better, they slashed their volumes from just under 13% of our exports to virtually zero last year. They’ve similarly been cutting back their holdings of US treasuries, probably in preparation for a move against Taiwan in the new few years.

But there are no alternative suppliers of ethane, which China’s petrochemical industry uses to make ethylene for plastics and other industrial chemicals. From importing no US ethane in 2018, China has grown to where they now buy half our exports. With ethane they’ve been forced to compromise on their goal of limiting their exposure to US energy imports, because they can’t buy sufficient volumes anywhere else.

Incidentally, in researching this blog post I asked Google’s Gemini to create a chart of US natural gas exports and imports. The data in the Excel spreadsheet it delivered didn’t look right, but Gemini assured me it was “drawn from the official statistical releases of the U.S. Energy Information Administration (EIA)”

Unconvinced, I retrieved the data from the EIA myself and uploaded a comparison to Gemini asking it to explain why they were different. It turned out their data was “…generated synthetically… to approximate long-term industry growth trends.”

Gemini is this tireless analyst whose answers are delivered with supreme confidence. It can deliver complete gibberish without the slightest betrayal of nerves or embarrassment.

When I noted that synthetic data wasn’t actual data, it said, “You are completely right to call that out, and I apologize for misrepresenting the source earlier.”

AI agents are good at saying sorry. They need to be.

I imagine that Gemini learned from this episode, at my expense. I’ve learned to trust AI only when I can corroborate its work. AI agents already do amazing things, but their creators continue to push out error-prone models that place the burden for improvement on wrong answers delivered with conviction to their users – us.

Venture Global (VG) has been a regular topic in this blog recently. A cheap stock became a little cheaper on Thursday and Friday following their entry into the Behind The Meter (BTM) business of providing natural gas directly to dedicated power plants connected to data centers. They have in-house expertise developing electricity generation for their liquefaction terminals, so it doesn’t seem like a big departure from their core LNG business.

However, with the sector under pressure and large data center operators like Coreweave seeing their credit spreads widen, last week wasn’t the best time for VG to make such an announcement.

We still think it’s attractively priced.

I was in the Carolinas last week seeing investors. Clients of Jim Agostini and his team at DaVinci Financial Designs in Columbia, SC have benefited for many years from their allocation to midstream. I had a most enjoyable visit with them where we as usual found much to agree on across investing and politics.

In closing, I’m very sad to report that Bill Shepherd, a long-time friend and client who was featured here in April when he celebrated his 100th birthday, passed away last week. Unfailingly cheerful, he was very proud of his English ancestors and our shared heritage. He will be missed.

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

Energy Mutual Fund Energy ETF

 

It’s Not Inflation, For Now

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Inflation fears are the widely held explanation for the continued rise in bond yields. This strikes us as an inadequate response that doesn’t correspond with the facts. Inflation expectations are not budging – either as reflected in the TIPS market or in survey data. Real yields are at their highest since the Great Financial Crisis, and it’s their increase that is fully responsible for the jump in bond yields over the past year. A significant difference with 2008 is that today stocks are close to record highs. Inflation fears are not visible, for now anyway (see Higher Yields Reflect Positivity).

That’s not to say that the market is cheap. Measures such as the Shiller Cyclically Adjusted Price Earnings (CAPE) or the Equity Risk Premium are showing valuations to be high, as we noted in June. But these measures are not good timing tools.

There is plenty to worry about – isn’t there always? Aside from the known big risks (no need to list them, we know what they are), future inflation should be of great concern to savers everywhere. Higher inflation, enabling negative real yields on government debt, is the likely resolution of our looming fiscal catastrophe. It’s how governments repay debt in devalued currency, performing a stealth default rather than a sudden one. It’s been used many times over the centuries.

But investors are showing no signs of concern about future inflation for now. In any case, CPI or the Fed’s preferred PCE deflator, are both losing their utility as a planning tool. They remain critical to forecasting interest rate policy and inflation adjustments. But inflation statistics are massaged in so many ways that they now have little to do with how consumers experience a rising cost of living.

BLS economists and the Fed inhabit a theoretical world where they subtract out quality improvements, extreme price changes, food and energy and don’t directly measure the cost of owning a home (see What’s Your Inflation Rate?). They’re not much use.

Today’s bond yields and stock prices reflect an optimistic view of future economic growth and profits. Bonds had to fall in order to offer an increased return to compete with stocks. There’s little sign that investors are at all worried.

Midstream energy, which we believe remains cheap, is providing plenty of reasons for optimism. Venture Global (VG) recently signed a 20-year deal with Conoco-Phillips to provide 1 Million Tonnes Per Annum (MTPA) of LNG. VG also just sought regulatory approval to begin expanded operations at their Plaquemines LNG export facility ahead of schedule.

Last month VG announced a long term LNG supply agreement with China Gas Holdings.

US energy exporters are seeing demand strengthen off the back of the ongoing disruption to supplies out of the Persian Gulf. Shipments of Natural Gas Liquids (NGLs) which include ethane, propane and butane, are expected to be up 10% this year. Enterprise Products Partners (EPD) is a big beneficiary, along with Targa Resources (TRGP).

China is a big buyer of US ethane, taking around half of US exports. Energy Transfer is expanding its Marcus Hook Terminal in Pennsylvania to meet growing demand.

From the narrow perspective of the midstream sector, there’s ample reason to hold a constructive outlook. Rising real yields combined with record high stocks mean that such optimism is rippling across many other sectors too.

It also seems to us that the mid-terms will represent an inflection point. White House concern for gasoline and diesel prices will be less acute once the votes are in. The weeks following, until the new Congress is sworn in, may represent Trump’s best opportunity to apply maximum military pressure on Iran before the incoming Democrats seek to curtail his freedom of action. Iran’s best negotiating opportunity is now, and they seem disinclined to seize it. Another leg up in oil and global LNG prices seems more likely than not after November 3.

Last week we were on the road seeing long-time investors. Geoff Lanceley, a transplanted Brit living in Houston, has been with us for over a decade. Over the years he and I have enjoyed a few Indian dinners together, coming up with many conservative solutions for the world’s problems. Following a fascinating career that includes stints in the Middle East in the energy sector before moving into asset management, he will be taking a well-earned retirement next May around his 80th birthday. We had a most enjoyable dinner with Geoff and his charming wife Lise and will look forward to seeing them again on our next trip to south Texas.

In New Orleans we enjoyed another visit with Keith Laterrade and his lovely wife Melissa. Every year Keith seems to pick a local restaurant better than the last. This year was Muriel’s at Jackson Square. Keith has also been invested with us for over a decade, to the undoubted benefit of his clients. Keith’s eclectic background includes playing as a goalkeeper many years ago in the English football league. Naturally we found time to discuss Manchester City, for whom he played on a couple of occasions.  and their numerous spending violations which are a huge story there.

Catching up with long-time investors and friends is one of the nicest parts of my job.

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

Energy Mutual Fund Energy ETF

 

 

Higher Yields Reflect Positivity

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Midstream had a tough month in September, with the American Energy Infrastructure Index (AEITR) -8.3%, its second worst month in the past five years. Rising treasury yields pressured sectors traditionally owned for their income.  The S&P Utilities ETF (XLU) was –5.9% for the month and is now –5.7% YTD through the third quarter. The Vanguard Real Estate ETF (VNQ) was –6.3% and is now +4.2% YTD. The S&P 500 Low Volatility High Dividend Index was –7.7% and is +4.4% YTD. The Barclays Agg was –2.6% in September and is –2.8% YTD.

The AEITR’s YTD performance of +17.9% is well ahead of other income-generating sectors, even after a lousy month.

The 1.2% increase in ten year treasury yields over the past year has been fully the result of real yields moving higher. Inflation expectations, defined as the difference between ten year nominal treasuries and TIPs (Treasury Inflation Protected Securities) have not budged and sit at around 2.3%.

The University of Michigan survey of consumer expectations has future inflation at around 3%, but similar to the bond market, this figure has been stable.

This is consistent with a positive economic outlook. Real yields have moved up because the market is expecting strong growth.

An important confirmation of this shows up in fund flows. In the twelve months through July, foreign investors bought a record $942BN in US equities and equity funds, while their purchases of US treasuries cooled. China has been steadily reducing their holdings for over a decade, which at $618BN are less than half their peak of $1.3TN in 2013.

It’s also consistent with the S&P500 being +12.8% YTD. In March, weakness in bonds hurt stocks, which were –4.9%. The explanation offered was that the NPVs of growth stocks that dominate the index were acutely sensitive to a higher discount rate on their much higher profits many years out.

Bonds had a worse month in September, but the S&P500 was only –0.4%. Over the past year in eight of twelve months stocks have been up and only two months (March and June) were down by more than 2%.

Surveys continue to defy the positive outlook held by investors. The University of Michigan reported that Consumer Expectations fell to 46.3 in September, down 10.4% year-on-year.  Political affiliation skews the result, but the White House will be frustrated to see that Republicans are becoming more pessimistic at a faster rate than Independents or Democrats.

Your blogger, who has never been surveyed, retains his confidence in America’s bright future, which has always been right.

A steady if unheralded improvement in the financial strength of midstream underpins its 20% five-year annual return, handily beating the S&P500 over that period at 13.8%. Leverage has steadily come down, with many companies in the 3.0-3.5 range Debt:EBITDA, down by 0.5X to 1.0X over the past decade.

Years ago, Kinder Morgan (KMI) used to argue that their diversified asset base could support 5.0X. Rating agencies disagreed, and in 2015 KMI cut their $2 annual dividend by 75%. Even now it’s only $1.19.

Wells Fargo is projecting 4.9% annual dividend growth for the midstream sector.

Capex has been creeping up, but in another sign of improved stewardship it’s mostly financed through internally generated cash rather than public equity offerings. Midstream generates far less in capital markets fees for Wall Street than it used to. The industry has grown while the number of names has shrunk. Today it’s mainly an investment grade, large cap sector.

The growth outlook for natural gas remains dominated by increasing exports and greater power generation. Wells Fargo expects feedstock for LNG terminals to more than double by 2035 (10.2% CAGR), while gas for power generation will grow at 5.6% annually.

Consequently, we think midstream remains attractively priced. The rise in real yields that reflects a robust growth outlook is good for midstream companies, which benefit from higher volumes. The Iran war has boosted the outlook for US exporters of hydrocarbons. The weakness in September doesn’t seem justified by the fundamentals.

Just over four years ago Stuart Kirk, then HSBC’s head of Responsible Investment, gave a delightful presentation about the extreme hype over global warming that dominated the left wing and media. He accused presenters of trying to “out-hyperbole” one another, and noted that even though the presenter just before him had warned that humans would not survive, “…no-one ran from the room. In fact, most of you barely looked up from your mobile phones.”

The presentation hastened Kirk’s departure from HSBC, and he now writes a column for the Financial Times.

Since then, the shrill voices warning of the end of the planet have been replaced by more sober consideration that places climate change alongside other major challenges such as malnutrition, access to clean water and reliable electricity. Regulators in the US and EU have reduced the burden on companies to report on potential climate change impacts.

As for Stuart Kirk, he’s moved on to condemn the current fear that fiscal profligacy will condemn us all to penury (see The climate doom-mongers now dread sovereign debt blowouts). He’ll probably find a lot of familiar faces on the other side of this debate.

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

Energy Mutual Fund Energy ETF

 

 

Venture Global Moves More Than Needed

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Market making in Venture Global (VG) must be a profitable business. More than most stocks, its price often follows a manic-depressive ride turning on the plausibility of presidential comments about negotiation with Iran. Following each dip as traders quickly conclude Trump’s  tweets on Truth Social are based more on hope than substance, the stock rebounds. It’s dropped more than 15% in a month four times this year.

VG’s prospects improved once Qatar was forced to stop shipments of LNG. That is pretty much all investors need to consider other than the short term profit opportunities from the liquefaction capacity they can access that’s not already committed.

Last week as US energy exporters reeled from another sentiment shift around negotiations, VG dipped below $13, a level it easily exceeded in early March on its way to a high for the year of $17.46 reached on March 27. VG’s business prospects since then have only improved. It’s doubtful Qatar was warning its expectant buyers of LNG that there would still be no shipments six months later. If you want your LNG delivered on time, better to buy American.

But the market has done what markets do, and some perceived last week’s dip as an opportunity.

Predictably, President Trump has thrown his support behind a ban on diesel exports, having already told Ukraine’s President Zelenskyy to stop bombing Russian refineries. This is the proximate cause of the global shortage with the other being the loss of Persian Gulf exports of refined products.

The US produced 4.8 Million Barrels per Day (MMB/D) of Distillate Fuel Oil last year, which includes both diesel and heating oil. We consumed 3.9 MMB/D, exporting the balance. We do import a small amount, mostly in New England from Canada. Distillate Fuel Oil represents 18-20% of domestic petroleum products demand.

The challenges in a ban on diesel exports include that diesel that would be redirected internally is produced near the Gulf Coast where it can be loaded onto ships. There isn’t the pipeline infrastructure readily available to move it elsewhere in the country.

The 1920 Jones Act, which often impedes efforts to move hydrocarbons on water within the US, mandates that goods moved between American ports must travel in ships that are US owned, built and crewed. It’s why Boston imports LNG; left wing energy policies have prevented adding pipeline capacity linking them to Pennsylvania. Instead, it comes from foreign countries because there are no Jones Act-compliant LNG tankers that could ship it from the Gulf coast.

During WWII the country was divided into Petroleum Administration for Defense Districts (PADDs) and the EIA still uses them. PADD1 includes New England. Its imports of distillate fuel oil rise in the Fall/Winter, making this an inopportune time to disrupt their supply.

These imports come from foreign sources, and since the impact of an export ban is likely to push foreign diesel prices up, this region would likely see higher, not lower prices at least initially.

Overall, the friction to the movement of existing diesel fuels caused by an export ban would reduce the expected price benefit. There would be little point in investing in new pipelines to transport diesel from Gulf coast refineries to, say, New England because of the temporary nature of the ban.

Trump’s best bet might be to voice support for a ban without doing much to implement one. Energy Secretary Chris Wright has suggested an export ban might be voluntary, which would allow the Administration to claim some action while avoiding blame for any resulting price distortions.

The Mediterranean vistas from Corfu, where we spent a few days last week, are mercilessly unsullied by wind turbines. Windpower might seem a logical choice for a Greek island with no local sources of coal or gas. In fact, there are no power plants at all on Corfu, which draws almost all its power from the Greek mainland via undersea cables.

EVs are surprisingly uncommon – Greece EV penetration is barely a third of the EU average. The fleet of cars is older than average – Greeks keep their cars longer because they’re poorer. And the charging infrastructure is not as well developed as elsewhere.

Corfu’s energy mix for electricity mirrors Greece since that’s where its power comes from. Natural gas is the biggest source at 37%, not far behind the US. Wind is 22% although as mentioned not from anywhere near Corfu.

Greece’s gas imports have been rising. Over half of their gas consumption is delivered as LNG, and the US is around three quarters of that. In June Greece’s gas importer Atlantic-SEE LNG Trade, expanded an LNG deal with VG.

They’re taking a longer-term view than some of the recent traders in VG stock.

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

Energy Mutual Fund Energy ETF

 

 

Scotland Taps Its Windy Coastline

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Last week’s blog post about inflation (see Estimating Your Retirement Spending) resonated with quite a few financial advisors. Several noted that persuading clients to accept sufficient exposure to stocks with the goal of maintaining purchasing power is one of their biggest challenges. The examples showing that many retirees will find their spending increases faster than stated inflation was especially well received.

A former colleague from JPMorgan offered some useful insight into housing costs. 40% of homeowners don’t have a mortgage, a group that is overwhelmingly in or near retirement. This insulates them from the approximately third of the CPI that seeks to capture the cost of shelter through the weird concept of Owners’ Equivalent Rent. Its weaknesses are regularly chronicled here (see  Why You Can’t Trust Reported Inflation Numbers).

The top 5% of households by income referenced in last week’s blog are even more likely to be insulated from housing inflation and in many cases downsize – although as I was reminded, some towards the higher end of this cohort increase their household expenses  by adding a second home.

Another reader also noted that the biggest wealth transfer in history is unfolding as baby boomers pass on their wealth to the next generation. For those fortunate beneficiaries, the concerns over retirement purchasing power will be less acute.

The prior week’s blog post on private equity’s discovery of midstream also drew comments (see Private Capital Sees A Cheap Public Market). We think the market doesn’t fully appreciate the cashflow reliability inherent in many midstream businesses. This is what’s drawing in outside capital, with structures that seek to isolate this benefit without imposing any meaningfully higher risk on existing investors.

JPMorgan found that investors in Oneok were critical of a structure that used capital with an IRR of 7.25% or possibly higher to reduce debt yielding around 5%, although the reduced leverage does justify this for some.

Williams Companies (WMB) took a different approach in their partnership with Blackstone by carving out a portion of Behind The Meter (BTM) deals into a separate entity. This approach allows for a valuation of specific assets, potentially at a higher level than when embedded within the overall corporate structure. We think there will be more examples of this which should ultimately help the sector resolve to a higher valuation.

Higher crude oil prices garnered headlines last week, along with record prices for diesel. The continued move higher in global LNG prices has been just as impressive if less widely reported. The European TTF benchmark is above $26 per Million BTU compared with the US at below $3. Exploiting the vast arbitrage is available to those with spare liquefaction capacity, notably Venture Global. Their strategy of retaining some capacity for themselves is allowing them to profit more effectively from today’s opportunity than Cheniere, which has committed 95% through 2035. The two companies offer a different risk profile and exposure to LNG price differentials.

But both stand to benefit over the long run, along with NextDecade from Qatar’s protracted inability to ship LNG out of the Persian Gulf. US hydrocarbon exporters more broadly should see a boost over the long term, including Enterprise Products Partners and Targa Resources for their ability to supply LPGs.

My wife and I are in Europe, home of the world’s most dysfunctional energy policies and consequently some of the highest electricity prices. European natural gas stocks have been running below normal levels for this time of year while prices have inconveniently moved up. Replenishing those stocks in time for winter will likely require government subsidies to avoid the political damage of even higher household fuel bills.

Like much of Europe, Edinburgh, where we visited last week, consumes energy more sparingly. Hotel corridors have motion sensitive lighting. The electric hand-dryers in the washrooms shut off more quickly. Windpower has been relatively successful in the UK, providing over a quarter of the country’s electricity and on some days all of it. Coal has been completely phased out.

Scotland generates more than it can use, and the infrastructure to transmit the excess south to England remains inadequate. Regional pricing doesn’t reflect local abundance, so Scots grumble about subsidizing their Sassenach neighbors with cheap windpower.

Britain’s surrounding waters are reliably windy. We saw several jacket foundations, the steel yellow lattice structures that support wind turbines, lined up on the port in Leith ready to be moved offshore. They’re built in China where coal is the dominant form of energy and shipped from the other side of the world. For decades the North Sea has provided oil and gas. Now it’s also providing electricity.

Household electricity prices in the UK are roughly double the US average, while industry pays two and a half times as much. Renewables are expensive in most of the places they’re deployed at scale around the world, although the US also benefits from cheap natural gas. Around a quarter of UK power comes from gas, but given the prices noted above it’s expensive. With coal reserves exhausted, windpower seems like a sensible option.

Thanks to the shale revolution, America remains the home of cheap energy.

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

Energy Mutual Fund Energy ETF

 

 

Estimating Your Retirement Spending

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An increasing number of my friends are nearing retirement if not already there. Many spent years working for large corporations, and few miss it. I have no similar plans – running your own business is the most meaningful paid activity I’ve experienced, and I can’t imagine any alternative could be as fulfilling.

My tribe of energy investors and golf club members is not representative of the general population. Nor is the subset of retirees who have enjoyed professional success to reach that stage. But they have more in common with the readers of this blog, and by extension to many of our clients.

According to the Census Bureau, a male in his early 60s has on average twenty years of life remaining and a one in four chance of reaching 90. But longevity is correlated with income. Wealthier people enjoy better health and make better life choices. $336K in annual household income gets you into the top 5% of households and adds another five years of life expectancy.

Here begins the bet on how one’s income will grow compared with inflation. The 95th percentile of household net worth is $3.8 million according to the Federal Reserve’s Survey of Consumer Finances. A household at the 95th percentile of net worth and income is earning (and presumably spending) around a tenth of this annually. Even assuming a 3% after tax return, that retirement pot will shrink over time. To paraphrase Mr. Micawber in Dickens’ David Copperfield, the difference between outliving your savings and not is the difference between happiness and misery.

The spread between the rate at which your spending outgrows the income from your retirement assets will heavily impact the odds of later financial happiness. Over a quarter century, as little as a 1% adverse spread will leave you with 22% less purchasing power. A 3% spread will cut your purchasing power in half.

The case for assuming 2% inflation is extraordinarily weak. Since World War II, inflation has averaged 3.5% and has rarely been below 2%. Fiscal profligacy such as ours has for centuries ultimately been resolved through debt monetization and currency debasement, a regular theme of this blog (see US Explores The Limits On Spending).

Politicians long ago quit recommending fiscal solutions. Tax hikes and spending cuts quickly turn a legislator into a paid lobbyist after a lost election. It is democratic if unwise.

And even his biggest fans must concede that President Trump is not a hard money man. If the FOMC raises rates by the end of the year as is currently priced in to the futures market, the White House response will be voluble and bombastic.

The Democrats caused the biggest inflation surge in fifty years with the uber-stimulus in their comically named Inflation Reduction Act.

Neither party is credible on maintaining stable prices.

Inflation has been above 3% for the past five years. It’s an especially poor measure of how much spending has increased for the top 5%. Inflation statistics intentionally adjust for better products and services (known as hedonic quality adjustments). The CPI and its cousins only set out to measure the cost increase of a basket of goods and services of constant utility, matching which will leave your living standard slipping against your peers (see Economists Having Fun With Inflation).

Moreover, the top 5% consume a basket of goods and services quite different from the average household. Surveys and Bureau of Labor Statistics data show that over the past five years the cost of fine dining, business class flights and live entertainment have all grown at around 6-8% per annum. Because, dear reader, you are fortunate to be richer than the typical American, your inflation rate is not close to what the government says it is.

What should our atypical retiree assume for her annual increase in living expenses?

2% seems ruinously optimistic, a level we’ve rarely hit and at odds with our fiscal outlook in spite of Fed Chair Kevin Warsh’s stated determination to retain it as the Fed’s goal.

4% is the average since 2021, but if the rest of the decade is similar, this still leaves our retiree steadily losing purchasing power.

5% is probably the lowest assumed inflation rate for someone in the top 5% of household income that wants to avoid feeling steadily poorer every year. 95th percentile household income has accelerated in recent years, growing at 2.9% over the past decade and 5.7% last year. Assuming a constant savings rate implies that the basket of goods and services consumed by that cohort has risen at the same rate.

Regular readers know that these blog posts guide to the buying opportunity that is midstream energy infrastructure. There are few asset classes that can match a 5% annual increase in living expenses. But a 4% dividend yield combined with a 3-4% dividend growth rate offers a decent chance of providing a commensurate after-tax return, unless you live in one of those blue, high tax states.

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

Energy Mutual Fund Energy ETF

 

Private Capital Sees A Cheap Public Market

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Last week Apollo invested $9BN in Oneok (OKE), who used $4BN to finance their $4.25BN purchase of Brazos Midstream’s Permian Midland Basin G&P assets while using the remaining $5BN to pay down debt.  

Apollo’s investment is structurally subordinate to OKE’s debt and entitles them to around 15% of Cashflow From Operations (CFO) but with an IRR cap of 7% for nine years, rising to 7.35% in Year 10 and 7.85% in Year 15. OKE can choose to accelerate paydown on Apollo’s interest. 

Because Apollo’s investment is subordinate to all current and future OKE debt, rating agencies will treat it as equity for leverage purposes, getting OKE to 3.25X Debt:EBITDA next year. But its cost to OKE is lower than its estimated cost of equity which we think is 8-9% (JPMorgan uses a 9.25% discount rate in their NPV estimate). So this looks like an attractive source of financing. They’re financing the acquisition of a cash-flow generative asset without diluting equity owners while also reducing leverage — not easily done.  

Apollo is accepting a fixed return on an investment that has a greater claim on cashflows than common equity holders but is still subordinate to everything else. The risk of OKE’s cashflows collapsing so as to threaten its ability to pay the fixed return they’ve agreed is de minimis, but Apollo retains none of the upside of an equity investor and has no board representation or liquidation preference.  

Nonetheless, Apollo must regard this hybrid investment as more debt-like than equity because of the high probability of earning their agreed upon IRR.  

Oneok is only the most recent example of private equity investing in publicly traded midstream businesses. In July Apollo joined Blackstone and KKR when they invested $5.34BN in a Williams Companies subsidiary providing behind the meter solutions to data centers.  

In 2024, Blackstone invested $3.5BN in EQT via a hybrid structure with a fixed return.  

Transactions are often driven by a differing perception of risk/return by the two counterparties involved. Apollo’s investment in OKE accepts what rating agencies regard as near-equity risk for a bond-like return. By contrast, Apollo regards the risk as more bond-like. Although they are subordinate in the capital structure to everything except common equity, the reliability of the operating cashflows supporting their return justify it.  

More broadly, private equity firms are offering this type of financing to midstream companies because the sector itself is cheap relative to its risks. Leverage defined as Debt:EBITDA has fallen over the past decade from 4-4.5X to 3-3.5X. Capex projects are more reliably underpinned by contracted demand and are generally in energy-friendly states like Texas. Distributable cash flow yields of 9-10% are around 2X distributions. If the midstream sector was valued 20% higher, their consequent lower cost of capital would make them less appealing to private equity. This is a group of investors that thinks the sector is cheap.  

Following the Brazos announcement, Spiro Dounis who covers the midstream sector for Citigroup, raised his price target for OKE from $97 to $108. Dounis sees the acquisition supporting 6% p.a. cash flow growth over the next several years. Oneok has recently pulled ahead of the American Energy Infrastructure Index after roughly tracking it for most of the year. 

The other day an investor asked me “why now” for midstream. Regular readers of this blog may think it’s always a good time to invest in the sector – we aren’t known for trying to call the top.  

One of the strongest reasons to invest now is that the sector continues to underprice the benefits to US exporters of the continued closure of the Strait of Hormuz and the shredding of Qatar’s reputation as a reliable supplier of LNG.  

EU gas storage levels continue to run well below target. The EU has a decentralized approach that sets broad storage goals while delegating execution responsibilities to operators in each country. Clearly Dutch buyers are more relaxed or have greater risk tolerance than Italian buyers.  

The TTF European benchmark is higher than immediately following the initial US/Israel attack on Iran. LNG shipments are not getting out. The LNG carriers are specialized ships, and their owners aren’t willing to expose them to Iranian missiles. By contrast, US Energy Secretary Chris Wright reported that 17 million barrels of crude oil exited the Strait of Hormuz on Monday, with US Navy support. It’s why oil markets are reasonably balanced.  

The continued rally in global LNG prices offers a near term opportunity to Venture Global, and to a lesser extent to Cheniere whose liquefaction capacity is largely pre-sold. But the Iranian threat will remain as long as hydrocarbons are shipped out of the Persian Gulf, benefiting these two exporters as well as NextDecade.  

The long term benefit to US energy exporters of being favored because nobody is likely to fire at their terminals remains underappreciated by investors. That’s the reason to invest now.  

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

Energy Mutual Fund Energy ETF

 

Energy Markets Remain Tight

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In the United Arab Emirates, they’ve started building metal cages to protect vital energy infrastructure from Iranian drone attacks. It’s probably inspired by the netting that Ukraine has been erecting over streets to protect its population from drones.

In a sign of the impact AI is having on how we use the internet, AI-generated images of the UAE cages proliferate. They range from highly credible to dystopian. The image shown here is, we believe, a real one.

Russia has also started protecting its oil facilities with netting or other low-tech material to impede drones.

Like Russia’s invasion of Ukraine, the Iran War is drifting into a stalemate. Every week that passes with limited egress through the Strait of Hormuz serves to strengthen the market position of America’s oil and gas exporters.

The strongest evidence of the war’s limited impact is the price of crude oil, which has confounded many forecasters by remaining stubbornly below $100 and less than $15 above its pre-war level.

Crude oil is the only hydrocarbon product signaling equanimity.

Refined products such as jet fuel and diesel have remained elevated because of reduced global refining capacity. Ukraine’s attacks on Russian energy infrastructure have stopped their diesel exports, driving refining margins for others to a record high. The EIA reports that US stocks of Distillate Fuel Oil (almost all diesel) are close to the lowest in over a decade.

Middle East refineries have reduced output of many products including diesel and jet fuel because of Iranian attacks on shipping. RBN Energy reports that global refinery runs were down by 5.1 Million Barrels per Day in 2Q26 compared with the prior year.

The ongoing maritime disruption has also hurt Qatar’s exports of Liquefied Natural Gas (LNG), which are reportedly down 96%. They’ve managed 18 shipments since the war began compared with 509 over the same period last year. It’s why the European and Asian LNG benchmarks are the highest they’ve been since the conflict began, unlike crude oil.

Global LNG prices are now more than double their pre-war level. Europe’s inventories are also lower than usual for this time of year, partly because they held back on pricing in recent weeks which shifted flows to Asia.

It seems unlikely Qatar will return to previous volumes of LNG shipments anytime soon. Both the US and Iran seem content to wait for the other side to offer concessions. Trump may regard the mid-terms as a logical decision point, and could adopt a tougher stance after that with little near term political risk.

Because of this, the prospects for Cheniere, Venture Global and NextDecade are the best they’ve been in living memory. Yet the stocks remain cheaper than they were in March, when the conflict was in its opening stages.

Last week I noted that few Republicans I talk to regard the decision to attack Iran as a success. Then a client I’ve known for almost twenty years and whose opinion I respect, provided an alternative perspective. He noted that together with Israel we have substantially degraded Iran’s military, killed enough leaders that the new cohort can never feel safe, removed any imminent nuclear threat, decimated their economy and seen their neighbors further align with us due to Iranian attacks.

We’ve done all this with minimal US casualties and only a modest jump in crude. The continued closure of the Strait was not anticipated, but there has been limited negative impact on the US economy.

That doesn’t seem too bad – and it’s boosted the prospects for US energy exporters.

In recent years, the midstream industry has pivoted towards more modest projects with less execution risk. The shale boom of 2014-18 produced mixed results for investors. Then Covid briefly hit energy consumption.

Legal and regulatory impediments followed with the Biden administration, most famously with the chronically late and over budget Mountain Valley Pipeline which only crossed the finish line when West Virginia Senator Joe Manchin insisted on legislation to smooth its passage in exchange for supporting an increase in the debt ceiling.

The liquids pipelines added since 2025 in the EIA chart were all either within Texas or were expansions of existing pipelines which are generally harder to challenge in court.

There have been some bigger projects to move natural gas – notably improving takeaway capacity from the Permian Waha hub in west Texas where gas has at times traded at a negative price because of too much of it chasing limited pipeline capacity. That problem is now largely fixed, enabling more gas to power data centers and feed LNG export terminals on the Gulf coast.

Midstream’s approach to capex is very different than a decade ago. Projects are de-risked, generally smaller and have more predictable cashflows. Boring is good.

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

Energy Mutual Fund Energy ETF

 

 

 

 

Strategic Patience

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Although the war with Iran has inflicted higher energy prices on the world, companies involved in US energy exports have been among the biggest beneficiaries. The availability of oil and gas that doesn’t need to dodge Iranian missiles in the Strait of Hormuz or Houthis as it exits the Red Sea has boosted US trade. Oil exports are running at 5.7 Million Barrels per Day (MMB/D), +57% compared with a year ago.

The continuing stalemate involving low level conflict boosts the prospects for US energy exporters every week it persists. The President’s announcement of “economic warfare” against Iran suggests “strategic patience” is currently driving policy. I talk to a lot of people who voted for Trump and are happy they did so, but few have anything positive to say about the choice to go to war or the way it’s been conducted.

Nonetheless, the protracted interruption of oil and gas shipments out of the Persian Gulf is good for investors in this sector. In time Iran’s influence over world energy markets will dissipate, but building the infrastructure to reroute shipments away from the Strait of Hormuz will take years. In the meantime, US firms are well positioned to gain market share.

South Korea, Japan and India are Asia’s biggest buyers as they’ve sought replacements for what used to come from the Middle East. The Netherlands and UK have shifted from sanctioned Russian oil as Europe ever so slowly disengages from Ukraine’s invader.

Natural gas exports are also growing as additional liquefaction capacity becomes available. The US became India’s biggest LNG supplier in June, shipping 562,000 metric tonnes of LNG (almost 1 Billion Cubic Feet per Day, or 0.9% of US output). This replaced canceled shipments from Qatar. European buyers have been holding out for lower prices, causing Asian buyers to snap up extra cargoes. Europe’s storage inventories of gas are at seasonally low levels at a time when they’d normally be building up in preparation for the winter.

US natural gas production is growing to meet increased demand for domestic power generation and LNG exports. The Iran War hasn’t made a material impact because LNG liquefaction capacity is the limiting factor. Production is growing steadily as new export terminals come online.

US crude exports have also jumped in response to limited flows from the Persian Gulf.

Targa Resources (TRGP) rose 7% on Tuesday following their announcement of a twenty year agreement to provide midstream services to Exxon Mobil in the Permian basin. That’s quite a move for a company with $60BN in market cap. +59% YTD; even by the standards of midstream it’s outperforming.

It’s also interesting though unsurprising to note the growing opposition to data centers. Pennsylvania is the most recent state to impose restrictions on new construction. Politicians from both parties are finding data centers an easy target. They do little for local employment, might boost your electricity prices and then put you out of work.

On the positive side, local opposition, which is increasingly common, does strengthen the appeal of behind-the-meter solutions which deliver natural gas directly to a dedicated power plant, thus bypassing the grid. This suits Williams Companies and Energy Transfer, both of whom are offering this solution to hyperscalers building data centers.

Last week the US Treasury intervened in the bond market, causing yields to briefly drop ten basis points by repurchasing $2BN of bonds. Low rates suit the indebted, including the Federal government. It’s not that they have extra cash lying around, like a corporation recycling profits into buying back stock. Purchases are funded with increased borrowing at shorter maturities. At the margin it helps home buyers by depressing mortgage rates.

But easier credit won’t trim inflation. It’s further evidence that the Trump administration does not have a hard money ethos and will always favor lower rates now at the risk of higher inflation later. Since voters have for decades rejected policies that would rein in our fiscal profligacy, manipulating interest rates to limit the consequences seems logical.

Fed Chair Kevin Warsh has been critical of the Fed’s bloated balance sheet, enduring evidence of our partial debt monetization. Should he try to reverse this trend that began during the Great Financial Crisis, it will be his most consequential policy change. Ending Quantitative Easing will enable the full transmission of our fiscal outlook to be reflected in higher bond yields.

It may not go well and may not happen at all.

The challenge in reducing debt monetization is another reason why we believe owning assets that have embedded protection, such as pipelines with their PPI-linked price escalators on the fees they charge, is prudent (see Inflation Protection From Pipelines).

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

Energy Mutual Fund Energy ETF

 

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