Progressives will maintain that the planet is on track to burn up, but realists will see an unfolding positive story. Transitioning our energy systems is incredibly expensive, slow and inflationary.

JPMorgan just published research (The Energy Transition: Reality check needed) acknowledging this and calling for a reset.

No big company says anything about energy without approval from its senior executives. It’s hard to think of a more highly charged topic. Forecasts that don’t assume “Zero by 50” are immediately seized upon by climate extremists as absence of fealty to the UN’s goal. BP handed off their Statistical Review of World Energy, probably after concluding it offered climate critics a soft target.

Wall Street banks like JPMorgan are voluminous publishers of investment and economic research. Jamie Dimon can obviously peruse only a tiny fraction of this output. But you can be sure he read this one given the sensitivity of the topic. Moreover, you can assume he broadly agrees with its conclusions. He has recently been critical of the Administration’s pause on new LNG permits, and has said it’s impractical to think we can suddenly stop using fossil fuels, which currently provide 82% of the world’s primary energy.

Combined with other moves, such as withdrawing from Climate Action 100+, it shows that the bank is taking a pragmatic, realistic approach. In his annual letter Dimon said, “One of the best ways to reduce CO2 for the next few decades is to use gas to replace coal.”

JPMorgan’s Reality Check research estimated that coal to gas switching could reduce emissions by as much as 17%.

We think this is not just another piece of Wall Street research but reflects JPMorgan’s pragmatic assessment of the energy transition and their role in it. Jamie Dimon has called the Department of Energy’s pause on new LNG permits “enormously naive.”

Jamie Dimon is the adult in a room full of juvenile climate extremists.

Russia’s invasion of Ukraine pushed energy security up the policy agenda for western Europe. The pandemic boosted government spending, leaving less fiscal room to fund the transition, and the inflation that followed pushed up interest rates. These three factors have rendered objectives that were already barely reachable now implausible.

Reality Check has many other useful insights. Just the planned solar and wind buildout to 2030 will take 0.5% of global annual GDP. The energy required would emit 207 million tonnes pa of CO2, equivalent of Argentina, assuming today’s energy mix of 82% fossil fuels.

This type of analysis heralds a more practical approach built around what’s possible versus the fantasies of climate extremists. It means more demand for natural gas, to the benefit of US producers and the associated infrastructure that supports them.

Wells Fargo’s Midstream Energy Weekender suggested that the sector is due to reprice higher. Their favored metric of Enterprise Value/EBITDA (EV/EBITDA) is at 8.2X. Five years ago it was around 11X, and performance since then has been good. To put these figures in context, if EV/EBITDA improved by one turn (ie 8.2X to 9.2X) that would equate to a roughly 20% price appreciation since pipeline companies are typically financed with 50% debt.

Wells Fargo also noted, “a growing realization that a confluence of factors could drive significant growth in US natural gas demand over the next 5+ years.” LNG exports, increased domestic manufacturing and demand from AI centers were the reasons cited. As regular readers know, we have long argued that natural gas infrastructure assets are cheap.

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There are signs that investors are beginning to act on this opportunity. Over the past year the American Energy Independence Index (AEITR) has kept pace with the S&P500’s AI-fueled run and last week moved ahead. YTD the AEITR is +10% vs the market’s +5%.

Tesla’s stock price continues to adjust to the new reality of declining EV demand. A couple of weeks ago an Uber driver in a Kia EV with 14% battery charge remaining said he loves his car. Charging only took about 30 minutes and he could usually find a charging station within 30 miles. After dropping me at the airport he was planning to do just that.

Robert Bryce reminds us that Stanford University’s futurist Tony Seba forecast in 2014 that “By 2025, gasoline engine cars will be unable to compete with electric vehicles.” Seba predicted that Internal Combustion Engines (ICEs) would be obsolete by 2030. Tony Seba is a soft target.

Your blogger will shortly be buying a new car. I’m not opposed to an EV – they work well as golf carts for example. But the inconvenience of charging, the waiting time involved and range anxiety demand a price discount to an equivalent ICE in my opinion. Around 25% would be enough to induce me to buy one. The market’s not there yet although it’s heading in that direction. So I’ll be buying a conventional car.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

As we sat down to lunch in London’s west end earlier this month, Richard told me his family had been good friends with Patrick Moore, presenter of BBC’s The Sky At Night from 1957 until his death in 2012. He was a passionate amateur astronomer who taught viewers what they were looking at in the night sky and contributed to early mapping of the Moon. He spoke quickly and seemed rather eccentric. I remember watching his TV show as a young boy.

The Horsehead Nebula (pictured) draws its red color from ionized hydrogen gas sitting behind the dark nebula. It’s the type of shot Patrick Moore would have used on his TV show.

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Moore believed the Sun’s impact on climate was under-appreciated and dismissed human activity as the driving force behind recent climate change. Perhaps he’d have a more nuanced view today. He was old enough to have met Orville Wright and later Neil Armstrong, connecting the two most defining moments in aviation history.

Richard is a business development manager for a leading international energy major. He’s responsible for developing the case for hydrogen imports to Europe and investigates investment opportunities for clean energy projects, part of supporting their developing energy transition portfolio. Richard has spent his career in energy, including with several European majors. In university he studied climatology, and investigated some of the ways in which volcanic ash and solar radiation can impact the climate.

He reached out to me because of our blog. I always enjoy meeting our readers – Richard multitasks by listening to our blogcasts on his commute rather than reading them. He was able to leave the office for lunch during my recent trip.

Every big energy company has an energy transition strategy. As shareholder-owned commercial enterprises, they don’t have the luxury of accepting inferior returns to achieve politically correct targets. Renewables investments must compete with traditional energy for capital and other resources. Skeptics might argue that solar and wind projects provide political cover to focus on oil and gas, where the real profits are.

Richard is well versed in the challenges of the energy transition. Like most people who have given serious thought to the topic, he believes we need to use much more nuclear. This blog often asserts that nuclear opponents haven’t thought very hard about practical ways to reduce CO2.

Richard noted that small cars lend themselves to electrification. We think they’ll need to be cheaper than equivalent conventional cars to attain mass appeal, because of the inconvenience of recharging. He believes hydrogen is a more practical solution for large trucks and long-distance transport because storing enough power in batteries adds too much weight to be economically practical. Daimler and Hyzon are actively working on liquid hydrogen trucks.

The EU is targeting 10 Million Tonnes Per Annum (MTPA) of domestic hydrogen production along with 10 MTPA of imports to jump start region-wide consumption of hydrogen by 2030. The European Hydrogen Bank is providing up to €100BN in support of these ambitions. De-carbonizing steel and cement production, perhaps with hydrogen, are priorities although the technical challenges are significant.

Europe has always seemed a better prospect for hydrogen than the US, where cheap natural gas renders the economics of hydrogen unworkable without substantial government subsidies. European politics is also to the left of the US, meaning there’s greater tolerance for high energy prices in exchange for reduced emissions.

Liquifying hydrogen prior to transportation makes it denser, allowing for more energy to be moved per unit of volume. However, chilling it to a liquid state is very energy intensive. Boil-off is a common problem for LNG tankers. Some of the LNG must be released in transit as it warms up and becomes gaseous. Boil-off losses are typically around 1% per day for LNG tankers and shipping liquid hydrogen faces the same problem but to a much greater extent due to the larger temperature differential. Hydrogen needs to be cooled to below -250C so many companies are looking at alternative means of transport such as combining it with nitrogen to form ammonia, which is liquid at a much more manageable -33C.

In the US Carbon Capture and Sequestration (CCS) received a boost in the 2022 Inflation Reduction Act which offers tax credits of up to $180 per metric tonne for permanently sequestered CO2. Occidental is a leader in this (see How Occidental Invests In Lower Taxes).

Rock formations that previously held natural gas (methane) can be good places to permanently store CO2. There’s a wonderful symmetry in extracting carbon atoms as methane molecules (CH4) and returning them to their source after use as CO2. The Netherlands has identified storage capacity for up to 3.2 Gigatonnes, more than the EU emitted last year.

The Dutch Senate has now passed a law to end natural gas production at Groningen, one of Europe’s largest, from October 1st this year to limit seismic risks from hydraulic fracturing. Groningen is not currently contemplated as a repository for CO2. Its closure leaves untapped reserves, and some politicians argue it could jeopardize the country’s security of supply. Possible re-use as a carbon dioxide store is yet to be seen but would certainly pose new challenges.

The steel and concrete well casings, through which natural gas was originally extracted, can become corroded from prolonged contact with CO2, requiring the replacement of the installed materials. Hydrogen produces its own challenges when coming into contact with steel. It’s a very small molecule so can penetrate the metal and cause embrittlement.

Safely ensuring the integrity of former gas wells and pipelines if repurposed for CO2 or hydrogen use might prove too expensive, resulting in the need to drill or build new, specialized, infrastructure.

There are likely better options. As is often the case, the biggest challenges in reducing CO2 are economic.

Richard is well-versed in these and other technical challenges facing the energy transition. I spent an absorbing lunch listening to him. We are fortunate to have people with his knowledge and ambition working on the problem.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

The Wall Street Journal called it “Biden’s Green-Energy Price Shock”, noting that electricity prices have increased by 21% since January 2021. That this has coincided with increased solar and wind output ought to surprise no-one. Thoughtful progressives should hail this as a positive development and argue that higher energy prices are an inevitable and worthwhile step in reducing CO2 emissions. But for the most part climate extremists have disingenuously argued that renewables are cheaper than reliable power – therefore they must feign surprise at rising electricity prices.

I spent last week in London. Like the rest of Europe, Britain endured a sharp rise in power prices following Russia’s invasion of Ukraine two years ago. Things have stabilized, but UK electricity is roughly 2X the cost of the US. Offshore windpower has been a success – the North Sea is a reliably blustery place. Last year wind generated 29% of the country’s electricity and 31% over the past twelve months. Natural gas still has a slight edge at 32%.

The US enjoys ample supplies of natural gas priced at around a quarter of what the UK pays. Expensive windpower isn’t the only reason for higher UK electricity prices.

Brexit either (1) inevitably harmed UK GDP growth by raising trade barriers to their neighbors, or (2) provided opportunities so far unexploited by the Conservative government, depending on whether you were against or for. Economic growth is anemic, and with voters going to the polls later this year PM Rishi Sunak has watered down earlier commitments to net zero, recognizing their economic and political cost going into an election he’s widely expected to lose.

Elsewhere in Europe Germany has embraced self-harm as national energy policy. Ruinously high energy prices (electricity is 4X or more vs the US) have led to reduced emissions via de-industrialization. German businesses are relocating and cutting domestic investment. German voters have been steadfast in their commitment to lead on climate change, a hugely expensive and ineffective effort swamped by China’s relentless coal-based growth.

Rising electricity prices are an easy target, as the WSJ op-ed showed. European energy policies have no place in America, and because of this our energy transition is going much better than theirs. Prices remain low and are attracting foreign direct investment. The US economy is growing strongly, easily the best among OECD countries. The benefits of cheap natural gas will grow as the only reliable way to meet increased power demands from data centers.

Americans impatiently expect persistent improvement from many things. This is curbing the efforts of climate extremists to foist expensive, intermittent energy on us without considering cost and reliability. We are less tolerant than Europeans of being told by liberal politicians what’s good for us.

Natural gas infrastructure is benefiting. In A Safe, Profitable Bet on the Green Transition, the WSJ noted how midstream companies such as Williams and Kinder Morgan are raising prices because of scarce capacity. Climate extremists have impeded new investments, thereby boosting free cash flow and helping traditional energy far outperform companies focused on renewables. Pipelines are beating the S&P500 this year.

Hug a climate protester and drive them to their next protest.

Visiting London, where I lived until 1982, triggers warm feelings of nostalgia along with sympathy for a great country that has endured poor leadership for too long. I delayed my arrival to avoid a widespread one-day rail strike. Such disruptions have been going on sporadically for eighteen months. Why do voters put up with that? Why are climate protesters still allowed to block traffic by standing in the road?

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I reconnected with my old boss who, to my great fortune 42 years ago, persuaded his New York office to take on a young man beginning his career in finance. It was nice to thank him.

I saw Arsenal play Bayern Munich in the Champions League. It is possible to buy a ticket if you’re willing to pay a price too embarrassing to disclose. I saw Hamilton, with an enthusiastic UK audience that loved every minute. The lyrics of “You’ll Be Back” sung by George III, cleverly reflect imperial Britain’s slipping dominion over a people ready and able to reject it while retaining an eternal bond of shared values and culture.

Most importantly I saw old friends – I’m drawn back annually and now in my 60s have determined to visit more frequently. There are many great places in the world. You can enjoy them without owning a home there.

America is the world’s greatest country. I’m proud of my English heritage although Britain’s too liberal for me. Visits remind me why I emigrated. But I’m going to keep coming back.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Vaclav Smil is often described as a polymath. His website says he does interdisciplinary research in the fields of energy, environmental and population change, food production, history of technical innovation, risk assessment, and public policy. He is Distinguished Professor Emeritus at the University of Manitoba.

I first came across his books when Bill Gates described Smil as his favorite author. His 2022 How the World Really Works: The Science Behind How We Got Here and Where We’re Going is one of his best.

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Mike Cembalest is JPMorgan’s Chairman of Market and Investment Strategy for Asset Management. He’s a highly skilled investment writer via his Eye on the Market series and annual energy papers and engaged Smil as technical advisor on energy topics for years. Smil is now 80 and has a less formal role. Cembalest says, “the opportunity to learn from him is one of the highlights of my 36 years at JP Morgan.”

For my part, both continue to be a vital source of information and insight via their writing.

We spend a lot of time thinking and reading about climate change. In a recent essay, Smil provided a dispassionate assessment of the energy transition grounded in facts.

Simply put, the world has no chance of reaching the UN’s goal of eliminating CO2 emissions over the next quarter century.

In 2018 when “zero by 50” was first articulated as a goal, UN scientists concluded that emissions needed to decline by around 45% from 2010 levels by 2030. Today that means eliminating nearly 16 billion tons of CO2 over the next six years, close to what China and the US generate today. Zero by 50 requires cutting almost half of India’s emissions every year, assuming no net growth anywhere else.

Global energy demand is generally forecast to rise by 10-15% by 2050.

Emissions haven’t even peaked yet.

Zero by 50 means replacing all thermal power generation capacity (currently 4 terawatts); converting 1.5 billion combustion engines including 50 million tractors; upgrading half a billion natural gas furnaces, 120,000 merchant ships and nearly 25,000 airplanes.

Smil often reminds how long previous energy transitions have taken. Coal surpassed wood in 1900 and didn’t peak until the 1960s. Then there’s the growth in developing world economies. Wood, charcoal, straw and dried dung provide around 5% of the world’s primary energy for 3 billion people, mostly for cooking. These people aspire to use natural gas.

Over the past quarter century combusted fossil fuels have increased by over half.

Many processes can’t be easily electrified. These include cement manufacture which requires high heat; fertilizer production which is a chemical conversion of methane (natural gas) into ammonia; and aviation because battery-powered planes defy aerodynamics. Smil also points out that a transition to solar and wind power means accepting less efficiency because renewables are low density (need large amounts of space) and intermittent (it’s not always sunny and windy).

The additional materials needed for EVs, solar and windpower and the rest of the energy transition are inconceivable. Smil estimates between now and 2050 we’ll need an extra 150 millions tons of copper (seven years of current production) just for EVs and 600 million tons in total; 40X as much lithium as is currently mined and 25X as much graphite and cobalt; 5 billion tons of steel (2.5X annual output).

All these minerals and inputs will have to be mined and produced without generating any new CO2.

Smil calculates that rich countries like the US would need to dedicate 20-25% of GDP to the energy transition through 2050, a level of commitment to a cause we achieved only once before, for less than five years during World War II.

When you look carefully at history, consider politics and add the desire of most of the world’s population to improve their living standards, only one conclusion is possible.

There’s no realistic likelihood of this goal being achieved.

Scientists, politicians and climate extremists have raised awareness but failed to inspire popular support for the policies they prescribe. This is democratic. It involves a substantial economic sacrifice by people today to benefit future generations. Democracies aren’t good at that. We can’t even embrace measures to curb our looming fiscal catastrophe even though America’s soaring debt is plain to see and not subject to any scientific uncertainty. Climate change and the deficit share this common challenge – getting today’s voters to care about generations not yet born is not a winning political message.

Vaclav Smil explains why we should stop worrying about climate change and plan on dealing with the consequences.

To turn it back to investing: the desire of so many to raise living standards has to be good for US natural gas, especially once the pause on LNG exports is lifted. And as it becomes clear that the solar/wind obsession is not making much impact, more pragmatic solutions are likely. A serious effort that is success-oriented instead of aspirational includes fast-tracking nuclear power and a worldwide coal-to-gas switch, emulating America’s biggest success in reducing emissions.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

JPMorgan’s 14^th Annual Energy Paper (subtitled “Electravision”) is as always packed with data and insights. Mike Cembalest has few peers among investment writers. Two themes, the slow electrification of western economies and the challenges of Electric Vehicles (EVs) stood out.

As Cembalest has noted before, renewables are gaining market share of power generation faster than electricity is growing its share of primary energy use. Around a fifth of US electricity generation comes from solar and wind. Texas is about a quarter of US windpower (see Windpower Stumbles On Unique American Mineral Rights) and Iowa relies on wind for over half of its electricity (See Offshore Wind vs Onshore). Wind’s market share doesn’t appear to correlate with electricity prices in states, but solar does.

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The growth in renewables is exposing more grids to intermittency, since it’s not always sunny and windy. Battery storage is expected to be the major solution, but so far it’s made few inroads. Pumped storage relies on using electricity when it’s cheap (ie midday solar) to move water uphill, releasing it to generate power when demand exceeds renewables supply (breakfast and dinner time). It’s low tech, and yet this still represents 70% of utility scale storage.

Therefore, existing dispatchable power (usually natural gas, sometimes coal) is being retained. Because renewables operate at much less capacity than natural gas plants (typically 25-35% vs >90%), adding 1MW of solar capacity does little to reduce the need for the traditional energy it’s supposed to replace.

The result is adding renewables means carrying ever more redundant dispatchable capacity. Regional grid operators report that new renewables lead to only 10-20% of equivalent capacity reduction of coal or gas. It’s why solar and wind aren’t as cheap as their proponents like to think (see Renewables Are Pushing US Electricity Prices Up).

It also means capacity buffers are falling. New England expects peak summer generation capacity to drop below 10% within a decade, from over 25% currently. The recent surge in data centers to support AI is putting further pressure on power supply.

We tolerate power outages which rarely last more than a few hours. We haven’t had any natural gas outages, which would occur if, for example, very cold weather interrupted production. We’ve had some near misses, including in New York on Christmas Eve morning in 2022. If gas supply was cut, technicians would need to visit every building to ensure no residual gas had leaked while the pilot light was out. Frozen water pipes would presumably be common.

Engineers estimated that restoring service to 130,000 customers could take five to seven weeks. Let’s hope none of us ever lives through that.

On Electric Vehicles (EVs), estimates of their carbon impact usually rely on a grid’s average emissions intensity based on its mix of power. But Cembalest argues that it’s the marginal source that is more important. For example, if most drivers charge their cars overnight, a grid’s heavy reliance on solar power won’t help. The grid may be relying on fossil fuels or even have to invest more in storage. Bad news for EVs is that marginal emission rates are 1.5X average ones, reducing the carbon benefits of EVs.

Cembalest recounts the sorry tale of the new owner of a Ford F-150 Lightning EV who encountered many non-working EV chargers on a trip north from the Bay area. Tesla owners still report very good experience with charging.

Hydraulic fracturing produces over half of America’s primary energy. This technique remains almost exclusively American although Argentina’s Vaca Muerta shale play is a rare foreign example. It’s hard to conceive how the US economy would look without fracking. We’d face higher energy prices, slower growth and continued reliance on foreign imports. The shale revolution has been an enormous benefit to Americans and our trade partners.

JPMorgan’s Annual Energy Paper is full of interesting facts. Europe is colder than the US, because it’s farther north. How much farther? The 44^th parallel north runs through upstate New York and across the Atlantic, passing just north of San Marino. 92% of Americans live below this line, while 82% of Europeans live above it. This is why 10% of European households have air conditioning vs 90% in the US. The increasing use of heat pumps in new European dwellings is making a/c available, since all that’s required is to run the heat pump in reverse on warm days. This will offset some of the efficiency benefits that come with heat pumps.

Mike Cembalest is in that rare category of writers whose output informs, surprises and is always worth reading.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

By Henry Hoffman, Partner, SL Advisors

In the realm of global energy, 2024 was heralded as a landmark year for the expansion of liquefied natural gas (LNG) projects, particularly for America. Optimism was buoyed by the prior year’s achievements, wherein American enterprises reached Final Investment Decision (FID) on the equivalent of 5 Billion Cubic Feet per Day (BCF/D). That’s one third of the amount of gas Europe was importing from Russia before the invasion of Ukraine! 

However, a regulatory interlude, specifically the temporary suspension of non-Free Trade Agreement (FTA) export licenses coupled with more stringent criteria for extending project in-service dates, has precipitated a recalibration of expectations. This pause has advantaged international competitors, notably with Qatar announcing a 16-MMt/y expansion. Consequently, the landscape for 2024’s FIDs is now markedly altered, favoring projects beyond American shores. 

According to the leading LNG experts at Poten & Partners, only a few domestic endeavors are still poised for progress. These include NextDecade’s (Symbol: NEXT) Rio Grande LNG Train 4, a notable candidate for a 2024 FID. Poten notes they have their DOE approvals in hand and Middle East buyers (Reuters has previously reported this is ADNOC) are in advanced discussions for offtake of 2-3 Million Tonnes per Annum (MTPA), enough to commercialize the project with TotalEnergies exercising its option for 1.5MTPA. NextDecade is targeting FID on T4 by the end of 3Q 2024.  

Nonetheless, the overarching sentiment within the industry is one of restraint, as projects that once seemed imminent now grapple with uncertain timelines. This unforeseen stasis extends beyond the U.S., affecting Mexican projects reliant on American natural gas, thereby creating a ripple effect that benefits international ventures in the UAE, Mozambique, and Papua New Guinea. 

In the intricate tapestry of global energy dynamics, the recent recalibration of the United States’ regulatory stance on non-FTA LNG export licenses has precipitated a notable shift. Asian buyers, initially on the cusp of cementing long-term procurement deals with U.S. LNG developers in the first quarter of 2024, find themselves at a crossroads, compelled to reconsider their supply strategies in light of these regulatory adjustments.  

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This pivot is not merely a transient phase but a reflection of a deeper reevaluation of supply chains amidst evolving policy landscapes. Poten highlights that Energy Transfer’s (Symbol: ET) Lake Charles LNG project epitomizes the challenges and resilience within this sector. The project has faced renegotiation barriers with potential buyers due to the uncertainty surrounding its non-FTA permit extension, essential for meeting its proposed in-service deadline of December 2025.  

This situation is further exacerbated by the U.S. Department of Energy’s stringent criteria for permit extensions, adding layers of complexity to an already intricate negotiation landscape. As a result, Energy Transfer’s attempts to amend pricing structures with buyers have encountered significant headwinds, underscoring the delicate balance between regulatory compliance and market competitiveness.  

Poten notes that Japan’s Kyushu Electric has delayed converting its Heads Of Agreement (HOA) with Energy Transfer into a binding Sales and Purchase Agreement (SPA) as one example of the effects of this disastrous policy. Conversely, Tellurian’s (Symbol: TELL) plagued Driftwood project may have received a lifeline, enabling it to capitalize on the current regulatory pause that has beleaguered competitors like Energy Transfer. 

The implications of this regulatory hiatus extend beyond mere project delays. It underscores a burgeoning competition for market share in the LNG sector, with other nations benefiting from America’s masochist behavior. This political maneuver disadvantages our allies in Europe and Japan while aiding rivals in the Middle East and Russia, manifesting significant and concrete impacts.  

Fortunately, in contrast to the partisan DOE, the American spirit lives on in domestic LNG developers, who, despite the current impasse, continue to forge ahead with negotiations and project planning. 

The Magnificent Seven may be shrinking to the Fab Four as the number of AI-linked market leaders diminishes. Tesla and Apple are down on the year while Alphabet lagged the S&P500. That leaves Nvidia, Meta, Amazon and Facebook leading. As with the dotcom bubble 25 years ago, if you can link your business to the new craze your stock will soar. 

Natural gas driller EOG Resources was relying on “machine-learning” at least seven years ago to optimize their E&P operations. Devon Energy uses AI to help achieve “sustainable growth.”  

Natural gas has a stronger link to AI than the examples above. Given the substantial increase in electricity needed to power new data centers, the efficiencies promised by the AI revolution won’t be achievable without it. Executives are becoming increasingly bullish in their outlook. “It will not be done without gas,” says Toby Rice, CEO of EQT America’s biggest producer of natural gas. Growth in data centers has led to sharp upward revisions in forecast electricity demand, now 3-4% pa versus just 1% a year ago (see AI Boosts US Energy). Microsoft is opening a new data center somewhere in the world on average every three days.  

US data centers are forecast to consume a tenth of US electricity by 2035, up from an expected 4.5% next year.   

“Intermittent renewables is not going to cut it.” warns Enbridge EVP Colin Gruending. 21st century technology relying on weather-dependent seems incongruous.  

Using more electricity will limit the market share gains of renewables. The slow pace at which we’re adding high voltage transmission lines is already impeding the hook-up of new solar and wind farms (see Renewables Confront NIMBYs).  

Many IT companies have made their own carbon commitments, and some worry that they’ll insist on zero-carbon energy. This sounds prosaic for revolutionaries, and it’s likely they’ll find creative ways to meet those obligations. Natural gas generated power with carbon capture technology is one possible solution. Or companies could simply buy carbon credits, a demand Occidental Petroleum is preparing to meet (see Carbon Capture Gaining Traction).  

US natural gas remains very cheap. The Henry Hub benchmark trades at under $2 per Million BTUs. In west Texas, gas is often produced along with oil. The shortage of infrastructure to move the gas has pushed prices negative at the Waha hub, meaning buyers get paid to take it.   

The US was the world’s biggest exporter of Liquefied Natural Gas (LNG) last year, averaging 11.9 Billion Cubic Feet per Day. We eclipsed Australia and Qatar who have been vying for top slot in recent years. The world wants more of what we have in abundance. LNG exports will double over the next four years. The Biden administration’s recent pause on new LNG permits threatens to halt further growth, harming efforts to reduce CO2 emissions elsewhere (see LNG Pause Will Boost Asian Coal Consumption).  

Energy executives have roundly criticized the pause. Our aging president is desperate to excite young progressives about four more years. It’s a bad policy likely to be rescinded after the election regardless of the victor. Surging power demand from data centers may lift domestic natural gas prices without additional LNG exports.  

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In other news there’s an absorbing interview between BBC journalist Stephen Sackur and Guyana’s President Irfaan Ali as this South American country prepares to exploit its offshore oil reserves. The Stabroek Block is a prolific region, with Exxon announcing a new discovery earlier this year (Bluefin).  

The BBC’s Sackur tried to put President Ali on the defensive over Guyana’s plans to export more fossil fuels, counter to the UN’s objective to eventually limit their use. The optics of a wealthy journalist from a rich western nation berating the leader of a poor country whose citizens aspire to higher living standards was powerful. In one interview it encapsulated the entire climate change conundrum. OECD countries have generated most of the world’s excess CO2 and want to reduce them. This will disproportionately benefit poorer countries like Guyana who are less able to afford climate change mitigation.  

And yet the president of Guyana (GDP per capita $25K) tells a reporter from the UK (GDP per capita $52K) that they’ve preserved a rainforest the size of England and Scotland combined which acts as a carbon sink. Where is the money from rich countries to pay for that, asks President Ali.  

Guyana wants to use its oil reserves to create wealth and reach western living standards. This will be an enduring problem unless OECD countries provide substantial financial incentives to induce the actions they’d like to see. 

The interview clip is the global climate conundrum.  

Indonesia and Malaysia are apparently among the few places on earth with geology suited to hold CO2. This has drawn the interest of Exxon Mobil among others, who recently secured “exclusive rights to CO2 storage” according to CEO Darren Woods. Meeting the “Zero by 50” goal requires burying 1 billion tons of CO2 annually by 2030, 25X today’s capacity.  

Schlumberger is investing as much as $500MM to buy Norway’s Aker Carbon Capture Holding. And Occidental is building the world’s biggest carbon capture facility in Texas.  

These are all examples of how the energy sector is positioning to continue providing reliable energy while also helping mitigate CO2 emissions.  

Policymakers have an ambiguous posture towards energy companies. They like to blame them for producing fossil fuels but want them to continue so that prices on 80% of the world’s energy don’t shoot up. There’s little support nor technical capability to stop using what moves the world’s economy.  

This shows up in myriad ways. A UBS banker recently complained about having to align financing decisions with a world warming by 1.5 degrees above 1850 levels. We’re already at 1.1 degrees, so almost there. Judson Berkey, group head of engagement and regulatory strategy, noted that more realistically we’re “hurtling towards a 2.8 degree warming.”  

“Banks are living and lending on planet earth, not planet NGFS,” added Berkey, referring to the Network for Greening the Financial System.  

If companies aren’t running their businesses consistent with Zero by 50, how is a bank supposed to make lending decisions under this more onerous constraint? 

JPMorgan Asset Management and several other big firms withdrew from Climate Action 100+ because they concluded their interests weren’t properly aligned. Political leaders haven’t been effective in persuading voters to accept higher energy prices to speed the transition.  

So the world follows ambiguity – not confronting China as it ramps up coal consumption; ignoring the boost to emissions to increase their living standards; pressing banks to pretend there’s no demand for traditional energy financing. Coal finance is among the most controversial areas for banks, because the world is supposed to be phasing out its use albeit with varying degrees of commitment.  

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The US Energy Information Administration in last year’s International Energy Outlook shows 2050 coal demand flat in their Reference Case and little changed in their six other scenarios. 

By contrast, the International Energy Agency (IEA) recently published Accelerating Just Transitions for the Coal Sector. As is common nowadays, the IEA’s forecasts are aspirational and routinely show fossil fuel consumption peaking at the time of publication. There’s no IEA scenario in which coal demand rises, even though last year saw record consumption. 

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Markets are looking through this. Midstream energy infrastructure, as defined by the American Energy Independence Index continued to outperform utilities. That’s because NextEra and their peers are responsible for delivering the energy transition. On one side sits the unappealing economics of renewables which push up power prices. This is in part because increased solar and wind use raises the amount of redundant capacity needed to back up weather-dependent electricity.  

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On the other side sit political and regulatory pressure to decarbonize the grid.  

Clean energy is also a huge investment disappointment. The sector’s operating margins are often unattractive and sometimes negative.  

According to Wells Fargo, Ohm Analytics revised down their forecast of residential solar installations to –19% versus last year. Wells Fargo is at –25%. One reason is that installers are going bankrupt.  

Ohm retains a positive longer-term outlook on residential solar for two reasons that are heavy in irony: (1) rising utility bills, and (2) increasing grid instability. Data center build-out is a recently appreciated area of demand growth following decades of no growth in electricity consumption.  

Higher prices and reduced peak demand buffers are a consequence of greater reliance on renewables. As power grids operate with diminished excess capacity the risk of a power outage rises. This will play out over the next several years.  

In brief, Ohm is forecasting increasing residential spending on solar panels because increased utility spending on solar panels is raising prices and reducing the flexibility of the grid. If too many households become self-sufficient in electricity generation and unplug from the public system, the substantial fixed costs of maintaining and building distribution infrastructure will get spread across a declining set of customers.  

That’s a problem for another day.  

The energy transition is an engrossing story, but we believe the best returns will continue to come from traditional energy and midstream infrastructure which continues to allocate capital based on IRR with limited impact from ESG-type influences.  

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Last week a Federal judge blocked completion of the Cardinal-Hickory Creek high-voltage transmission line. The 102-mile project linking Dubuque County, Iowa, to Dane County, Wisconsin has one mile remaining. Three environmental groups opposed its construction through a Mississippi River wildlife refuge. It’s needed to upgrade an existing transmission line built in the 1950s, add capacity, and bring new solar and wind power to Madison, WI.

Environmentalists are far from one homogeneous group. Locally, they can oppose infrastructure enabling the energy transition they support nationally. An FT video on the Cardinal-Hickory Creek website shows an environmentalist holding a feather (“I found five today”) lost by a bird unsuccessfully navigating the pylons.

Power lines are an unfortunate ugly corollary to electricity use. Because solar and wind need large spaces, their output must travel long distances to customers.  Climate extremists wishing to project a coherent view must reconcile the two. Nuclear and natural gas take up less room so can be placed nearer their customers.

The big problem with energy infrastructure isn’t the opposition from environmentalists. It’s the legal process that allows last-minute delays to projects that are almost complete.

Cardinal-Hickory Creek was first conceived in 2011. Public engagement began in 2014, authorizations were in hand by 2020 and construction began in 2021. 115 renewables projects with 17 gigawatts of capacity depend upon its completion. Nobody will build anything that can be derailed at the finish line when capital has been long committed and spent. But this is America’s process today.

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We’re suddenly moving into a period of high demand growth for electricity following decades of flat demand. Electrification, including increased use of EVs was expected to add 1% pa to demand. Data centers are suddenly the new power hogs.

Wells Fargo estimates that AI will add 16% to US power demand by 2030. In less than a year, 1% annual demand growth has become 3%+.

For some this will increase the urgency to add even more solar and wind, although it’s hard to imagine that we could be doing any more. Therefore, it will boost natural gas demand.

Last year the Energy Information Administration (EIA) projected natural gas use in electricity generation was about to peak. The EIA produces unbiased research, unlike the International Energy Agency (IEA) whose publications are mostly fantasy appealing to climate extremists.

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This loss of demand will be made up for elsewhere in industry and via LNG exports once the pause on new permits is lifted. But now the trajectory has changed. Wells Fargo estimates that AI will boost natural gas by 7 Billion Cubic Feet per Day (BCF/D) in order to meet just 40% of the incremental power load. Their upside case is 16 BCF/D. Last year the US produced 105.5 BCF/D from the lower 48 states.

This analysis only considers US data centers. But they’re being built all over the world. The AI revolution is global. Projected increases in electricity generation will add to global LNG demand. US natural gas prices are cheap. Chad Zamarin, a senior vice president at Williams Companies (WMB) says, “Domestic U.S. markets are oversupplied.”

Companies that produce electrical equipment should do well. Transformers are on a two year backlog. But assuming this will be good for renewables is to bet on a transformation of how infrastructure gets built.

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America’s regional grids are increasing spending. But we’re adding the fewest miles of transmission in a decade. This is the morass into which investors in clean energy and utilities are jumping. Regardless of how strongly you believe in renewables and how sleepless rising sea levels make you, financing solar, wind and new power lines looks like a good way to lose money.

Morocco’s Noor Ouarzazate solar complex, operated by Saudi Arabia’s ACWA Power International, has had to shut down for most of the year because of problems at its storage unit. The facility has suffered repeated problems. A government agency called for its closure in 2020 because of high cost.

Morocco has a goal of getting renewables to half its power capacity by 2030. Their primary energy consumption is 7% renewables, with the balance from fossil fuels. Give them credit for trying. Many Moroccans would likely prefer adding cheap energy over green energy to raise living standards. Per capita energy consumption is a tenth of the US.

It seems increasingly clear that the AI revolution is going to boost natural gas consumption. Adding new pipelines is no easier than adding power lines. But pipeline operators can add small amounts of capacity at the margin. They don’t face any new competitors. Toby Rice, CEO of EQT, said, “Our pipeline infrastructure is maxed out.”

Rather than being compelled to deliver the energy transition, natural gas pipelines are positioned to compensate for the transition’s inability to deliver what politicians have promised.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Treasury bills yielding 5.3% are not the worst place to put some cash. Long term expected returns on US large cap equities are generally 5-7%. Schwab expects 6.2%. JPMorgan is at 7%. The Equity Risk Premium is the lowest it’s been in over two decades. S&P500 earnings projections for this year and next are roughly unchanged over the past three months, but stocks are +10% driven by the AI boom.

The Fed doesn’t target asset prices, but the release of the FOMC’s projection materials last week confirmed that they expect to cut rates later this year. Stocks duly rose.

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The Fed is walking a precise path. FOMC forecasts for the Fed Funds rate are aligned with the market. December SOFR futures are at 4.5% versus the median blue dot at 4.6%. Policymakers can be forgiven a degree of immodesty. They have quelled inflation without causing a recession.

On the back of this success, they now plan to cut rates with inflation still above their target and the unemployment rate below their projected equilibrium. This drew criticism from Larry Summers who thinks they’re too eager to cut rates. The counter argument is that current Fed policy is restrictive, and having avoided a recession to this point they don’t want to stay too tight for too long.

The economy is doing well, and the margin for error is on the side of slower rate cuts or none this year. If the unemployment rate dropped back to 3.7% the 4.6% year-end projected Fed Funds rate would look optimistic.

With stocks historically expensive against bonds, which themselves don’t look that cheap, there shouldn’t be any great rush among investors to commit new cash to equities.

The exception is midstream energy infrastructure, which has quietly been delivering strong returns for over three years and is drawing the attention of more buyers.

Williams Companies CEO Alan Armstrong told the CERAWeek energy conference that the need for permitting reform has made building infrastructure more difficult. This has reduced competition within the midstream sector, leaving incumbents in a strong position. Climate extremists (hug one) have done this. Armstrong said Boston burns garbage, oil and coal to generate electricity rather than allow pipelines to bring in natural gas from Pennsylvania.

We agree with Armstrong that any serious effort to reduce emissions should exploit cheap natural gas to displace coal. As the world concludes that the UN IPCC “zero by 50” goal is out of reach under current policies, pragmatism will favor solutions like this.

In 2017 we wrote about Stanford University’s Tony Seba (see A Futurist’s Vision of Energy). Seba tells you what the future will look like. His presentations are engaging and his forecasts far from mainstream. This makes them exciting, by forcing the viewer to contemplate a world very different from today.

Seba’s not the only person to have made spectacularly wrong energy forecasts. Vaclav Smil is a brilliant writer on energy whose many books include How the World Really Works. Smil eschews long term forecasts, recalling a 1983 meeting of the Internation Energy Agency (IEA) where he drew some comfort because his, “was less ridiculous than that of the World Bank’s chief economist.”

In 2017, Tony Seba opened his presentation with a photo of horse-drawn carriages in New York’s 1900 Easter parade followed by a 1913 photo of Fifth Avenue with all cars and no horses. It’s great theatre and draws the audience to embrace the notion that dramatic change is all too common.

At the time of that presentation, Seba forecast that by 2030 EVs would be 100% of US auto sales and that global oil demand would be 70 Million barrels per Day (MMB/D). We’re halfway to that deadline. Today US EVs are 10% of sales if you include hybrids. Global oil demand is at a record 103 MMB/D and the IEA regularly revises its forecasts up.

Seba’s website still uses the 1913 photo labelled “Where is the horse?”

Unbowed by the improbability of the 2017 forecasts, Seba currently expects 95% of US passenger miles to be “served by on-demand autonomous electric vehicles owned by fleets, not individuals.” Never mind that the average US car is over 12 years old and that today fleet-owned autonomous cars are limited to a few experiments in places like Tempe, AZ.

Change is coming, and sometimes it’s faster than expected. Tony Seba is not short of invitations to speak at events. However, profits do not come to those following his vision.

Seven years ago, Exxon’s US EV forecast was a 10% market share by 2040, likely to be a big miss. They also forecast 115 MMB/D of global crude oil demand at that time, which is quite possible given recent trends.

Aramco CEO Amin Nasser told CERAWeek that the “current transition strategy is visibly failing” and that emissions will increasingly be determined by the “global south” (meaning the developing world including Asia). He’s right.

This energy transition will last decades as did previous ones from wood to coal to oil and gas. Futurists are fun but the incumbents are where the money is.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund