Natural Gas Is The Solution

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
Natural Gas Is The Solution
Loading
/

With forecasts for power demand growth seemingly increasing every month, it’s clear that part of the solution will be “behind the meter”, meaning new natural gas power plants directly connected to their data center customers without the need to connect to the grid.

This also sidesteps potential complaints that existing electricity customers are subsidizing the new ones because the cost of added infrastructure is broadly shared across a network. Although adding data centers is a vital step in developing AI capabilities, they don’t add many jobs.

Once constructed, oversight of a warehouse of servers is not labor-intensive. Like bitcoin miners, they don’t have much political clout, so operating independently of the grid is likely to become more widespread.

Texas has its own grid that operates without any meaningful connections to other states. Their forecast growth in peak summer illustrates the problem. Having increased at 2% pa for the past couple of decades, they now expect a tripling of that growth rate over the next nine years. Nobody knows if the power infrastructure to support this can be built on such a schedule. We’re adding 148 new gas power plants across the country, up from 133 in April, according to S&P.

Renewables are too unreliable to receive serious consideration because data centers need to run all the time, not just when it’s sunny or windy. Several nuclear projects are being pursued but none are likely to be operational before the 2030s. So natural gas is the only remaining solution. Williams Companies has discussed offering co-located gas generation as a complete solution for data centers.

Because the technology companies building these new facilities care about their carbon footprint, Carbon Capture and Sequestration (CCS) is often part of the package. Exxon Mobil thinks data centers could be 20% of the total CCS market by 2050.

Too few people in America appreciate how significantly the energy sector has boosted our economy. The casual observer contemplating equity markets sees technology stocks and anything linked to AI driving returns. While true, this view doesn’t give sufficient credit to the energy sector and how our access to cheap, reliable hydrocarbons has let the US leap ahead of other developed countries.

Construction of manufacturing plants has tripled from pre-pandemic levels. Part of this is the result of all the fiscal stimulus the Biden administration pumped into the economy, from spending to offset the drag caused by covid lockdowns to the Inflation Reduction Act. But there can be little doubt that access to cheap, reliable energy has played an important role. Manufacturing employment has stopped its multi-decade decline.

Natural gas is in demand for data centers and to power new manufacturing. But it’s also the biggest source of reduced CO2 emissions by displacing coal. Roughly two thirds of the million metric tonnes we’ve cut is down to natural gas. This has happened with little fanfare and scant support from environmental extremists. Yet it’s been more important than all the solar and wind we’ve built.

America has come to Europe’s aid with exports of LNG, with over half of our volumes sent there to replace lost Russian imports. The widely criticized LNG permit pause, an ineffective sop to progressives, injected uncertainty into our willingness to continue with long term supplies. Fortunately, that will be lifted next month.

The US Department of Energy (DoE) is expected to release the environmental study whose preparation the pause was intended to allow – apparently it wasn’t possible to keep approving permits while doing research.

In a letter obtained by the NYTimes, outgoing DoE head Jennifer Granholm said increased exports would drive domestic gas prices higher, by as much as 30%. Even if true, US natural gas is around $3.25 per Million BTUs versus over $12 in Europe and Asia. It would still be very cheap compared to global prices.

We often use a chart showing growing LNG export capacity as new terminals are completed. Surprisingly, this year volumes are down. It’s not the permit pause, which had no impact on existing projects, but is the result of slower than expected completion at a couple of expansion projects and downtime for maintenance elsewhere.

In some cases, FERC has been slow to issue approvals – whether this was politically motivated or simply the result of diligent regulators depends on your perspective. But the net result has been that feedgas demand from all our LNG terminals averaged 12.53 Billion Cubic Feet per Day (BCF/D) this year, down slightly from 2023 and the first drop since we began exporting LNG in 2016.

There’s every reason to expect higher volumes next year. For many energy challenges, natural gas is the solution.

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

Energy Mutual Fund Energy ETF

 

Measuring The Midstream Mood

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
Measuring The Midstream Mood
Loading
/

Last week my partner Henry Hoffman attended the 23rd Annual Midstream, Energy, and Utilities Symposium, held by Wells Fargo. The mood was understandably upbeat, underpinned by strong fundamentals and the more coherent regulatory framework expected following the election.

Given our focus on natural gas, we were naturally interested in this element of the energy story. Data centers in support of AI are driving power demand sharply higher. Randy Fowler, CEO of Enterprise Products Partners, noted that ERCOT which runs the Texas electricity grid is forecasting 150GW of power demand by 2030, up from 85GW currently. We heard other reports that demand may even double by then.

Grid expansions of this magnitude typically take several years. Therefore, it seems unlikely existing infrastructure will be able to meet the increased demand from data centers, which will lead to “behind the meter” solutions whereby a data center builds its own power source or buys it directly from a provider without going through the grid. The several announcements involving nuclear power contemplate this. However, the widely reported Microsoft deal to restart a reactor at Three Mile Island has run into problems with FERC as this power supply wouldn’t be totally separate from the grid.

Cheniere is planning to take advantage of the more co-operative regulatory environment to “permit it all”, which in their case could bring their total permitted LNG capacity to 90 Million Tons per Annum (MTPA), around 12 Billion Cubic Feet per Day (BCF/D). This would give Cheniere alone more export capacity than any other country. Cheniere’s CFO Zach Davis expects the global LNG market to grow from 400 MTPA to 600 MTPA by the early 2030s. He also noted 1,200 MTPA of global regassification capacity, indicative of robust demand.

Anticipation of an improved regulatory environment has pushed midstream stocks higher since the election. Some of this can be achieved by the new administration through executive actions, but building any type of US infrastructure nowadays is too often tied up in legal challenges. Climate extremists have learned how to use the courts to slow hydrocarbon projects but just about anything can suffer interminable delays. Williams Companies’ (WMB) general counsel highlighted four areas that require attention:

  • Limiting challenges to approved permits.
  • Reducing state-level authority to block projects based on technicalities.
  • Streamlining water-crossing permits under FERC jurisdiction.
  • Imposing stricter time limits on federal reviews.

A bipartisan effort to pass legislation reforming permitting was moving forward until the election. Some attendees felt the political winds were shifting. WMB reported more frequent discussions with members of Congress. A handful of Democratic governors have suggested that shifting more oversight of infrastructure to the Federal level could ease political pressure they sometimes face.

NextDecade, a company we’ve followed closely as they’ve moved forward with their plans to build the Rio Grande LNG export terminal in Brownsville, TX, expressed confidence that robust demand would support adding further capacity beyond their Stage One project. They also expect any outstanding permit issues to be resolved by November next year.

There’s very little evidence that the animal spirits of 2016 will offer a reprise of “drill baby, drill” with its subsequent poor investment returns. Most management teams were singing the same tune, which is to maintain strong balance sheets, prioritize accretive investment opportunities and focus on growing free cash flow per share.

Kinetik’s CEO Jamie Welch was more bullish, saying, “On January 21st, don’t be surprised if animal spirits take over.”

In other news, we recently made a small investment in New Fortress Energy (NFE) across our portfolios. NFE provides natural gas using floating terminals called “Fast Liquefied Natural Gas’ or FLNG. Accessing offshore reserves speeds delivery to customers, a significant advantage given the 3-5 years it typically takes to build an onshore LNG export terminal. The company has endured some cost over-runs and recently raised additional equity which enabled them to refinance their debt. It’s currently a small position but we think it’s attractively priced at current levels.

My wife recently retired as a pre-school teacher at our local church. She didn’t do it for the money, which is fortunate because their compensation structure might kindly be described as parsimonious. But she did receive a form of payment which is priceless, in the form of hand-drawn cards from five year old students saying I love you, a reward rare in investment management as I often noted.

However, several years of strong performance in midstream has stimulated warm feelings among countless clients, and I have felt the love this year as I’ve met with and corresponded with many of you. The 2020 pandemic was a miserable period in so many ways. But there were sparkling rewards for those who retained their conviction.

One investor cited a tripling of the value of his investment (excluding dividends) which yields over 14% from his original cost. He called it, “a good result for sticking with things when your hands are bloody from the pain.”

Another long-time investor called me and read off similarly rewarding figures from client accounts.

We appreciate the continued support of so many investors, who are overwhelmingly long term and not just in for a quick trade. Some have been with us since the firm’s founding in 2009. We never forget that you’re the reason we are in this business.

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

Energy Mutual Fund Energy ETF

 

US Leads Natural Gas Demand And Supply

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
US Leads Natural Gas Demand And Supply
Loading
/

It’s clear that natural gas demand is heading higher over the next few years. It’s less certain that this will push prices higher. New LNG export terminals are going to double our volumes sent overseas over the next five years. The widely criticized pause on LNG permits that President Biden imposed last January only applied to new projects.

Previously issued permits were unaffected and those construction projects largely continued. The pause did inject uncertainty into contract negotiations for projects that were seeking enough commitments to reach a Final Investment Decision (FID). Japan is one foreign buyer that expressed concern at the time over the uncertainty this created about the US as a supplier.

Incoming President Trump is widely expected to lift the permit pause soon after he’s in office. This will lead to more visibility about export volumes from 2030 and on, given that it’s not uncommon for a new project to require five years to build following FID.

The second source of new demand is from new natural gas power plants to power all the new AI-related data centers that are planned. JPMorgan reported that global gas turbine orders are +33% YoY, driven by demand in Saudi Arabia which is replacing many older turbines with more efficient models, and the US because of data centers. Excluding China orders are +61% measured by GW of output capacity.

Demand for heavy-duty turbines able to provide baseload supply (defined as 100MW of output), is similarly strong.

Continued coal-to-gas switching, our biggest source of reduced CO2 emissions in the US, is a third source of natgas demand.

A google search of, “Is solar power cheaper than gas?” delivers numerous affirmative responses, including Google’s AI result. There are at least that many journalists toiling away in willful defiance of overwhelming evidence to the contrary. Saudi Arabia is a reliably sunny place and they’re driving the growth in gas turbine demand.

In the US, renewables’ advocates routinely overlook the cost of intermittency. In the marketplace for reliable power, solar and wind have no place. The persistent championing of renewables by the International Energy Agency and other progressive commentators denies empirical evidence to the contrary. They’ve helped countless investors create small fortunes from big ones by investing in clean energy. The real money has been made from independent thinking.

It’s clear that demand for US natural gas is headed higher. But even though US gas volumes are set to rise prices, which are perennially among the cheapest in the world, may remain low as supply increases commensurately.

US oil output is likely to rise somewhat. Trump’s new Treasury Secretary Scott Bessent’s “3-3-3 plan” targets 3% GDP growth, 3% deficit to GDP and 3 million barrels a day of new oil production. His ability to influence oil output is limited. For example, Chevron expects this year to be their peak capex spend in the Permian as they prioritize growing free cash flow over production.

Markets still expect some higher production in response to more pro-energy regulation and greater access to Federal land. Increased oil from the Permian in west Texas could add to the supply of associated gas, an unsought companion to the crude that’s produced there.

In their investor day recently, Enbridge raised 2025 EBITDA guidance modestly on the back of organic growth in their natural gas pipeline business which is their major area of focus.

Nuclear power can be part of the solution for new data centers, albeit not until the 2030s given how long new plants require for construction. Small Modular Reactors (SMR) have seemingly been on the horizon for years. However, earlier this year the Department of Energy released a guide to help companies use the sites of retired coal plants for nuclear facilities. This takes advantage of already existing connections to the grid.

TerraPower, led by founder and chairman Bill Gates, recently broke ground on its Natrium SMR project in Kemmerer, WY which would be the first nuclear plant to be situated on a former coal plant. It’ll use molten salt (natrium is the Latin word for sodium) rather than water as coolant, since it has a much higher boiling point.

As Terrapower points out, it is the only “coal-to-nuclear project under development in the world.” Why isn’t the Sierra Club behind efforts like this?

Between increased natural gas and ongoing innovation in nuclear, one day we’ll find we’ve transitioned away from intermittent renewables. Among the many positives will be that wretched little girl Greta being consigned to the dustheap of history.

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

Energy Mutual Fund Energy ETF

 

 

Lemming Leadership

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
Lemming Leadership
Loading
/

Sometimes this blogger stumbles across a phrase that begs to be used as the title for a blog post. Who better to be the subject of this one than the far-left climate extremists whose policies have led to higher energy prices, deindustrialization and job losses.

Start with Germany. Ryanair’s CEO Michael O’Leary recently described Germany as being run by “a government of idiots” because they followed the “stupid solutions” pushed by the Green Party. No doubt O’Leary’s perspective is the narrow one of the airline executive. He criticizes airport fees of over €50 per passenger which he believes will relegate Berlin to “a regional airport at best.”

Germany imposes some of the highest aviation taxes in Europe, partly to curb CO2 emissions. Lufthansa CEO Carsten Spohr agrees with O’Leary, commenting that, “More and more airlines are avoiding German airports or canceling important connections.”

More broadly, Europe’s energy policies are driving de-industrialization. The auto sector represents 7% of EU GDP, far higher than in the US. They’re having to build EVs the market doesn’t want using energy that’s priced too high. No wonder Volkswagen is planning factory closures, lay-offs and pay cuts.

Angela Merkel, German chancellor 2005-21, bares as much responsibility as anyone for these failures. She led the country to depend heavily on Russian natural gas and endorsed Green policies including shutting all their nuclear plants and diving headlong into windpower.

Appeasement of Russia following its 2014 annexation of Crimea led to the 2022 invasion and Germany’s current scramble to reinvigorate its military following decades of dependence on the US for defense.

But such poor leadership isn’t only across the Atlantic. Angela Merkel has her fans among the Democrat establishment in the US.

Five years ago Harvard awarded her an honorary degree, citing, “shrewd resolve and pragmatism” and sensible policies including the nuclear phaseout. She’s on a book tour and was recently feted by Barack Obama at an event in Washington, DC.

Merkel endorsed Kamala Harris for president, which for voters aware of Germany’s penchant for economic self-harm likely cemented the Democrat as too liberal.

Last month’s election sent a clear message against progressives on a range of issues including energy policy. America’s big enough to accommodate varying approaches to energy, so we can see which states are managing climate change without widespread collateral damage.

Texas is the biggest user of windpower and second in solar. Sunny Florida is third in solar. Both states are adding jobs, people and investment because they provide cheap, reliable energy in a regulatory environment that promotes new business formation.

California is #1 in solar and has expensive electricity provided on a creaky grid. Diablo Canyon, a nuclear power plant, was almost shut down prematurely due to pressure from environmental extremists.

German voters have been led lemming-like over the cliff into energy purgatory and economic malaise. American energy policies have generally been enlightened with a few exceptions such as liberal Massachusetts which imports LNG because it won’t allow gas pipeline infrastructure linking it to the Marcellus shale in Pennsylvania, and New York which forbids new natural gas hook-ups.

The Sierra Club and its peers have been an irritant but largely inconsequential, which is why the US economy continues to do so well.

Fund flows into the MLP sector have been negative for years. From 2018-23 there were five years of outflows. For much of this year the pattern continued. Meanwhile equity funds have seen almost $140BN in inflows since the election as investors assessed the market’s prospects with generally less regulation.

My friends in Naples may not be fully representative of the overall electorate (ie wealthy, white, older and male). But they’re certainly cheered by the election and consequent market reaction.

Energy including midstream is a clearer election beneficiary than any other sector. In November MLP funds saw their strongest monthly inflows in almost eight years. 2024 is suddenly on track to be the best year since 2017. We do a lot of calls with clients and for that reason generally gain assets. But there’s still no FOMO, no irrational exuberance, at least among the new investors we talk to.

Wells Fargo noted that midstream’s correlation with crude oil prices has weakened significantly to 0.23 this year versus 0.53 over the past five years. During periods of market weakness this has been a common topic for clients wondering why their toll-model investments are moving lower with oil prices.

AI data center demand for natural gas has been an important driver of recent performance, but with leverage averaging around 3.3X Debt:EBITDA, pipeline businesses are just less risky than in the past. We think the low correlation with commodity prices will persist.

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

Energy Mutual Fund Energy ETF

 

The 21st Century Fuel: Natural Gas

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
The 21st Century Fuel: Natural Gas
Loading
/

In recent years as extreme views on climate have become increasingly fringe, no hydrocarbon has enjoyed more of a reassessment than natural gas. Enbridge CEO Greg Ebel talks about the “energy evolution” rather than a transition.

The US is adding over 140 new gas power plants this year as demand from data centers builds. Accommodating the intermittency of solar and wind is often achieved with supporting gas peaker plants, which have the ability to ramp up when it’s not sunny or windy.

There are even efforts to produce Renewable Natural Gas (RNG), which simply means it’s natural gas produced synthetically with low emissions rather than extracted from underground.

Divert is a company based in Massachusetts that takes food waste and by letting it decay in an anaerobic environment (ie deprived of oxygen), derives methane (natural gas). In a podcast (listen to Energized; The Future of Energy) CEO Ryan Begin explains how the process works. Enbridge is an equity investor and last year signed a $1BN infrastructure agreement with Divert to help them develop their business. Enbridge also sponsors the podcast.

CEO Begin goes on to explain how food waste is mostly water, so the vast tanks they build are in effect water treatment plants. Their inputs come from food processing companies, when they have to dump a batch of product that was contaminated or otherwise improperly produced. Supermarkets are another important source.

Most discarded food winds up in landfills where the methane it generates while decaying goes into the atmosphere. Because methane is a greenhouse gas, Divert can show that its business is helping the climate as well as making something useful out of waste.

Not that long ago, conventional wisdom on climate change held that all hydrocarbons needed to be eliminated. In his 2022 book How to Avoid a Climate Disaster Bill Gates pushed this view, warning that relying on natural gas as a “transition” fuel would support its use for too long to hit the UN’s Zero by 50 goal, which is widely regarded as unachievable.

In rejecting natural gas with its capability to displace far more harmful coal, Bill Gates aligned with that wretched little girl Greta and her band of poorly educated extremists in an otherwise thoughtful book.

Another example of the new appreciation is Terraform Industries, based in California and founded by Casey Handmer who was profiled recently in The World Ahead 2025, published by The Economist. Terraform is a start-up solar power company, which in itself is unremarkable. What sets them apart is their plan to use that solar power to produce synthetic natural gas.

The process derives hydrogen from water via electrolysis, adds CO2 and via a chemical reaction produces methane (CH4).

Terraform’s concept represents a remarkable shift. For years we’ve read that solar is the cheapest form of electricity, an assertion unsupported by the continued dominance of natural gas in power generation where it is around 40%. The efforts of climate extremists have been directed towards replacing natural gas with renewables such as solar.

Yet Divert and Terraform are two companies dedicated to producing natural gas confident that they’re aligned with efforts to reduce GHGs and combat climate change. They’re recognizing the importance of dispatchable energy, there whenever you need it, which is is how 80-90% of the world operates.

Divert is capturing methane that would otherwise be emitted into the atmosphere.

Terraform has decided that rather than trying to accommodate the debilitating intermittency of renewables, they should use them to create the reliable energy that the world wants.

It’s a remarkable evolution.

Terraform’s  Handmer says, “We won’t rest until we’ve saturated the global market for any hydrocarbon at a price cheaper than fracking.” The natural gas they produce is $35 per Thousand Cubic Feet (MCF), a price he claims puts them, “in economic contention in many markets that rely on imported fuel.”

US natural gas currently trades at around $3 per MCF. LNG at benchmark delivery points in Europe and Asia is $14 per MCF. So it’s not obviously competitive just yet, although Terraform’s process can presumably operate wherever customers and sunshine co-exist. Perhaps when the distribution costs of regassifying LNG and moving it by pipeline to where it’s needed are figured, the economics start to look better.

The efforts of these two American companies illustrate a growing trend of evolution towards lower-emission energy without destroying economic growth in the process. Both recognize the critical importance of reliable, secure energy. The vision of climate extremists and progressives has wrecked Germany for little tangible benefit.

As Enbridge CEO Greg Ebel says, coal was a 19th century fuel and oil a 20th century one. Natural gas is the 21st century fuel.

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

Energy Mutual Fund Energy ETF

 

November Was A Great Year

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
November Was A Great Year
Loading
/

Like millions of families across America, on Thanksgiving we gave thanks for being with friends and family, along with “…sunny days and that we’re all together.” I added a silent appreciation that left-wing climate extremists were resoundingly defeated on November 5th.

The market’s realization that the election had ushered in sensible, pro-American energy policies took the American Energy Independence Index +15% for the month, a return that in different circumstances would be satisfactory over a full year. The YTD performance is +52% the best of four consecutive up years.

President-elect Trump seems to be in the Oval Office already. His pronouncements from Mar-a-Lago on tariffs, illegal immigration and drugs carry more weight and press coverage than anything emanating from the White House.

In preparation for transactional foreign policy, Mexican President Claudia Sheinbaum asserted that migrant caravans are no longer reaching the US-Mexico border. Why is that only happening now?

European Central Bank chief Christine Lagarde has said the EU should embrace a “checkbook strategy” and increase imports of US LNG and defence equipment. They sorely need both. Seeing the fast response of foreign leaders to the election simply highlights how weakly the current Administration has promoted US interests.

It’s likely Europeans will be buyers of LNG next year anyway. Northwest Europe has endured colder than normal weather recently, and North Sea windspeeds have been inconveniently low. As a result, storage withdrawals have been higher than usual, although overall levels remain ample.

European natural gas futures markets reflect increased European demand. Buying more US LNG should be an easy way for the EU to deflect Trump’s promised tariffs.

UK power generation has relied on natural gas more than usual over the past month, given the calm, cold weather. The prospects for the cleanest hydrocarbon are diverging markedly from the outlook for crude oil, where its role in transportation is changing. The International Energy Agency (IEA) is little more than a renewables cheerleader and has long forecast an imminent peak in oil demand.

Greg Ebel, CEO of Enbridge, argues that we’re going through an energy transformation, not transition. On a podcast series called Energized: The Future of Energy he classifies the 19th century as being about coal, the 20th about crude oil and the 21st about natural gas. North America’s biggest pipeline operator rejects climate orthodoxy that all hydrocarbons are going away, arguing instead that natural gas is a vital partner to increased reliance on intermittent solar and wind.

The UK is a case in point. Although windpower is on average their biggest source of electricity, roughly half the time natural gas provides the most.

Meanwhile China’s growing EV market is likely to dampen one source of demand growth for crude oil.  They recently reached a milestone in that half of new auto sales now run on batteries. This often fools people into thinking that China is making substantial progress in decarbonizing their economy, ignoring that their EVs, like China itself, run principally on coal. They’re regressing towards a 19th century fuel because energy security is what drives policy in Beijing.

China’s energy deficit needs to close before they can take a more confrontational approach over Taiwan. It’s still some years away. Friends of mine with a military background, and therefore better placed to have an opinion, say their military isn’t yet ready.

But China’s heading in that direction, building up their military capability while reducing their dependence on imported energy. Increased power generation from coal and renewables helps because they’re both sourced domestically. This is why the Chinese government has pushed EV adoption.

Nonetheless, moderating crude imports from the biggest driver of demand growth is likely to weigh on prices and global consumption.

Although “drill baby, drill” is widely expected to have a limited impact on E&P behavior, some increased production is likely at the margin as the new administration opens up more public land for drilling. 90% of oil and gas production is on private land and so not much impacted by the White House. However, an improved regulatory environment will encourage some increase.

Barron’s recently wrote about the impact of AI on oil drilling in the Permian, where it’s lowering break evens and driving energy sector productivity higher than any other industry, delivering 60% more oil a day with 40% fewer workers over the past decade. This is bearish for oil prices although not for industry profits.

If we do see lower crude prices it will stimulate demand, delaying any potential peak in oil consumption.

Whichever way crude moves, midstream investors are unlikely to care. The sector has shown little connection with oil prices this year and there’s every reason to think that will continue to be the case.

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

Energy Mutual Fund Energy ETF

 

Midstream’s Goldilocks Phase

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
Midstream’s Goldilocks Phase
Loading
/

The word of the week is re-rating. Both Wells Fargo and Morgan Stanley have suggested that, notwithstanding this year’s 50%+ return in midstream energy infrastructure, further upside is possible. They posit that a re-rating of the sector would not be unreasonable given the strong fundamentals.

Enterprise Value/EBITDA (EV/EBITDA) is a widely used valuation metric, although my partner Henry correctly points out that this is less useful when leverage varies throughout a sector. By this measure though, MLPs remain below their ten-year average while c-corps, representing roughly two thirds of the investible universe, are at their ten-year average.

Reasons why fair value might exceed the average include the sharp increase in gas demand for data centers and the secular drop in leverage, which is 3.0-3.5X (Debt:EBITDA) versus 4.0X and higher a decade ago.

The increase in natural gas demand is real. 148 new power plants are under construction or have been announced as of September, up from 133 in April.

Entergy is building two new gas-fired power plants in Richland Parish, LA for a $5BN Meta data center in nearby Holly Ridge, LA. According to Morgan Stanley, Meta has, “expressed a need for the project to be completed quickly.”

America’s tech giants need more electricity. Nuclear can meet some of this but restarting old reactors takes years. Solar and wind, the choice of climate extremists, are weather-dependent. Natural gas, which already provides 40% of our power, is the best solution. You can still read poorly informed commentators stating that renewables are now cheaper than hydrocarbons. They’re not. The choices data centers are making clearly show that natural gas is the preferred option.

Midstream companies have also been de-risking their balance sheets. After peaking at 4.1X during the pandemic, leverage has been steadily falling. Reduced capex has helped. Few want to embark on a new greenfield pipeline project anymore. Leverage recently reached 3.2X.

Climate extremists have learned how to weaponize the court system so that interminable delays make completion uncertain and IRR less attractive. Investors like us have come to appreciate the consequent boost to free cashflows even if it’s an unintended result of efforts by the Sierra Club and their motley crew.

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

Some have expressed concern that the incoming administration’s energy mantra “drill baby, drill” will lead to a repeat of the poor investment performance under Trump’s first term. But there’s little evidence that another bout of over-production will depress oil prices, and sanctions on Iran will likely remove at least one million barrels per day from global markets. US natural gas prices are held down by associated gas production from Permian basin oil wells in west Texas and New Mexico. It’s unlikely any E&P company will “drill baby, drill” with reckless abandon for more gas.

Several people have asked us whether the construction of the Keystone XL pipeline will be restarted. A story on Politico said Trump was planning to reissue the permit as part of a raft of energy-related executive orders on his first day in office.

Keystone XL was an expansion of the existing Keystone pipeline intended to solve Canada’s perennial challenge of getting crude oil from Alberta to overseas markets. Because it crosses the border, the US State Department was required to issue a permit.

Back in 2010 a limited permit was granted under Obama with numerous conditions attached. By 2012 with increased sensitivity to climate opposition, Obama canceled it. Trump reinstated the permit upon taking office in 2017, and Biden duly rescinded it four years later. Canada’s TC Energy sued the Federal government for $15BN in damages once they finally threw in the towel.

Given this history, one might think there would be little appetite to start again, especially since construction takes longer than a single presidential term. TC Energy is now principally a natural gas pipeline company, having spun off its liquids business in the form of South Bow. And the Canadian federal government completed TransMountain Express at considerable taxpayer expense after buying it from Kinder Morgan (KMI). An ongoing dispute between Alberta and British Columbia led KMI to conclude that they had no place in the middle of an inter-provincial squabble.

Completed substantially over budget, TMX now moves crude oil to the pacific coast for shipment to export markets. So Canada’s need to find egress for its crude oil is not as acute as several years ago. Our betting is that the reissued Keystone XL permit will provide a welcome change of regulatory intent but won’t lead to any construction.

We just might be in a Goldilocks period for midstream, with the desire to build, baby build due to positive fundamentals tempered by continued financial discipline. Under such circumstances, re-rating doesn’t seem unreasonable.

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

Energy Mutual Fund Energy ETF

 

 

 

 

Pipelines Are Cheap; Stocks Are Not

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
Pipelines Are Cheap; Stocks Are Not
Loading
/

Market strategists often point out that valuations aren’t a good timing tool, but it’s still worth staying on top of whether the market is cheap or not. Stocks were having a good year leading into the election, and the Republican sweep took the market another leg higher. Residents of Naples, FL, our winter home, are politically right of center with a demeanor that is unfailingly cheerful, for good reason because it’s a beautiful place.

So, my friends at the golf club are nowadays exhibiting even more good cheer than normal, with happiness from the election and with their portfolios easily offsetting the clean-up cost of two recent hurricanes. My hope is that their sunny disposition continues indefinitely because they’re so much fun to be around. But I’m also watching the Equity Risk Premium (ERP).

With both the S&P500 and bond yields rising at the same time, valuation was never going to be compelling. What’s striking is that the ERP (defined here as the yield spread between  S&P500 earnings and the ten-year treasury) is the least attractive in at least twenty years. This blog has noted that stocks aren’t that cheap to bonds for at least the past year, which is why we don’t employ a market-timing overlay across any of our portfolios.

The Cyclically Adjusted Price Earnings (CAPE) model popularized by Robert Shiller also shows stocks to be expensive. This has been true for several years, demonstrating the weakness in valuation as a timing tool. Nonetheless, CAPE has a good record in predicting future ten year returns from stocks, as shown in this article from 2020. Since then the market’s continued strong returns have discredited the analysis somewhat, but a tool with a robust history going back 80 years or so is still worth considering.

Markets can remain expensive for a long time. Factset is forecasting earnings growth of 15% next year which would be the best since 2021 when profits rebounded from the pandemic. The current optimism is well founded. But it’s hard to make a case for declining bond yields given the outlook for the deficit, tariffs and deported illegal immigrants.

By contrast, midstream energy infrastructure remains cheap, and to this blogger offers a good chance of continuing to outperform the broader market as it has done for the past five years. A recent Bloomberg article noted that labor productivity in oil and gas extraction has improved faster than any other sector over the past decade. Continued innovation in shale has led to increasing output per well and fewer rigs employed while production continues to reach new highs.

Finally, some notes from my partner Henry Hoffman who attended the TD Energy Conference in New York last week:

The conference featured an insightful discussion between John Miller of Washington Research Group and Dustin Meyer, who oversees Policy and Regulatory Affairs at the American Petroleum Institute.

A key point of discussion was the impact of energy policy on recent elections. Meyer noted that while the primary concerns were immigration and inflation, he attributed part of the inflation issues to the Biden Administration’s climate initiatives. He criticized the increased regulatory burdens and climate mandates, highlighting their contribution to rising costs and inefficiencies.

Meyer expressed concern that industry professionals are unclear about compliance expectations under the current EPA, describing the administration’s approach as disjointed with extensive, yet unclear, directives. He also touched on the Inflation Reduction Act, labeling it as a partisan effort that indiscriminately funnels funds into various clean energy projects without a clear strategy. Meyer mentioned a division within the Republican Party over whether to repeal the act or retain elements that are gaining GOP support, such as the tax credit for carbon capture, known as 45Q.

On the topic of U.S. LNG, a representative from Cheniere’s Investor Relations conveyed optimism about the growth prospects for U.S. LNG. He underscored Cheniere’s significant role, accounting for half of the U.S.’s LNG 15bcf/d of exports, equivalent to two LNG tankers daily from their facilities alone. He highlighted Cheniere’s consumption of 7-8% of all U.S. natural gas and affirmed the company’s capability to continue expansion at their target of 7x EBITDA build multiple. He anticipated that the halts on issuing non-FTA licenses by the DOE would be quickly reversed under a new Trump administration.

In a separate session, NextDecade’s CFO, Brent Wahl, shared optimism about U.S. LNG export growth.  Specific to RGLNG, he expects no hurdles from FERC for a SEIS by next year and hopeful for a reversal of the DCCCA’s 3-judge panel’s vacatur sooner. Wahl also noted strong support from stakeholders for continuing with Train 4 once permitting challenges are addressed.

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

Energy Mutual Fund Energy ETF

 

An Energy Secretary With Relevant Experience

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
An Energy Secretary With Relevant Experience
Loading
/

Sitting next to me at Newark airport on Monday while I waited to board an airplane was an FT reporter. I know this because he made a phone call to discuss the Trump appointments “on background” with a source who, based on one side of the conversation, had recently been in Mar-a-Lago. Chris Wright, Trump’s soon-to-be Department of Energy (DoE) head, was the topic. Yes, the source confirmed, the pause on LNG permits would be lifted as a first order of business. A lighter regulatory touch should be expected.

None of this is news by now, but a DoE head drawn from the energy sector is a remarkably rare event. Jennifer Granholm, the current head, and ignominious architect of the LNG pause, is a former governor of Michigan and Harvard law graduate with no industry expertise or nuclear background.

The DoE website informs that the National Nuclear Security Administration (NNSA) “is a semi-autonomous Department of Energy agency responsible for enhancing national security through the military application of nuclear science.” Oversight of our nuclear deterrence is a not widely appreciated but vital DoE responsibility.

Ernest Moniz, who led the DoE 2013-17 and his predecessor Steven Chu (2009-13) both under Obama, at least shared a background in science. But the DoE hasn’t had an executive from the energy sector since at least 1998.

Incoming DoE head Chris Wright is CEO of Liberty Energy. Their website includes a lengthy presentation called Bettering Human Lives which was worth reading even before Wright’s appointment. It provides a robust and unapologetic justification for being in the hydrocarbon business, some of which we recently highlighted (see Trump Energizes The Pipeline Sector).

Lifting people out of energy poverty so they can cook with propane or natural gas rather than animal dung is closer to doing God’s work than carpeting open spaces with solar panels and windmills. Chris Wright is no climate denier but will approach global warming as one of several huge challenges along with malnutrition, access to clean water, air pollution, endemic diseases and human rights.

Northern India and parts of Pakistan have endured severe smog in recent days, caused by pollution from burning coal. Schools have closed and residents of affected areas have been advised to stay indoors. They are potential beneficiaries of increased US exports of LNG, since natural gas generates around half the CO2 emissions of coal per unit of energy output. The Sierra Club and other far left progressives have nothing useful to say to these people.

Bettering Human Lives is found under the ESG section of Liberty’s website, unashamedly claiming the moniker with better justification than most. Energy investors have correctly responded with enthusiasm to the likely path US energy policy is about to follow.

Increased power demand from data centers has provided support for pipeline stocks this year, since natural gas will be the main source of additional electricity. The number of gas-fired power plants either announced or in development duly rose to 148 in September, up from 133 in April according to S&P Global Platts.

The map shows most of them in a wide swathe across Texas and into the northeast, in the general area of natural gas production. Although labeled “fossil fuel-fired power plants” they are all natural gas. Coal-burning power plants are being phased out in the US, with the last large one built back in 2013.

Valuations remain attractive, with midstream offering yields of 5% well covered by cashflow. Payouts are rising, companies are buying back stock, leverage is down and valuations still attractive. In our opinion it’s hard to find anything negative to say about the sector’s prospects.

NextDecade (NEXT) had some good news recently, albeit somewhat legally obscure. The U.S. Court of Appeals for the D.C. Circuit ruled that the Council on Environmental Quality (CEQ) wasn’t empowered to issue regulations related to the National Environmental Policy Act. If the CEQ wasn’t top of mind for you, well you’re not alone.

In the summer a panel of the DC Circuit vacated the FERC permit for the construction of NEXT’s Rio Grande’s LNG terminal (see Sierra Club Shoots Itself In The Foot). As a result of the CEQ ruling, NEXT has filed a petition arguing that their permit was wrongly vacated. The entire process is obviously generating healthy legal fees, but more importantly shows signs of heading towards a positive resolution.

Perhaps our incoming DoE head will conclude that the Sierra Club is creating more problems and few solutions with their frivolous lawsuits. It’s time someone took them on.

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

Energy Mutual Fund Energy ETF

 

Pipeline Real Yields Are High

/0 Comments/in /by
SL Advisors Talks Markets
SL Advisors Talks Markets
Pipeline Real Yields Are High
Loading
/

When investors ask what return they should expect from an investment in midstream, we typically suggest dividends plus growth plus buybacks. Dividend yields are around 5%. Wells Fargo is forecasting 4% dividend growth next year, and buybacks of around 2% of market cap. 5% + 4% + 2% suggests an 11% total return, assuming no change in valuation.

Valuations are attractive, with Distributable Cash Flow (DCF) yields above 9% and expected to grow 5-10% over the next few years. Leverage of around 3X Debt:EBITDA is becoming the norm for investment grade midstream companies. An 11%pa return over the intermediate term looks reasonable.

But what about over the long run? For years the energy sector has labored under the fear of stranded assets as the world moves away from hydrocarbons. Experience shows that this was unfounded. Developing countries are driving consumption higher as they seek western living standards. India for example is seeing SUVs increase their share of a rapidly growing domestic auto market.

Status is one reason, but the poor state of Indian roads is another. The clearance between the bottom of a car and the road is critical when potholes and poorly designed speed bumps proliferate. Bigger cars need more gasoline. India is a long way from peak emissions.

Solar and wind are failing to meet the promises of climate extremists. Sloppy reporting routinely claims that these two are the cheapest forms of electricity. This is still not the case as a recent post by the Energy Information Administration showed. And it omits the cost of either battery storage or dispatchable power (usually natural gas) for when it’s not sunny or windy.

Renewables require vast amounts of space. Unlike hydrocarbons, they are not energy- dense. Vaclav Smil, probably the most intelligent writer on energy, shows that an acre of land dedicated to solar power serves 1.21 homes. In the case of wind, it’s 0.17.

You know where this is going.

There are approximately 145 million US homes. Powering all of them with solar power would require 120 million acres of land dedicated to solar, about 5% of all the land in America. We could put solar panels on every rooftop and we’d still need a lot of space.

If we relied fully on wind it would take almost 38% of our landmass.

We’re going to use more solar and wind, but climate extremists need to embrace nuclear and coal to gas switching to be taken seriously.

The election showed that Democrat climate policies resonate less than illegal immigration and inflation.

Pipelines that move hydrocarbons, especially natural gas, will be here for the foreseeable future. These infrastructure assets have long lives and deliver predictable cashflows that are linked to inflation. Wells Fargo has calculated that roughly half the industry’s EBITDA relies on contracts that incorporate tariff hikes linked to PPI.

Ten year real yields, as defined by Treasury Inflation Protected Securities (TIPS) are 2.1%. With ten year notes at 4.45%, implied inflation is 2.35%. It’s been edging up, and while Republican policies are good for the energy sector there’s little reason to think inflation will be 2%.

Trump ran on an expansionary fiscal platform. Ejecting illegal immigrants, good policy though it is, will tighten the labor market for low-skilled workers. And tariffs could push up prices depending upon how they’re implemented.

Recognizing the risks, Fed chair Jay Powell has paused further rate cuts.

Investors need to protect themselves against inflation that’s 3% not 2%.

The approximate 5% yields on midstream energy infrastructure translate to a real yield of 2.65%, 0.55% better than TIPS. But while TIPS will keep up with inflation, midstream will likely do better. JPMorgan expects dividend growth rates of 8% for large-cap c-corps over the next couple of years and 4% for large MLPs, both of which are above plausible inflation forecasts.

Given the reliable cashflows that characterize the sector, with dividends likely to consistently grow well in excess of inflation they should have real yields comparable to if not below TIPS. Dividend yields of 4.5% wouldn’t seem unreasonable, similar to treasuries.

The dividend yield on the S&P500 is a paltry 1.2%. Stocks offer a negative real yield of –1.15%, 3.8% less than pipelines, even though the latter comes with widespread inflation-linked tariffs.

Although pipelines have outperformed the market for the past five years, there remains a compelling case for investors seeking inflation protection to own them. That should apply to every one of today’s savers.

The point of investing is to preserve purchasing power. In our opinion midstream offers the best chance to do so.

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

Energy Mutual Fund Energy ETF

 

image_pdfimage_print