Episode Archive - Page 2 of 41

Cheaper AI Probably Means More

February 2, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Cheaper AI Probably Means More

00:00 / 00:05:23

Following Monday’s “sputnik moment” for AI the market has had a few days to consider the ramifications of DeepSeek’s apparent breakthrough. Mark Zuckerberg reaffirmed Meta’s plans to spend $60-65BN on data centers. They have embraced an open-source approach to AI, believing that sharing code freely will drive penetration. Since DeepSeek also published their code any insights will spread to other platforms.

On Tuesday Chevron announced plans to partner with GE, Vernova and investor Engine No 1 to build gas-powered data centers. So far there’s little sign that capex plans are being trimmed, although as Zuckerberg noted it’s still too early to judge the full impact of DeepSeek.

Meanwhile Microsoft (MFST) is probing whether DeepSeek improperly used OpanAI’s proprietary model to improve its own. Energy investors are educating themselves on the power needs of AI.

Wells Fargo trimmed their forecast of the long term boost to US natural gas consumption from 12 Billion Cubic Feet per Day (BCF/D) to 11 BCF/D in 2035. Although directionally it’s not what energy investors would like, an 8% revision a decade out comes with substantial uncertainty.

In 1865 British economist William Jevons observed that improved efficiency in coal use led to greater consumption. Appropriately I asked ChatGPT to explain: … as technology improves the efficiency with which a resource is used, the overall consumption of that resource may increase rather than decrease.

Jevons Paradox simply means if demand elasticity exceeds supply elasticity consumption will rise, something taught in every beginner’s Economics class. This prompted MSFT CEO Satya Nadella’s tweet that the same effect might add a further boost to AI use.

We’ll just have to monitor developments in the months ahead.

Meanwhile the LNG export story continues to unfold positively. Morgan Stanley has buy recommendations on Cheniere and NextDecade (NEXT). They have a $10 price target on NEXT assuming Train 4 is completed, but they go on to add that they also expect Train 5 and that would push their price target to $15.

FERC is expected to issue their preliminary supplemental Environmental Impact Statement (EIS) by the end of March with the final one in July. Current expectations are for the issue to be resolved by the end of the summer.

Last year environmental extremists persuaded a judge to issue a stay on the original EIS that NEXT had relied on to move ahead with the project (see Sierra Club Shoots Itself In The Foot). It’s hard to see how the world gains from being denied cheap US natural gas. It makes energy more available to those without in emerging countries and provides a cleaner alternative to coal.

For example, India is boosting its use of domestic coal for power generation while it reduces imports, hitting another record high for coal-derived electricity last year. Renewables boosters continue to assert that solar and wind are the cheapest form of power generation, while developments relentlessly show the opposite. High renewables penetration comes with higher prices.

The Alerian MLP ETF (AMLP) is losing another constituent as the remaining outstanding shares of Enlink are absorbed into Oneok (OKE). This follows a well-established trend of publicly traded partnerships going away and the pipeline sector increasingly being made up of conventional c-corps, a trend we’ve noted since 2018 (see Are MLPs Going Away?).

For investors in MLP-dedicated funds it exacerbates the problem of concentration (see AMLP Is Running Out Of Names). This is compounded by their costly non RIC-compliant structure (see AMLP Has Yet More Tax Problems). Add to these shortcomings that MLPs are generally more involved in crude oil than natural gas, which left many of them bystanders to last year’s big story (see There’s No AI in AMLP).

We are having more conversations with investors about ways to avoid these three problems.

Lastly, at the time of writing the White House is preparing to impose tariffs on imports from Canada and Mexico. US refineries are configured to process Canadian heavy crude more readily than the light crude that comes from shale formations. Concern about tariffs is more prevalent outside the country than here, which suggests who’s more vulnerable.

Canada’s Energy Minister Jonathan Wilkinson reminded listeners on a recent Politico Energy podcast that tariffs on Canadian crude will increase US gasoline prices, especially in the mid-west where refineries import Canadian crude. He also suggested that Canada might slow exports of hydro-based electricity from Quebec to northeastern states and natural gas to the Pacific northwest. This is ironic, since both regions have robust political commitments to renewables and are generally blue states.

Trump has suggested that oil imports may be exempted from the tariffs. There’s little apparent concern among US energy companies about the potential for economic disruption. We’ll see how it plays out, but the US looks to be in a strong position.

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

Energy Mutual Fund Energy ETF

Pipelines And The Jevons Paradox

January 29, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Pipelines And The Jevons Paradox

00:00 / 00:05:49

Venture capitalist Marc Andreessen called it, ”AI’s sputnik moment.” The news that Chinese start-up Deepseek may have leapt ahead of the US in AI caused an unpleasant start to the week. In 1957 Sputnik’s orbit led to the creation of NASA and fears that Russian satellites could attack the US from space. While Americans have not yet been moved to gaze skyward for Chinese AI-powered threats, its impact was felt by AI-linked sectors of the stock market.

Natural gas pipeline stocks that have enjoyed a tailwind from anticipated data center power demand dropped sharply. At such times it’s worth reviewing valuation and the underlying fundamentals.

The yield on the American Energy Independence Index (AEITR) recently fell below 5% as pipeline stocks continued to appreciate. Last year’s 45% total return was well in excess of cash flow growth but yields at the start of last year were unreasonably high.

Distributable Cash Flow (DCF) yields on the largest pipeline stocks are above 11%, providing ample payout coverage. Some of the lowest-yielding stocks have the highest coverage. For example, Williams Companies yielded 3.6% after its stock dropped almost 10% on Monday. But its DCF yield rose to 7.8%, more than 2X its payout and expected to grow at 7-8% into 2026. They raised their dividend on Tuesday by 5.6%. Kinder Morgan’s (KMI) yield rose to 4.2%, also more than 2X covered by its 8.6% DCF yield.

The data center story boosted both stocks over the past year. Even so, last week’s KMI earnings call was not dominated by AI expectations, with only a couple of questions on the topic which CEO Kim Dang referred to as, “singles and doubles, connecting to power plants, that types of things.”

Energy Transfer’s yield rose to 7%, higher than the sector since it trades at an MLP discount. Its DCF is almost 2X its payout yield at 13.9%. On Monday they announced a 1.6% increase.

Investors will want to assess how much data center power demand is reflected in current valuations. The capex numbers being floated for construction have been startling. Just last week Mark Zuckerberg said Meta could spend up to $65BN this year to achieve its AI goals.

Microsoft (MSFT) expects to spend $80BN this year on data centers. Meta’s stock even rose on the news, as investors contemplated that less compute-intensive AI development could boost free cash flow.

MSFT CEO Satya Nadella tweeted that the Jevons’ paradox could apply, in which efficiency improvements raise overall demand. Perhaps a breakthrough in training AI models will boost their penetration, which could drive power demand even higher than recent projections. DeepSeek’s insights will spread across the industry since it’s open source. It seems incongruous to conclude that better AI will reduce its use or its demand for reliable power.

Wells Fargo expects that the computational improvements demonstrated by DeepSeek will slow near term power demand but still sees 11 Billion Cubic feet per Day (BCF/D) of additional natural gas consumption by 2035, down modestly from their previous forecast of 12 BCF/D. Still, it’s not often that a single news development results in an altered ten year outlook.

It’s worth remembering that data centers only caught investors’ attention last year. The outlook for natural gas demand was already strong based on rising living standards in developing countries. LNG offers both sellers and buyers flexibility versus pipelines, and the US is increasing its lead as the #1 exporter.

The world is preparing to buy more. Regassification capacity, which enables importers to turn LNG back into a usable gaseous form, is growing faster than supply. For every Billion Cubic Feet (BCF) the US exports, there will be 2 BCF of regassification available. These projects were not predicated on data centers. The fundamentals for traditional energy remain sound.

Enduring such market corrections is never pleasant. They’re rarely over in a day, but history shows that eventually judgment on valuations prevails and prices respond. One good development is that forced selling from MLP closed end funds isn’t likely to depress prices much. These hapless managers including Tortoise, Kayne Anderson and Goldman Sachs destroyed enough capital during the pandemic-induced collapse that they’re now of inconsequential size (see MLP Closed End Funds – Masters Of Value Destruction).

Recent market action reminds why adding leverage to an undiversified portfolio of stocks simply betrays the hubris of the portfolio manager at the expense of the investors.

The worst performance came from Venture Global which began trading on Friday after pricing its IPO at $25, which we felt was too high (see Nothing Ventured, Nothing Gained). On Tuesday it traded below $18, down 28% over two days and far worse than AI darling Nvidia.

Regardless of the outlook for domestic power demand, growing US gas exports will require a doubling of the natural gas pipelines supply to liquefaction terminals over the next four years. The regulatory environment will be more conducive to growing the production and movement of hydrocarbons. Energy is the president’s favorite sector.

AI is far from the whole story.

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

Energy Mutual Fund Energy ETF

Nothing Ventured, Nothing Gained

January 26, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Nothing Ventured, Nothing Gained

00:00 / 00:05:13

One source of recent volatility in midstream has come from a stock that wasn’t even listed – Venture Global (VG), the LNG exporter whose IPO priced on Thursday. The fundamentals could not be more positive. Trump has reversed the LNG export pause, wants US energy dominance and asked our trading partners to buy more American oil and gas. It’s hard to conceive of a better environment to launch an LNG IPO.

VG rather overplayed their hand though, originally seeking a valuation of over $100BN, double Cheniere’s (symbol: LNG) who handles half of all US LNG exports.

As investors contemplated VG’s proposed valuation, the effect was to highlight how cheap Cheniere is. Its stock duly rose, along with NextDecade (NEXT), a company we like that is building its first LNG export terminal.

Underwriters found quite a pushback from potential buyers on VG’s lofty pricing, and repeatedly lowered the target range. On Friday it priced at $25 – far below the mid 40s valuation underwriters had been suggesting a week earlier. Gains in other LNG stocks quickly evaporated. LNG and NEXT have gyrated without any actual trading in VG.

We still think the IPO price for VG is high – or more accurately, we think it highlights how cheap Cheniere is, at around 11X EBITDA vs 14X for VG. IPO buyers should still prefer these two stocks in our opinion.

VG also has a mixed reputation with its customers. While they have the same type of long-term sale-purchase agreements common to the industry, the spike in global natural gas prices following Russia’s invasion of Ukraine enabled them to delay commissioning of their Calcasieu Pass terminal. Although the facility was exporting LNG, VG said it wasn’t yet fully operational, and they were therefore not bound to supply gas under the long term contracts. Instead they sold supplies on the spot market, reaping $BNs of additional profit.

Shell, BP, Galp and Repsol initiated arbitration proceedings claiming that this gas should have been supplied to them. The plaintiffs claim VG improperly gained $3.5BN. This dispute is a risk factor in VG’s S1 filing with the SEC.

It seems that Shell and the other buyers are guilty of not negotiating a tight enough contract. VG offered attractive liquefaction pricing, and perhaps the buyers accepted more delivery risk as a result. VG also took an aggressive interpretation of their obligations, evidently surprising their customers. It looks like VG’s CEO Michael Sabel is cut from the same cloth as Energy Transfer’s chairman and former CEO Kelcy Warren. It’s great to be in business with him as long as you’re sure your interests are aligned (see from 2018: Energy Transfer: Cutting Your Payout, Not Mine).

Last week in Naples, FL was miserably cold, a condition that drew little sympathy from family and friends enduring single digit morning temperatures in the northeast. The freezing weather once again showed the importance of reliable, dispatchable energy. The PJM grid, which extends from NJ to Illinois and Tennessee used record amounts of natural gas to generate the electricity customers needed to stay warm.

The claims of climate extremists that solar and wind are cheaper than traditional energy have been thoroughly discredited. Opportunistic power that’s only available when the weather co-operates requires natural gas back-up. This surplus capacity raises costs, as the chart from Bjorn Lomborg illustrates.

It’s fortunate that in the US progressives haven’t done any lasting damage with their policies, other than in a few liberal states such as California, Massachusetts and New York. Our friends on the Jersey shore are certainly happy that plans for offshore windpower appear to have stalled.

Some solar and wind can work as long as a grid doesn’t become too reliant on them. At low levels they can drift in and out of the supply mix. Dependence is costly.

It’s one of the reasons the FT wrote Davos hits ‘peak pessimism’ on Europe as US exuberance rises. Former climate czar John Kerry made time to fly there in his private jet to talk about climate change. The European energy policies that he no doubt admires prompted Christine Lagarde, president of the European Central Bank, to say it was “not pessimistic” to say that Europe was facing an “existential crisis”.

Lastly, the FT wrote something we’ve long noted – US stocks at most expensive relative to bonds since dotcom era. Valuation isn’t a good timing tool, and stocks have been relatively expensive for at least a year. But it’s worth noting, because midstream energy looks like the exception to us (see Pipelines Are Cheap; Stocks Are Not).

Last week’s post, The Energy Story’s Trifecta, makes the case and has generated a lot of positive feedback.

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

Energy Mutual Fund Energy ETF

The Energy Story’s Trifecta

January 22, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

The Energy Story’s Trifecta

00:00 / 00:05:00

I was chatting with an investor the other day, and he remarked that there are three powerful legs to the midstream story. They are demand growth for natural gas; attractive valuation; the incoming administration’s support for traditional energy. He felt that there’s too little appreciation of the underlying support from these three elements.

Last year the market began to appreciate the likely impact of new data centers on natural gas demand growth. Renewables remain a footnote in terms of actual US power generation. Solar and wind produce 16% of our electricity while natural gas is 43%.

We’re enjoying the Natural Gas Energy Transition because growth in production is 8X that of renewables – over the past five years, ten years and for all of the 21^st century.

S&P expects data centers to add between 3 Billion Cubic Feet per Day (BCF/D) and 6 BCF/D to gas demand by 2030.

Williams Companies expects power demand to grow at 10X the pace of the past decade. Much of this will be supplied by natural gas, but even where intermittent energy plays a role it’ll require natural gas back-up because data centers don’t only run when the weather co-operates.

Kinder Morgan sees natural gas demand up 19% by the end of the decade (around 20 BCF/D). Increased LNG exports and pipeline sales to Mexico will add to industrial sector demand.

Canadian pipeline company Enbridge has a similar growth forecast for natural gas across North America.

The demand for US LNG is supported by investments many importing countries have made in regassification facilities that allow them to convert gas from the near-liquid form in which it arrives by tanker back in to the gaseous form required by users.

Cheniere notes that global regassification capacity is 2X the expected supply of LNG, which shows that demand is likely to be more than equal to supply over the next several years.

The positive demand story would be unremarkable if it was reflected in high valuations for midstream stocks, but it’s not. The S&P500 trades at around 25X 2025 Factset EPS. Although valuation isn’t a good timing tool, this is historically not an attractive comparison with bonds.

By contrast, large cap pipeline stocks trade on average 10 turns cheaper at a P/E ratio under 15X (see Pipelines Are Cheap; Stocks Are Not).

Distributable cash flow yields, which represent free cash flow less maintenance capex, are over 11%, more than 3X the equivalent for the broader market.

As we often tell people, there’s no irrational exuberance present in this sector. Valuations and fund flows still exhibit excessive caution in our opinion.

Completing the trifecta, we have a new administration that is fully behind US oil and gas production. In his inauguration speech Trump even repeated “drill baby, drill.”

Chris Wright, the new Energy Secretary, brings a pragmatic and refreshing approach. He acknowledges climate change but rejects the dystopian view of progressives. He will be a strong advocate for US LNG exports which will help foreign buyers use less coal. The ludicrously partisan permit pause on new LNG export terminals will finally be lifted.

An improved regulatory environment will lower costs for E&P companies, but all signs are that increased output will need to be profitable.

US energy underpins America’s past decade of strong growth and rising living standards. As Germany has pursued its energy transformation (“Energiewende”), electricity prices have soared and manufacturing has slumped, all while global CO2 emissions have continued rising. It’s a pointless effort while China burns 55% of the world’s coal and plans to go higher.

Democrats and liberal politicians in other western countries have pursued ruinously expensive subsidies for renewables and electrification of transport while applauding China’s auto market where EVs now exceed a 50% market share. This is even though they run on coal which is their dominant source of electricity.

President Trump obviously won’t engage with China on climate change. But had he signed the Inflation Reduction Act with its $TNs of financial support for renewables, you know he would have confronted China over their emissions first.

Compelling fundamentals and attractive valuations co-exist in President Trump’s favorite sector. Energy investors got the election outcome they wanted. Some will recall that Trump’s first term in office coincided with poor returns as executives overspent and overproduced. Profits returned under Biden in spite of his leftward shift once in office.

We think Trump’s second term will be much better for energy investors than the first.

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

Energy Mutual Fund Energy ETF

More Gas Demand Is Coming

January 19, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

More Gas Demand Is Coming

00:00 / 00:04:58

Last week the Energy Information Administration (EIA) released their Short Term Energy Outlook (STEO). People are often surprised to learn that US power demand has remained the same for the past couple of decades – at around 4,000 Terrawatt Hours (TwHs). The economy and population keep growing but offsetting this is improving energy efficiency.

Electricity demand changes slowly. Utilities need to plan for new supply years in advance to allow enough time to add new generation and supporting infrastructure. So although the projected increase looks visually small, it’s a long time since the industry has had to plan for any meaningful increase.

The PJM grid system, which extends from mid-Atlantic states to Tennesse and Illinois, is forecasting 2% annual demand growth over the next decade. ERCOT, which covers Texas, is expecting similar annual growth through 2030. The EIA expects 2% demand growth across the country this year and next, although this will be spread unevenly with some areas seeing 2-3X as much.

Renewables’ advocates typically promote added generation capacity as evidence of the energy transition to solar and wind, although as we regularly note the real transition is to natural gas (see The 8X Energy Transition). Last year the US added 50 gigawatts of solar and wind capacity, which produced an additional 50 billion kilowatt hours.

Adjusting for the different orders of magnitude and assuming the new capacity came online smoothly during the year (ie on average was available for half the year) gets to a 28% capacity utilization. That’s less than a third the uptime of natural gas power plants, which are also needed to compensate for the absence of solar and wind during dark and windless conditions (wonderfully named Dunkelflaute in German). We also added 10 gigawatts of battery storage.

Nobody knows if this was money well spent, because cost-benefit analysis doesn’t intrude on the deliberations of climate extremists. But we did use less coal, which was unambiguously good because it’s the highest emitter of greenhouse gas emissions per unit of energy output.

The EIA STEO is forecasting that this year natural gas derived power generation will drop by 55 TwHs even while total demand rises by around 70 TwHs. They expect increased solar to approximately equal the new demand.

We think that’s an unreasonably pessimistic natural gas forecast. Natgas has been gaining market share over the past decade, rising from 28% in 2014 to 42.5% last year. Over that time it’s captured more than half of the incremental demand and in 2024 was 76%.

We know data centers are driving the increase in power demand, and that they need reliable power that’s not dependent on the weather. Midstream companies such as Williams report high levels of interest in “behind the meter” arrangements by which a data center contracts directly with a gas supplier to supply a dedicated power plant. This bypasses the grid and can offer a faster solution.

The US Department of Energy thinks AI could consume up to 12% of all US power generation within the next three years.

Energy consulting firm Enervus thinks as many as 80 new gas power plants could be added by 2030, representing 46GW of new capacity. This is almost 20% more than was added over the past five years.

So a forecast that the share of US electricity generated from natural gas will decline this year seems to overlook what we know is happening with AI, and the clear commitment of the incoming Trump administration to favor domestic hydrocarbon production.

The STEO forecasts that LNG exports will reach 16 Billion Cubic Feet per Day (BCF/D) by 2026, up from 12 BCF/D last year. Pipeline exports will also grow, by 1.4 BCF/D as flows to Mexico increase.

The LNG story received a boost from Trump’s November victory since it assured that the permit pause announced a year ago would be lifted. LNG terminals represent best in class energy infrastructure assets since they have 20-30 year contracts, providing unprecedented cash flow visibility.

Privately held Venture Global, which operates the Calcasieu Pass and Plaquemines LNG export terminals, is planning an IPO that could value the company at over $100BN. The pricing looks a little ambitious to us, but it has drawn attention to publicly traded LNG companies Cheniere and NextDecade, whose comparatively cheap valuations have drawn in new buyers. Both stocks have rallied strongly since Venture Global announced its IPO.

US LNG remains one of the most attractive sectors in our opinion. Cheap US natural gas and a president who wants energy dominance is a powerful combination. We think the return potential from LNG is not yet fully recognized by the market.

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

Energy Mutual Fund Energy ETF

New Energy Policies Are Here

January 15, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

New Energy Policies Are Here

00:00 / 00:04:46

It’s now less than a week until Donald Trump takes over in the White House. The past couple of months have caused many to wonder why there’s such a long gap between the election and the inauguration. It’s a holdover from the eighteenth century when the time was required to allow messengers to travel to the capital with election results but is clearly no longer required. Joe Biden should have had the good grace to keep a low profile during this interregnum, but instead chose to issue executive orders promoting liberal policies on offshore drilling and immigration.

Biden will soon be gone, and attention is turning to the energy-related executive orders Trump is planning for his first days in office. He’s widely expected to lift the LNG permit pause, which will improve certainty for negotiations on long-term supply agreements.

Chris Wright, Trump’s nominee to head the Energy Department, will bring an articulate voice explaining why US LNG exports are good for everyone involved. Bettering Human Lives, a report published by Wright’s firm Liberty Energy, recounts the history of hydrocarbons and offers insight into how energy policy is likely to be pursued. It’s well worth reading.

Trump’s opposition to windpower represents a shift from his first time in office when his administration was supportive. Communities are increasingly objecting to the visual intrusion of huge wind turbines. It’s reasonable to ask why supporters of weather-dependent energy in the US don’t first demand reduced coal use by developing countries. Getting emerging Asia to displace coal with LNG is one of the most effective ways to reduce CO2 levels.

The Energy Information Administration (EIA) published data late last year showing that construction costs for solar and wind have stopped falling, while those for natural gas continue to. This is why clean energy stocks have performed so poorly and why electricity tends to be expensive where renewables provide a high share.

The data is through 2022 so missing the recent demand for electricity from data centers which is driving investment in natural gas power generation. Large providers of such equipment such as Siemens Energy report increasing backlogs, so it wouldn’t be surprising to see the cost of natgas power edge up somewhat when the EIA updates their information.

The other day I was chatting with an investor, and while he’s fully bought in to the primacy of natural gas he wondered whether nuclear power might at some point displace it.

Nuclear energy seems such an obvious solution to the world’s need to deliver reliable carbon-free power. Vocal opponents such as the Sierra Club promote a completely unrealistic view of how the world can generate electricity. I often note that the US navy operates almost a hundred nuclear reactors in aircraft carriers and submarines. There’s no record of any problem with any of these. Perhaps we should just let the US navy run all our civilian nuclear reactors.

Unfortunately, western countries have a poor record of building new nuclear plants anywhere close to on time and on budget. The most recent nuclear facility completed in the US, the Vogtle plant’s Units 3 and 4 in Georgia, came in seven years late and $17BN over budget. They cost over $15 million per Megawatt of power generation.

The UK’s Hinckley Point C reactor cost $18 million per Megawatt and was built by France’s EDF. France gets around two thirds of its electricity from nuclear. This represents 35% of their primary energy, far more than any other country. Finland is second, relying on nuclear for 26% of their primary energy, but their output is a tenth of France’s.

So it’s disappointing that the leading French company delivered such an expensive result. The French government has even decided to cap nuclear at 50% of total power generation, versus 70% currently.

Western countries haven’t yet figured out how to build commercially viable nuclear plants.

Most of the addition of nuclear power is taking place in developing countries, led by China. Costs are far cheaper at around $2-3 million per Megawatt. This is partly because developers are unburdened by costly legal challenges from NIMBY homeowners. However, they’re also using cheaper technology that relies on sodium cooled fast breeder reactors. JPMorgan reports that these have been rejected in the US as having shorter useful lives and increased risk of fire.

China is today’s leader in developing new nuclear.

There are numerous efforts to resurrect nuclear power in the US, including restarting old reactors and placing small modular reactors on the sites of decommissioned coal plants where connectivity to the grid is already in place. We should hope these are successful, but given the time involved and cost, natural gas is unlikely to be threatened by nuclear for many years.

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

Energy Mutual Fund Energy ETF

Pipeline Earnings Or Cashflow?

January 12, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Pipeline Earnings Or Cashflow?

00:00 / 00:05:45

Wells Fargo has recently suggested that the market may start paying more attention to the P/E ratios of midstream stocks. The sector has historically been valued using Free Cash Flow or Distributable Cash Flow (DCF), which is FCF less the maintenance capex necessary to preserve the value of existing assets.

P/E hasn’t been used much in the past because depreciation tends to understate the cash flow potential of infrastructure. The tax code allows for pipelines and other assets to be depreciated, while their ability to generate cash flow improves over time. Properly maintained, midstream infrastructure consists of appreciating assets.

I’m often reminded of the Transcontinental Gas Company’s pipeline built in the 1950s to move natural gas from Texas to population centers in the north east as far as New York City. This pipeline, long ago depreciated to zero, is part of the Transco system owned by Williams Companies. Allowing the owners to write down their investment for tax purposes didn’t reflect the actual value of the asset.

Wells Fargo thinks that the entry of generalist investors into midstream will encourage a more conventional approach to valuation. They cited South Bow (SOBO), the liquids pipeline spinoff from TC Energy last year, which looked unattractive based on DCF but better on P/E, and subsequently outperformed the sector.

Wells Fargo goes on to note that the midstream sector does trade at a P/E discount to the S&P500 (18.2 vs 21.7).

There has been some discussion that the new administration may reintroduce accelarated depreciation on some assets such as real estate although this could extend to infrastructure as well. By frontloading depreciation expense instead of using the straight-line method, it would depress near term earnings making P/Es look less attractive.

The spurt in power demand from data centers is likely to push capex higher for some of the natural gas-oriented pipelines. Because of this, investors relying on P/E are still likely to consider DCF and FCF yield as well in order to gain a more complete understanding of a company’s prospects. Earnings and cashflow are both important.

Friday’s strong payroll report cast more uncertainty on the prospects for further rate cuts from the Fed. The FOMC has the luxury of doing nothing for several months while the new administration’s policies take shape. Tariffs are widely considered inflationary. Extending the low tax rates due to expire this year will add fiscal stimulus to an already strong economy.

It’s a short step from the FOMC on hold to worrying about a potential resurgence in inflation. Should this happen, pipelines could offer useful protection since valuations are still attractive and roughly half the sector’s EBITDA comes from tariffs that have explicit inflation escalators built in. This was behind 2022’s 21% return on the American Energy Independence Index versus the S&P500’s -18%, when CPI inflation peaked at 9%.

Last year the world’s temperature averaged 1.5C above pre-industrial levels, the first time we’ve reached this threshold beyond which scientists warn that irreversible climate change is likely. It’s an incongruous thought at a time when most of the continental US is enduring well below average temperatures.

Sometimes I flippantly note that if global cooling was caused by rising CO2 levels, I’d be moved to install solar panels, buy a Tesla and adopt all the other virtue-signaling behavior of liberal zip codes. There’s a reason I leave New Jersey for Florida at this time of year.

What we’re seeing is the wholesale failure of progressive policies to reduce emissions, because they ignore the desire of developing countries to raise living standards with increased energy consumption and they naively believe intermittent, weather-dependent energy is the total solution.

It’s possible that policymakers may learn from this and adopt a pragmatic path to success, which would be a worldwide effort to encourage coal to gas switching for power generation. Critics of this approach argue that natgas still generates CO2. But it’s on average only half as much. Don’t let perfect be the enemy of good. Emissions would come down.

The US has achieved the world’s best combination of reduced CO2 and economic growth by doing exactly this. The correct choice is to encourage similar behavior around the world, especially in emerging Asia.

The China Coal Transportation and Distribution Association expects output to rise 1.5% this year, an outcome wholly inconsistent with reducing emissions and one that makes a mockery of the constraints imposed on their citizens by liberal US states.

Even with the US withdrawing again from the Paris Climate Accord, we are well situated to support the successful implementation of such a coal-to-gas policy. This is the world’s best option. US exports of LNG can do more to reduce global emissions than the failing efforts of the past couple of decades.

We’re invested in natural gas infrastructure because we expect this will increasingly become clear to policymakers. Growth in US natural gas output continues to swamp renewables.

Last week my daughter and I braved frigid cold to ski in Vail with long-time friend and client Bill Edwards, whom we annually credit with also being Vail’s Best Ski Instructor. Like many of our clients, he was a friend first. Any skiing ability I have is a credit to his patient instruction over many years. The lapses are my own work.

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

Energy Mutual Fund Energy ETF

Energy Policies Are Moving Right

January 8, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Energy Policies Are Moving Right

00:00 / 00:05:21

Data center demand for natural gas was the big energy story last year. Wells Fargo referred to “a momentous year for midstream” with this as the biggest driver. It’s been consistently cited by JPMorgan and Morgan Stanley.

Wells Fargo calculated that C-corps outperformed MLPs by 23%. This was a substantial difference and means that the Alerian MLP ETF (AMLP) underperformed the S&P500 in a year when midstream generally beat the market by 20%. This is partly because MLPs are perennially “cheap” since their investor base is limited to wealthy Americans willing to tolerate a K1. US tax-exempt and foreign institutions face onerous tax liability and reporting requirements, so generally avoid MLPs. Retail investors don’t want K1s.

The other reason MLPs lagged is that pure-play natural gas names began converting to c-corps following a ruling from FERC in 2018 that prevented them from including their equity holders’ tax liability in calculating their required return on pipeline tariffs. So today MLPs have limited direct exposure to the biggest story in midstream – data center power demand to be satisfied mainly with natural gas.

Valuation as defined by Enterprise Value:EBITDA (EV:EBITDA) has risen to 11X, close to the 12X ten year average. However, a move to 12X would be more appreciative than it might appear. Since midstream companies typically finance their assets with around 50% debt, an EV:EBIDTA move from 11X to 12X, roughly a 9% increase in EV, would be double that on the company’s equity since their debt obligations would clearly be unaffected.

2024 was an exceptional year. Nonetheless, the math suggests that a reversion to the mean for valuation, plus a 5% dividend yield, could generate a total return of around 23%. We’re not predicting such. But energy is incoming President Trump’s favorite sector.

Dividend yields are close to the ten year treasury, historically very tight. However, this relationship has lost relevance. Dividend coverage has moved higher in recent years as c-corps have become more prevalent. The old MLP model of paying out 90% of distributable cash flow no longer prevails, with payout ratios of 50-60% common today.

JPMorgan’s Eye on the Market Outlook 2025: The Alchemists was published on January 1. I occasionally interacted with Mike Cembalest, the author and Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management, 20 years ago when I worked there. I enjoy his writing as much as anything I read. It is deeply researched and full of insights.

In discussing AI, data centers and the growing demand for power from “hyperscalers” (ie Google, Meta, Microsoft, Amazon etc) the report noted: The hyperscalers will probably have to hyperscale back their commitments for green power consumption and rely heavily on natural gas, as they have been.

US natural gas prices have risen 44% so far this year (as of January 6). Winter storm Blair is the reason, not AI. Even so, $3.70 per Million BTUs (MMBTUs) remains far below global prices. Futures on the European TTF benchmark and Asian JKM are both trading in the $14.50-15 range.

US energy remains cheap. Whenever I walk past a store on a hot day with its doors open, using its air conditioning to draw in shoppers, I’m reminded how rare such a sight is elsewhere in the world. Increased US LNG exports over the next few years will benefit our trade partners, reduce coal consumption and modestly lift US prices. It’s a small price to pay.

The pendulum is swinging back from progressive ideas such as uncontrolled immigration and switching to renewables with no cost-benefit analysis. Canada is the latest country to chart a new direction as PM Justin Trudeau concluded when he resigned on Monday. Conservative leader Pierre Poilievre has promised to cancel the country’s much hated carbon tax, which is set to rise to C$170 per metric tonne (US$119) of CO2 equivalent by 2030.

The chart on illegal immigration included in Mike Cembalest’s annual outlook caught my eye more than most, along with this explanation: Biden immigration policies directly led to the largest unchecked, uncontrolled and unmanaged migrant surge on record which will negatively impact major urban fiscal positions for many years.

Cembalest’s writing is apolitical since they have a diverse client base. He’s no ideologue. The sentence above shows how such a view has become solidly mainstream. The general retreat from left wing policies is overdue and represents a positive environment for hydrocarbons. It doesn’t mean we’ll stop working on lowering greenhouse gas emissions, but we are moving into a period of more careful cost-benefit analysis.

This is good for the cleanest hydrocarbon, natural gas.

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

Energy Mutual Fund Energy ETF

Last Year’s Favorite Blog Posts

January 5, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Last Year’s Favorite Blog Posts

00:00 / 00:05:09

We enjoy the feedback from our blog readers, which along with the pageviews inform future topics. Looking back over last year’s posts, natural gas growth, the challenges facing renewables and obstructionist climate extremists were among the themes that resonated most.

The most popular post was The Inflationary Energy Transition, which reviewed how US electricity prices have been rising. This ought to shock renewables proponents, because we’re constantly told that solar and wind are cheaper than conventional energy. The overwhelming absence of supporting evidence has done little to silence this crowd. Indeed, the International Energy Agency (IEA), which has adopted the mantle of renewables cheerleader, reiterated this belief last year. Hopefully under Trump the US will cut its funding.

An op-ed in the WSJ last week by Bjorn Lomberg included a chart showing that electricity prices rise with solar and wind penetration all over the world.

If the IEA and others would simply say that renewables cost more and are a better choice because of rising CO2 levels, at least they’d have credibility on the issue. But by misrepresenting the economics they’ve lost any right to be taken seriously.

A Concentrated Bet On Renewables Stumbles showed how Costa Rica’s grid has moved almost fully to renewables, led by hydropower at 73%. A drought blamed on El Nino forced daily power cuts on consumers. Renewables Are An Energy Footnote showed how modest the impact of solar and wind has been in the US in spite of enormous subsidies and glowing media coverage. Natural gas production has increased 8X renewables over the past decade, and even if you eliminate exports and just count the gas that’s consumed domestically, it’s still 4X as big.

What became clear to us last year is that we are experiencing The Natural Gas Energy Transition, One day we’ll run out. One day perhaps everything will run on electricity from nuclear plants. But over any meaningful forecast period natural gas demand will continue to grow. Investment returns last year reflected this. The S&P Global Clean Energy Index was –25% last year. Midstream energy infrastructure was +45%. On Thursday there were new reports of closures among German solar firms.

The Energy Transition Towards Natural Gas showed how the US is benefitting from this, at least in those regions where energy policy hasn’t been hijacked by progressives (ie New England and the Pacific northwest). For more, see Blue State Energy Policies.

Sierra Club Shoots Itself In The Foot showed how environmental extremists’ use of the courts to slow projects was likely to prolong use of coal across developing countries where energy demand continues to grow. NextDecade’s (NEXT) construction of an LNG export terminal in Brownsville, TX was cast under some uncertainty due to the ruling. The stock lost almost half its value in the days following.

However, by the election it had recouped some of that and Trump’s victory propelled it higher. In recent days it’s back to its levels prior to the August court ruling, as investors have concluded that the project will continue to completion with minimal if any delay.

In this video (watch Let’s End The Sierra Club) we noted how they’re even against nuclear power with a set of dystopian policies that would impoverish billions of people and cause widespread starvation.

We’ve long believed that natural gas would remain a crucial source of energy for the foreseeable future. It seemed to us that greater renewables penetration would require natural gas to provide reliable energy for when it’s not sunny and windy. Slow renewables growth simply means greater use of reliable gas. Both themes are at work. Natural Gas Demand Keeps Growing and A Gassier World explained why.

And in 2024 the demands of data centers for reliable power added to the strong fundamentals.

Consequently, Drilling Down On AI was one of our most read blog posts. The Coming Fight Over Powering AI reminds that power demand growth is on a trajectory that will challenge the ability of utilities to add necessary infrastructure.

Last year not a single client commented on the relationship between crude oil and midstream – unsurprisingly, since oil finished down on the year. We reviewed this in Oil And Pipelines Look Less Like Fred And Ginger. Persistently strong operating performance and reduced leverage have finally broken whatever connection existed – and that only arose at times of strong energy sector sentiment (usually negative).

Someone once said that if you want to understand a topic, write a book about it, the point being that the research required will make you an expert. Writing a blog is similar, and astute readers can be relied upon to catch any sloppy analysis. It’s also an enjoyable part of my job.

Thank you for the regular feedback.

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

Energy Mutual Fund Energy ETF

Economists Having Fun With Inflation

January 1, 2025/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Economists Having Fun With Inflation

00:00 / 00:05:02

The other day I read a tweet complaining that since 1971 household family income had increased 5.5X (from $10K to $55K) while the median cost of a new car has gone up by 12X ($4K to $48K). It’s not quite correct. Median family income has risen to $101K, so has almost kept up. But it did remind me that car price inflation as calculated by the Bureau of Labor Statistics (BLS) has substantially lagged car prices. Car CPI has averaged 2.2% since 1970, resulting in a mere tripling and far less than actual prices.

The reason is what the BLS calls hedonic quality adjustments – not to be confused with hedonistic, although indulging in the latter might help consumers accept the result of the former.

The CPI is calculated on the basis of a basket of goods and services of constant utility. This last phrase is critical, because it means that any improvement in a product or service that provides increased utility gives you more for your money – in other words, a price cut. CPI seeks to keep this constant.

It’s a concept only familiar to economists, and we have written about it before (see Why Inflation Isn’t What You Think). Non-BLS economists – which is to say, most of us – think about how much more a new car costs than it did last year. Or an iphone, flight or house. We don’t think of improved quality as a theoretical price cut.

Economists around the world love hedonic quality adjustments. In their tribe this is not a controversial topic. However, I am increasingly convinced that their application is uneven, unintuitive to users of inflation statistics and not helpful to anyone interested in maintaining their standard of living.

In 2013 I wrote about airfares (Why Flying is Getting More Expensive) and noted that the only quality adjustment the BLS had made was to factor in easier cancellation terms as an implicit price reduction. Since then, few would dispute that flying coach has become a degrading experience with less legroom, no meals and a general feeling of being cargo rather than people. The BLS never makes adjustments for a decrease in quality, even though it’s certainly the case with flying. And I’d suggest that regular travelers to New York City on NJ Transit could identify another form of transportation where quality has dropped.

What’s the hedonic quality adjustment for regular delays?

The other problem with these adjustments is that they’re applied to indivisible objects. For example, if an improved car provides you with greater utility, what exactly can you do with the excess? Today’s new car provides more utility whether you like it or not. You can’t take the extra and apply it somewhere else. You’re unlikely to conclude that increased utility in one purchase allows you to accept reduced utility in another, such as an airplane ticket. Only BLS economists think like that.

From 2019-21 during the pandemic, household incomes rose 3%, lagging new car prices (+14%) along with most other things. Voters remembered in November.

But the real mistake lies in thinking that keeping up with inflation means keeping up with the neighbors. Social security payments are linked to CPI, but that just means slipping to a lower percentile of income over time. It’s even more important for anyone planning retirement in a decade or two. Assuming that today’s household expenses will increase at inflation so their savings only need to keep up will turn out to be inadequate.

A more realistic goal is to target median family income. That has increased by 4.4% pa over the past decade, versus CPI at 2.8%. $100K in household expenses in 2013 required $154K in 2023 to maintain its purchasing power relative to the median. If it grew at the CPI the family would have $131K and would have fallen behind their peers of a decade earlier.

The median family income has roughly kept track with car prices over the past fifty years, which has enabled car prices to increase well ahead of car price inflation. It simply shows that car price inflation as calculated by the BLS isn’t a very useful figure. For savers this applies to inflation statistics more generally.

So make your new year’s resolution to grow your savings at a more appropriate rate. We will naturally suggest that midstream energy infrastructure has a better chance than most investments of delivering.

And if this New Year’s Day discussion of hedonic BLS weaknesses is challenging your foggy brain, I hope you can blame it on excessive hedonism the night before.

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

Energy Mutual Fund Energy ETF

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