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

 

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

 

Many years ago, when we were researching silver mining companies, I was fascinated to learn how insensitive production and consumption were to prices. Unlike gold, which is mostly held as an investment, silver has many industrial uses. Consumer electronics represents over a third of demand. Silver has few good substitutes and is a comparatively small part of the total cost of the products it supports. So manufacturers just pay what they must.

Most silver is produced as a byproduct of either lead, zinc or gold. As such, the price of silver isn’t a major influence on output. The result is that silver volumes aren’t that sensitive to price, which is why its price volatility is generally higher than for other precious metals such as gold.

There’s an interesting analogy with oil and gas in the US. Price forecasts for crude are bearish. The Energy Information Administration (EIA) expects Brent to average $51 a barrel next year. Goldman Sachs sees oil in the low 50s by 2H26 (see The Energetic Outlook For Energy). Brent is currently around $67.

The EIA sees only a modest impact on production, with US output falling from 13.4 Million Barrels per Day (MMB/D) this year to 13.3 MMB/D in 2026. As we noted in last week’s blog post, the EIA’s forecast production drop looks optimistic.

Upstream companies are preparing for something more dramatic. ConocoPhillips says it may lay off up to a quarter of its workforce by the end of the year. Chevron expects to cut by 15-20%. Perhaps the analysts at the EIA are wary of publishing forecasts that will antagonize the White House.

Oil wells in the Permian basin in west Texas and New Mexico produce associated gas, which means the oil/gas combination that comes out of the ground has to be separated. The oil is what they want. The region has been chronically short of gas infrastructure for years, although demand from data centers and LNG export terminals has recently spurred several new pipeline projects.

This raises an interesting problem. If crude output drops farther than the EIA expects, natural gas output from the Permian will fall too. This will occur just as demand from data centers and LNG export terminals is ramping up. It’s why the EIA expects the Henry Hub natural gas benchmark to reach $5 per Million BTUs (MMBTUs) next year, compared to $3 currently.

In a quirk of the relationship between the two commodities, softness in crude oil could drive natural gas prices higher if E&P companies respond by cutting oil output, since in the Permian this would lower gas output too.

Just as silver production can be driven by the price of gold where they’re mined together, gas output in the Permian can depend on the price of oil.

This will create an opportunity for drillers in the Marcellus and Utica shales in Appalachia which is rich in gas and natural gas liquids, therefore responsive to gas prices.

Some have warned of a glut of US LNG supply, but importing countries are building regassification terminals too. The capacity of importers is on pace to be roughly 2X the world’s liquefaction capacity. So if every import terminal operated half the time, 100% of the world’s LNG export terminals would be in use.

EQT, a gas producer, just signed a deal with NextDecade. Normally it’s the buyers of LNG who contract for liquefaction capacity, but in this case a producer wants to lock in the ability to send their US-sourced natural gas overseas.

Weak oil prices have hurt sentiment across the energy sector. Even though midstream infrastructure has limited sensitivity to commodity prices, this has probably given some potential buyers pause before committing capital. The positive natural gas outlook hasn’t provided a sufficient counterweight, perhaps because regional gas prices vary widely since transportation costs can exceed the Henry Hub benchmark.

By contrast, moving oil costs a small fraction of the price of a barrel. There’s a global crude price that commands attention while movements in regional gas prices don’t resonate as much.

US natural gas prices are low by global standards. Even at $5 per MMBTUs the spread to European and Asian LNG benchmarks will sustain the economics of gas exports to those regions. As for data centers, the other source of demand growth, they’re most concerned with reliable power and how quickly it can be delivered. The newest data centers are seeking uptime of all but three seconds a year (i.e. to run 99.99999% of the time). Solar and wind, with their 20-35% capacity utilization, are hopeless in this respect.

Oil and gas prices in the US look set to diverge.

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

Energy Mutual Fund Energy ETF

 

Now that we’re more than six months into Trump 2.0, comparisons with Trump 1.0 are spreading. For energy investors, Trump’s first term was a huge disappointment compared with the high expectations held by many when he took office. A year ago, as investors pondered the impact of a Kamala Harris presidency, we were often asked if we worried about a progressive in the White House.

In fact, Joe Biden’s presidency was far better for energy investors. His antipathy towards hydrocarbons fostered cautious capex among energy executives, a sharp contrast with the exuberant spending plans that accompanied Trump’s 2016 victory. Trump 1.0 led to overinvestment and weak prices, compounded by the demand destruction of pandemic lockdowns. Financial discipline returned during Biden.

The result was a –6.2% annual return under Trump 1.0 and a +33.8% annual return under Biden. Left wing policies inadvertently enriched traditional energy investors. However, following Biden’s debate disaster on June 27, 2024 the midstream sector continued its strong performance when polls shifted towards Trump.

Trump 2.0 has been better for energy investors than before but more volatile. A regulatory environment that once again is supportive of hydrocarbons has helped, and companies have been more cautious about spending. Oil and gas prices have fallen this year as the new administration has made clear its desire for increased production. The president’s love for hydrocarbons favors volumes over profits.

Energy executives are being more cautious than eight years ago, and the top US shale producers have mostly been cutting capex as both oil and gas prices have remained under pressure. OPEC+ is abandoning their production cuts and Trump’s efforts to negotiate peace in Ukraine are regarded as likely to bring more Russian energy exports onto the market.

By contrast, midstream companies have been increasing their planned spending, with the biggest c-corps in the sector raising 2026 capex by 44% compared with plans a year ago.

The difference is oil versus gas. Growth in electricity demand for new data centers and additional feedstock for new LNG export capacity are the twin drivers of natural gas growth. Today’s data centers will tolerate only 3 seconds of downtime a year (i.e. 99.99999% uptime) which makes intermittent renewables a poor choice. Natural gas power plants are usually the best choice, which will drive the share of our electricity derived from gas above its current 43%.

Much of the new activity is centered in Texas. Gas pipelines are being built to connect with new data centers and to feed into the growing LNG export capacity. The map from RBNEnergy shows how much energy infrastructure is being added in Texas and the Gulf coast.

Takeaway capacity for gas is being added in the Permian in west Texas. Oil wells in that region also produce “associated gas”, which means it’s not what they’re drilling for but comes out of the ground anyway. Even though E&P companies have been trimming their budgets, mature wells become gassier as they mature, so gas production won’t be as affected by reduced capex.

LNG export capacity continues to grow – most recently Venture Global announced Final Investment Decision for Phase 1 of CP2 LNG, a $15BN project that is expected to become operational in 2027.

There’s also increased activity in the northeast centered around gas production in the Marcellus shale.

Some may identify parallels with 2016 when the energy sector geared up for more production and throughput, pulling back as investors soured on growth that wasn’t accretive. The big difference today is that long term commitments are underpinning both the new LNG terminals and the additional gas pipeline capacity.

Leverage of 3-3.5X Debt:EBITDA is lower than the 4-5X that was more common eight years ago. Kinder Morgan’s credit rating was recently upgraded by Fitch based on their expectation that leverage would remain below 4.0X.

2Q25 earnings across the sector generally came in as expected with no great surprises.

Many years ago pipelines were organized as Master Limited Partnerships (MLPs), free from corporate taxes in exchange for complicated tax reporting for those wealthy US investors so inclined. As most of them converted to a conventional corporate structure (“c-corps”), they accepted a corporate tax liability in exchange for accessing a broader investor base.

Helped by depreciation rules that understate the true useful life of their assets, taxes have remained low. For the selected US c-corps in the chart, their average estimated tax rate this year is only 5%. It’s not expected to increase meaningfully until 2028 and compares favorably with the average tax rate paid by S&P500 companies of 25%.

The One Big Beautiful Bill (OBBA) cut rates by an average of 4% for E&P companies and likely had a similar effect on midstream as well. Weak energy prices may have weighed on the sector this year, but at least tax policy is allowing investors to retain more of the profits.

It’s another reason we think midstream energy infrastructure offers attractive prospects.

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

Energy Mutual Fund Energy ETF

 

 

The other day I listened to an interview with the CEO of Anthropic, Dario Amodei, on an Economist magazine podcast. Anthropic is in AI safety and research. They write large language models for sectors including healthcare and financial services. Many people think AI will create such fundamental change that it will eliminate jobs across large swathes of the economy.

Anthropic takes their role in this type of creative disruption seriously. They even have a Philosopher-in-residence, Amanda Askell, whose job it is to think about such things. Preparing for this new world, she says that employment should not be the only way we measure our worth.

Worrying publicly about the mass unemployment the success of your company will cause may be a smart way to excite investors about your business prospects. It may also be the height of hubris at a market peak, depending on your perspective.

That AI offers enormous promise is undeniable. Healthcare stands ready for a revolution in diagnostics as AI models assimilate hundreds of millions of case histories, test results, x-rays and outcomes to encompass the medical sector’s collective experience. There can be no greater benefit to humanity than enabling longer, healthier lives.

Will such revolutionary change slash healthcare employment? Many think it will. I’m not convinced. I doubt patients will accept a diagnosis from a computer, other than perhaps for conditions that can be treated today at an urgent care center. I see AI as increasing the tools available to health care professionals. Your doctor will interpret results from a model, or perhaps multiple models. The returns to education will increase.

I don’t think AI will replace financial advisors. People are not going to trust their health or their money to an algorithm, even while the management of both will increasingly rely on professionals using these tools.

Would an AI financial advisor have overweighted AI stocks? Or LNG exposure? Any credible portfolio construction must be designed for at least one business cycle of 5-10 years. With 100-150 years of historical market data, there just aren’t enough non-overlapping time segments to train a model.

Legal risk seems a prosaic impediment to the AI revolution. Humans make mistakes all the time. When doctors or financial advisors deliver unacceptable outcomes, they get sued, but the consequences are limited to the individuals involved. These are idiosyncratic risks. If an AI model replaced a whole class of professionals, it would introduce systemic risk.

Flawed diagnostics or improper portfolio construction could impact thousands of people simultaneously. Class action lawsuits would follow, targeting the deep pockets of the software companies who built the model. Plaintiffs might even use AI to identify patterns of damaging medical care or investing.

If this seems implausible, note that Tesla just suffered a Florida jury award of $243 million for an accident in 2019 involving their autonomous driving software. Last year over 39,000 Americans died in auto accidents, overwhelmingly due to human error. People drive recklessly and make mistakes all the time.

Autonomous vehicles could cut this dramatically. Society accepts 39,000 deaths because each was caused by the idiosyncratic risk of different individuals. If Tesla’s AutoPilot cut this by 99%, lawsuits from families of the 390 remaining fatalities would bankrupt the company, even though thousands of lives had been saved. Without legal reform, the move from idiosyncratic to systemic risk will create exposures to corporations that in America’s litigious society will be ruinously expensive.

The standard of competence of an AI model needs to approach flawlessness, exceeding the average human professional by orders of magnitude.

I love how Google search results using AI are so improved and relevant. In the 1980s and 90s when I was trading interest rates, I often put on a yield curve trade in the late summer to exploit a seasonal tendency for it to flatten in the fall. I asked Google if this pattern still exists and learned it does. Old Google would have hunted for relevant websites that didn’t properly address the question. Or I would have downloaded years of historic data and spent hours building a spreadsheet to answer the question myself.

December ‘26 SOFR futures yield less than December ‘27 SOFR futures, suggesting rates will come down next year and then move up the year before the election. I think it’s more likely that rates in two years will be lower than next year.

Trump’s continued bashing of the Fed is counterproductive in the near term. Any rate reduction needs to be unambiguously supported by the data to avoid the appearance of lost independence. They’ll move slowly.

But over time Trump will probably bully the FOMC into partial submission. Tariffs and immigration policy may by then be hurting growth. Complaints that tight monetary policy is keeping US interest expense intolerably high, because we owe so much, will be more widespread.

I think the short Dec ‘26/long Dec ‘27 spread trade is worth doing.

If you’re concerned about monetary policy taking more risk with inflation, as President Trump would like, you should own real assets. We think midstream energy infrastructure, with price hikes often linked by regulation to PPI, offers good protection in such a scenario.

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

Energy Mutual Fund Energy ETF