SL Advisors Talks Markets

Life Is Better After Greta

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Life after Climate Change: Better than you think by Bjorn Lomberg was recently published in the National Review. Lomberg has published several books arguing that climate change isn’t the existential disaster often portrayed in the media. His most recent is False Alarm: How Climate Change Panic Costs Us Trillions, Hurts the Poor, and Fails to Fix the Planet. He offers a thoughtful counter to that wretched young woman Greta who lectured us from the UN in 2019 (“How dare you?”). Her star has been falling ever since, with occasional news coverage only when her protests lead to an arrest.

The National Review article and two other pieces were brought to my attention by a long-time client and friend as examples of unconventional thinking that deserve more widespread dissemination. Lomberg harnesses facts to present a future unlikely to be catastrophic. He notes that global hurricanes last year were the second weakest batch since 1980 when satellites began capturing data. The UN Climate Panel expects strong hurricanes to increase by 10-20%. Annually, they cause damage worth 0.04% of GDP, a figure expected to continue falling. A richer world will have more property to damage but will also be better able to afford resiliency to protect lives and assets.

Heat deaths have been rising, but globally 8X as many people die from cold, which makes blood vessels constrict to maintain warmth for internal organs, driving up blood pressure. It’ll sound flippant, but I spend much more money and effort avoiding cold weather, by spending most of the winter in Florida. I like 90 degrees. If we faced global cooling I would be far more agitated. The prospect of glaciers returning to New Jersey would be a deterioration in quality of life hard to pin on the state’s Democrats.

Lomberg goes on to note that the % of land burned in forest fires has been falling from around 4.2% in the early 1900s. And that improving living standards will reduce malnutrition. Higher energy prices and reduced access to fossil fuels will directly impede this process. For good measure he adds criticisms of solar and wind that will be familiar to regular readers (intermittency; low energy density; heavy reliance on steel and concrete). Lomberg doesn’t dispute that rising CO2 levels will cause warming, but he advocates assessing the costs and benefits of different policies, something rarely heard from climate extremists.

The UN advocates for energy policies that will constrain planetary warming to 1.5 degrees Celsius above 1850. Today we’re only 0.4 degrees away from that theoretical threshold at which disaster becomes unavoidable. Modelling the climate is complicated and precise forecasts aren’t credible. We should address the risk but human lives are at stake from impetuous liberal energy policies too.

Mark Levin’s American Marxism includes text from AOC’s Green New Deal to remind how far left policies on climate would lead to Federal control of vast parts of the economy via an army of new bureaucrats spending $TNs. The Green New Deal’s preamble asserted disproportionate harm to “indigenous communities, communities of color…women”. For more detail of its shortcomings, see The Green New Deal’s Denial of Science and The Bovine Green Dream.

Bjorn Lomberg cites a study showing that cheap US natural gas had allowed poorer households to be better heated, saving an estimated 11,000 lives each year.

A monthly newsletter by Stephen Leeb (The Complete Investor) was the third piece shared by my friend. Leeb makes the case for higher long term crude oil prices, arguing that global demand will inevitably keep rising because of emerging economies led by China, and that current prices imply unrealistic assumptions about future supply growth.

Research from Goldman Sachs shows that the increased costs of developing large new oil reserves has reduced capex and average reserve life while also driving up break-evens. The industry’s investment has been in a down cycle for almost a decade. US shale led to lower prices and convinced companies to curb spending. The ESG movement made big public companies sensitive about supplying what amounts to 80% of the world’s energy. The consequent increase in free cash flow has been good for shareholders. Hug a climate protester.

But Russia’s invasion of Ukraine made the EU consider energy security for the first time in living memory. Renewables have delivered hype but not yet made a meaningful dent in the global energy mix. Today even European companies like Shell are increasing their investments in reliable energy, following their American peers in the hope of recouping recent stock underperformance.

The views expressed in the writings shared by my friend have always represented pragmatic realism. As they become more mainstream we’ll all benefit from more balanced climate policies that consider cost-benefit tradeoffs. The tiresome Greta is becoming an anachronism, reflecting all that is bad about the extreme climate movement.

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

SL Advisors Talks Markets

Sending More Carbon Back Underground

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Last year’s Inflation Reduction Act (IRA) raised the tax credit for CO2 that’s permanently buried underground. Some CO2 is used in Enhanced Oil Recovery (EOR) to help push crude out of mature, low pressure wells. It can then be pumped back into the well for permanent storage. This is Carbon Capture, Use and Sequestration (CCUS). The IRA tax credit for CCUS via EOR is $60 per metric tonne. There are still some sources of naturally occurring CO2 that are tapped for EOR, a counterintuitive process that IRA tax credits will likely cause to be phased out.

Burying CO2 without using it to produce fossil fuels is more in keeping with the spirit of climate change, and so Carbon Capture and Sequestration (CCS) draws larger credits than CCUS. The biggest credit goes to CCS that extracts CO2 out of the ambient air, called Direct Air Capture (DAC). CO2 exists at about 412 parts per million and is fairly evenly distributed. DAC is expensive, but the IRA’s $180 per tonne credit is enough to justify private sector investment. Extraction facilities can be placed wherever is convenient – such as above a geological formation that used to hold hydrocarbons.

There’s a beautiful symmetry here, in that carbon atoms are first extracted as hydrocarbon molecules. For example, natural gas (methane) is CH4. Their combustion causes the carbon atom to break from its hydrogen atoms and recombine with oxygen, forming the CO2 atoms whose increasing presence is a main driver of concern about global warming. Some of the best places to permanently store CO2 molecules are where CH4 molecules and other hydrocarbons were originally found deep underground.

The map is unfortunately a little grainy, but nonetheless makes clear that CCUS projects are either linked to old oil/gas wells by CO2 pipelines or sit directly above them.

Energy infrastructure investors should care about this for two reasons. One is that carbon capture offers a new revenue source, since the pipelines and other hardware required are owned and will be built by existing midstream businesses. Enlink is especially well positioned, since they have a significant presence in Louisiana moving natural gas to the state’s petrochemical industry. Providing transport for the CO2 byproduct back to the geological formations that sourced the hydrocarbons is a good fit.

The second reason is that increased use of carbon capture enhances the benefits of traditional, reliable energy versus solar and wind. In all of human history we’ve never transitioned to a form of energy that  is less reliable and takes up far more space than what we’re already using. Solar panels and windmills are a regressive step in many ways.

Cheap natural gas and IRA tax credits are a potent combination that is drawing industries to the US. OCI, a Dutch fertilizer company, is building a $1BN ammonia plant in Texas that will capture 95% of the emissions generated by its process. Ammonia is widely used to produce fertilizer, one of Vaclav Smil’s four pillars of civilization (along with steel, cement and plastic).

The “blue” ammonia OCI will produce costs $119 per metric tonne more than conventionally produced ammonia. But they estimate that the IRA tax credits will be worth $145 per tonne. It’s a perfect example of why European businesses are being drawn to America.

German politicians have drawn comfort from the drop in industrial energy use following Russia’s invasion of Ukraine. Some credited conservation measures by energy-intensive manufacturers, but the data shows that a drop in output is the real explanation. America’s energy policies unlocked cheap oil and gas. European companies such as OCI are investing here because of that. German energy policies led to enormous investment in windpower and neglected natural gas because they thought Russia would maintain supply until it was no longer needed. They have the world’s most expensive electricity as a result, with any reduction in CO2 emissions swamped by China’s consumption of half the world’s coal. German energy policies are a catastrophe.

Berkshire Hathaway continues to lean into the wind by increasing its traditional energy investments. Most recently Buffett invested $3.3BN for 50% of the Cove Point LNG plant, adding to the 25% already owned via Berkshire Hathaway Energy. He obviously sees a bright future for exports of US natural gas.

Lastly, the Mountain Valley Pipeline (MVP) saga took another turn with the US Court of Appeals for the Fourth Circuit’s decision to halt construction in response to a lawsuit filed by the Wilderness Society. The suit concerns a 3.5 mile construction corridor through the Jefferson National Forest. Even an act of Congress specifically approving MVP has been insufficient to break through the legal obstacles. Infrastructure permitting in the US is a mess.

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

SL Advisors Talks Markets

Celebrating The 4th of July

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Independence Day is a wonderful holiday. It involves being outside in warm weather with the family to eat and watch fireworks. What’s not to like? Perhaps more than at any other time of the year, Americans rightly feel pride at our great country. As a transplanted Brit for now 41 years, my riposte to the inevitable jokes about a long-ago war is to point out that if it had gone the other way I wouldn’t have moved. 

Ronald Reagan was my first president, and his sunny optimism has seemed right ever since. I have a small bust of him on my desk. He would chuckle to know that it was picked up at the Truman Little White House in Key West gift shop, a Republican memento bought at a museum honoring a Democrat president.  

At the 1992 Republican National Convention, former President Reagan said “America’s best days are yet to come.” Two years later in his poignant letter disclosing Alzheimer’s he ended with the same sentiment. Warren Buffett shares Reagan’s consistently positive outlook, but negativity is all too easily found in the media. As we argued recently, it doesn’t fit the facts (see So Many Pessimists).  

In April, The Economist declared that America’s economic outperformance is a marvel to behold. There’s no bad time for this view but rereading it while contemplating an afternoon of bbq then pyrotechnics will make a thoroughly agreeable day even better.  

The charts date back to Reagan’s time in office and his 1992 speech. There were plenty of reasons then to dismiss such simplistic optimism. In 1989 Paul Kennedy published The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500 to 2000. It remains an insightful history of how economic might usually drives military power (the EU is a notable exception). Eventually empires sink under the weight of maintaining global hegemony. But Kennedy’s prediction that Japan would eventually supplant America at the top of the economic pyramid was spectacularly wrong.  

China is our strategic competitor. But their economy is still only three quarters the size of ours with four times the population. And ominously, that is now declining. I like our chances better than theirs. And as far as where I’d rather live – well, let’s just say it’ll be a cold day in hell before China is fending off hordes of western immigrants seeking a Chinese lifestyle.  

In 1982 when I moved to the US, I left the UK’s GDP per capita of $10K for America’s $14K. Today’s figures are $46K and $80K. Decades of lower productivity capped with the self-destructive if understandable Brexit vote have taken their toll. British living standards have slipped behind Germany’s. Relative to the US, UK households are as far behind today as Italy was in 1980. Few would have made that bet. Vindication of a decision to emigrate 41 years ago relies on more idiosyncratic metrics. But, as in trading, it’s important to go with the major trend.  

The data also reflects American exceptionalism because nobody else has been able to keep up. Our problems include fiscal profligacy, a poorly functioning electoral process heading for a rematch of two polarizing old men that nobody wants, and wokeness out of control. We’re managing to overcome all those headwinds. Whatever problems we have are self-inflicted, and not insurmountable.  

We love our flags in America. In England the Cross of St George has replaced the British Union Jack at sporting events. The united kingdom is less so nowadays. Brexit exposed that the Scots would prefer to be run out of Brussels than London. They even root for England’s opponent in the World Cup. If a vote on Scottish independence was held in England they’d be sent packing. 

The British flag was on full display during Charles III’s coronation, and his mother’s funeral last year. It’s flown on special occasions. But normal British reserve constrains such overt patriotism.  

America is different. The waterway behind our shore house in Point Pleasant, NJ shows a flag at every home. These don’t just fly on Independence Day, but on every day. Ours is on the left. Proud of my English heritage, I originally added the Cross of St George appropriately positioned below our Stars and Stripes. Regrettably it was made from cheaper material that a few months of coastal breeze turned ragged. It had to be retired. Our American flag is indefatigable. Like America.  

Happy Birthday America.  

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

SL Advisors Talks Markets

Using More Of Every Energy Type

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On Monday the Energy Institute (EI) published the 72^nd edition of the Statistical Review of World Energy. BP handed off this responsibility last year. They probably felt that saying anything about energy consumption would inflame climate extremists without commensurate benefit.

The EI launched the publication with a webinar, which predictably was both upbeat on renewables while lamenting their slow penetration. The interesting data in the review mostly concerns fossil fuels, which one panelist complained remain at 82% of primary energy consumption despite renewables being cheaper. Unspoken was that it might be the result of a conspiracy by energy companies to willfully deny themselves the higher profits widespread solar and wind could provide. Or maybe they’re just not cheaper.

Renewables (defined to exclude hydropower and now four fifths solar and wind) nonetheless reached a 7.5% share of the world’s primary energy consumption last year, up almost 1%. China is the biggest consumer of renewables power at 29% of the global total. They’ve grown their consumption at almost 25% pa over the past decade. China provides many energy superlatives.

Some may be surprised to learn that global natural gas consumption fell 3% last year, but this was a demand response to Russia’s invasion of Ukraine. Prices paid by Europeans jumped as much as threefold, and in Japan almost doubled. US prices rose too but remain far below other global benchmarks.

The result was that natural gas consumption fell in every region of the world except the US, where it rose 5%. The US consumes 22% of global output and is also the biggest producer with a 24% market share.

Regular readers are familiar with the growth in US Liquefied Natural Gas (LNG) exports, up from almost nothing a decade ago to 104 Billion Cubic Meters (BCM) last year. Global trade in LNG used to be dominated by Asia, but last year European LNG imports rose 57%. The global LNG trade reached 542 BCM, up from 516 BCM the prior year with a ten year Compound Annual Growth Rate (CAGR) of 5%. Japan replaced China as the top LNG importer as the Chinese lockdown slowed domestic economic activity. However, China is expected to displace Japan this year or next. Increased LNG typically reduces coal demand, a goal most will find desirable.

Coal consumption grew slightly, although surprisingly not in Europe in spite of their need to replace Russian natural gas. Energy conservation and slower growth caused overall energy consumption to dip in the EU, while sanctions had a similar effect on Russia. China continued to burn over half the world’s coal, increasing slightly from 54.6% to 54.8% of global consumption. This is 9X the US, where consumption has been declining at a 5.5% CAGR.

The best news on China is its continued growth of nuclear power, which has a 15% CAGR over ten years. The US remains the global leader in nuclear, producing roughly 2X the output of China. But this lead will shrink as China continues to build new power plants.

The climate change debate pits OECD countries with high living standards against developing countries whose desire for western lifestyles requires more energy use. US per capita energy consumption is 2.5X China’s and an astonishing 20X Africa’s. Our figure is flat over the past decade, while for the non-OECD countries the ten year CAGR is 1%. Poorer countries still have a lot of catching up to do.

Our CO2 emissions from energy have a ten year CAGR of –0.5%, compared with 1.6% for China. If CO2 levels eventually reach a point that harms the planet, it’ll be because China’s emissions were the tipping point.

If you care about US natural gas consumption and exports, the review was full of encouraging realism.

The world’s major energy companies are confirming the long term future of natural gas with their spending decisions. The forecasts of declining global consumption are what’s required to hit increasingly unlikely net-zero emissions targets, such as the IEA Net Zero Outlook in the chart.

China keeps signing long term LNG purchase agreements, including one recently with Qatar. On Monday China’s ENN Natural Gas’s Singapore subsidiary signed a 20+ year deal with Cheniere. Shell’s CEO recently told investors “Liquefied natural gas will play an even bigger role in the energy system of the future than it plays today,”

This all fits well with America’s growing dominance in the global LNG trade.

The US Energy Information Administration (EIA) warned that much of the country is at risk of energy shortfalls this summer. US power generation has grown at 0.5% pa over the past decade, so the problem isn’t caused by soaring demand. But solar and wind edged up to 15% of electricity generation last year, from 14% in 2021. Their intermittency is increasing our risk of power outages. The eastern part of the country is assessed as low risk, so living in NJ has its good points. But if your air conditioning doesn’t work when you need it in July, blame the climate extremists.

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

SL Advisors Talks Markets

Stocks Aren’t Cheap

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The Equity Risk Premium (ERP) is a measure of the relative attractiveness of stocks versus bonds. It compares the earnings yield on stocks with the interest rate on ten year treasury notes. For much of the past decade it’s shown stocks to be relatively attractive compared to the average relationship going back to 1962 – of no particular significance also my entire lifetime.

Quantitative Easing (QE), first unveiled with acute insight by Fed chair Ben Bernanke during the Great Financial Crisis (GFC) and abused by successive Fed chairs ever since, made bonds unattractive. QE has evolved from a unique solution to a banking crisis into a form of partial Federal debt monetization. The problems facing regional banks trace their roots to many banks mistakenly concluding that if the Fed was loading up on long term bonds that must make it acceptable to do so. This suspension of critical thinking exposed the absence of competent risk management. America’s more than 4,000 banks have a greater need of chief risk officers than the pool of qualified candidates can supply.

Since the founding of your blogger’s firm, SL Advisors, in 2009, stocks have represented the only meaningful source of return. Bonds have had some good years because the Fed has more or less adopted permanent QE, at least judging from their balance sheet. Repeated promises to kick the QE narcotic habit have done little more than impose a brief pause in the inexorable growth of the central bank’s bond holdings.

The Fed’s eventual zeal to vanquish inflation has over the past year or so improved the relative appeal of bonds. But fixed income investors must still compete with return-insensitive foreign central banks, pension funds with inflexible investment mandates that require bonds, and our own Federal Reserve with its bloated [$8TN] in holdings. Bonds are a long way from cheap. Ten year yields of 3.75% remain inadequate compared with long term inflation unlikely to return to 2% and a Debt:GDP ratio heading relentlessly up. But some might agree that yields on shorter maturities justify the discerning investor in considering modest exposure. Treasury bill yields above 5% almost seems like a fair return, provoking nostalgic recollections of the time value of money and the “float” banks make on the days required in processing checks.

Last year we responded to the lethargy with which Charles Schwab Bank and its peers raise deposit rates by sweeping client cash into two year treasury notes. More recently our Florida homeowners’ association moved its funds in excess of working capital out of a parsimonious 2% bank “savings” account and into the glorious bounty of 5.25% 90-day treasury bills.

In April when we last examined the ERP, we concluded that stocks were not cheap. Behavioral finance teaches that overconfidence afflicts too many investors. Opinions come with much wider confidence intervals than are usually acknowledged. Humility among investors is acquired while learning this, if fortunate at only modest expense. There are many ways to value the market, some of which probably make it appear cheap. The ERP is not a secret.

Since April, earnings forecasts have stopped falling. This stabilization has offered hope that the recession promised for later this year will be postponed, helping propel stocks higher. The yield curve has similarly responded. At one point during the demise of Silicon Valley Bank, traders were betting on a Fed Funds rate below 3% by the end of next year, suggesting a cut of almost 2%. More recently, Fed chair Powell’s warning of a couple of years before rates come down left many unconvinced. But traders have shown him enough respect that the ignominy of a premature capitulation on inflation has been quietly shelved.

Stocks have looked beyond the end of declining earnings forecasts and anticipate upward revisions. Expected growth in profits for next year has moved above 10%. However, when stock prices and bond yields rise together, the inevitable casualty is equity valuation. Whatever you thought in April, an S&P500 at 4,400 is less appealing than the 4,100 of two months ago.

We’re not about to eschew stocks to become bond investors. There’s no alternative to equities for investors who wish to preserve their capital’s purchasing power. Tactically switching out of stocks and back in requires two good timing decisions. Taxes on realized gains make it even harder.

At the risk of repeating an admonition frequently offered on this blog, midstream energy infrastructure stocks remain dirt cheap. Ample dividend coverage, continued financial discipline and pipeline tariffs that are often linked to inflation make this a sector whose entry needs no skill at market timing. We’re not selling anything.

But for the investor with cash to invest in the broader market, we’d suggest that the need for action is not urgent. Today’s entry point is likely to be available again, and perhaps better ones too.

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