SL Advisors Talks Markets

Energy Lifts Poor Countries Up

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The International Energy Agency (IEA) released their 2024 World Energy Outlook last week. The IEA has become a renewables cheerleader in recent years, issuing projections of energy consumption that are frequently implausible. However, they still produce a Stated Policies Scenario (“STEPS”) which omits their more fanciful projections.

Electricity demand from data centers has been a regular topic of discussion with investors as US grids have increased ten-year demand projections from 1% to around 5% pa over the past year or so. The IEA concedes that it’s hard to precisely forecast the growth in global data center demand, but generally expects demand from air conditioning to be substantially higher.

Like almost all growth in energy consumption, this is driven by developing economies. An extended heat wave in India this summer resulted in a doubling of sales of air conditioning units. One homeowner said, “I’ve endured the worst summers under just a fan. But this year, my children suffered so much that I had to buy our family’s first air conditioner.”  His monthly electricity bill increased 7X.

40% of the world population (around 3 billion people) live in the tropics, where ChatGPT estimates only 8-10% have access to air conditioning. The IEA believes a/c penetration in emerging economies will rise from 0.6 per household to almost 1.0 by 2035, close to the US.

The natural response of people that are sweating profusely is not to blame CO2 emissions but to get cool. You can’t fight climate change if you’re too hot, don’t have access to electricity or cook dinner on a fire of animal dung.

This is why energy demand will keep going up.

The IEA provides figures on energy poverty. 750 million people (world population is around 8.2 billion) don’t have access to electricity. More than 2 billion don’t have access to clean cooking, meaning they use open fires of either wood or animal dung. To quote the IEA, “This results in over 4.5 million premature deaths worldwide each year due to ambient (outdoor) air pollution, and nearly 3 million deaths from household air pollution.”

The moral response of OECD countries, especially the US, should be to help provide these people with access to electricity and clean cooking, by exporting natural gas. Democrat policies that impede such US exports betray a philosophy that is deeply anti-humanity. We believe such pragmatic solutions will continue to gain traction, just as nuclear power is enjoying a US renaissance.

Energy exports are in the great US tradition of helping less fortunate countries prosper. They are ethically correct and in the interests of our national security.

Current policies assume China will begin reducing emissions in 2030, reaching zero by 2060, a decade later than the UN IPCC goal. China burns over half the world’s coal and a “show me” attitude is appropriate towards the country that generates 31% of global emissions. It’s not at all obvious that their emissions will peak as planned. New York City’s policy that forbids natural gas hookups to new buildings is a virtue-signaling, self-inflicted irrelevance.

I spent last week visiting clients in South Carolina, Georgia and New Orleans. I always enjoy such encounters, but they’re especially convivial when an advisor can report that 100% of his clients invested with us are profitable. This happened more than once, and I credit the advisor’s propitious timing. Nonetheless it is a great pleasure to be tangentially associated with such success.

Our investors tend to favor Republicans, and as a registered Republican myself I enjoy their company. But I often note that midstream energy infrastructure should appeal to moderate Democrats too since natural gas is the main driver of reduced US CO2 emissions. If climate extremists would get out of the way the benefit could extend to other countries.

Discussion topics usually included the election. It’s often believed that the “permit pause” on new Liquefied Natural Gas (LNG) export terminals announced by the Department of Energy in January to try and excite progressive climate extremists means current LNG exports are capped.

This is not the case.

LNG export terminals take years to build, and the pause did not impact already issued permits. Therefore, LNG exports will double from 12 to around 24 Billion Cubic Feet per Day (BCF/D) over the next few years as new capacity is completed. The US will be doing its part to provide electricity and clean cooking to developing countries in Asia as well as natural gas to friends and allies such as Ukraine.

From the moral high ground, the Sierra Club is an insignificant speck in the ditch.

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

SL Advisors Talks Markets

Heat Pumps Need Natural Gas

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I was surprised to read the other day that sales of heat pumps across Europe dropped 47% in 1H24 versus a year earlier. The EU has adopted more aggressive policies to combat climate change than any other region. Residential adoption of heat pumps is part of their green agenda.

We recently replaced an oil furnace with a gas one – doing our part to reduce emissions since the new furnace is more efficient and gas generates less CO2 per unit of energy output than heating oil.

Heat pumps utilize an ingenious technology which relies on increasing the pressure/temperature of a refrigerant inside a coil, warming the air passed over it.  This cools the refrigerant, which is recycled back through a compressor which raises the temperature back up. The same equipment working in reverse provides air conditioning.

The electrification of energy consumption underpins the energy transition. Heat pumps use less energy and generate CO2 dependent on the source of electricity. So in the utopian vision of climate extremists, we’ll all heat our homes with solar panels and windmills.

We never seriously considered installing a heat pump. Because they work like a/c in reverse, they rely on ductwork to warm the house. Our 1928 home has radiators, and we weren’t interested in tearing out walls to replace them.

Around 16% of US homes have heat pumps. They come with a lot of qualifications. Carrier, a leading US manufacturer of heat pumps, warns that, “… when outside temperatures drop below freezing, the efficiency of a heat pump is affected as the unit requires more energy to maintain warm temperatures inside the home.”

This is because the compressor is placed outside. Carrier suggests either installing an “auxiliary electric heater” for when the outside air is very cold but prefers adding a furnace (presumably natural gas) which would take over when needed.

This seems ruinously expensive. Figures on furnace augmented heat pumps aren’t available but it seems a common solution.

Natural gas power plants also provide reliable power when it’s not sunny and windy. The energy transition relies heavily on gas to compensate for shortcomings in equipment that’s supposed to enable us to do without it. This is supporting relentless growth in consumption globally.

There’s the added inconvenience that an accumulation of snow and ice on your compressor can impede its operation. So the homeowner might find she has to venture out in a blizzard to shovel snow off the unit.

Much of the information on heat pumps is from proponents, so is overwhelmingly positive. They seem to be best suited to mild climates where snow is rare – from North Carolina on south for example. They’re outselling gas furnaces in the US, although sales fell 17% last year. However, gas furnace sales were down 27%.

Heat pumps are more popular in Scandinavia than anywhere else, which suggests that operating in a very cold snowy climate isn’t insurmountable. Natural gas and electricity are both more expensive than in the US. In addition, there are financial incentives to reduce fossil fuel consumption, which also explains why Norwegians drive so many EVs.

Oslo sits on the 60^th latitude and the average low in January is 23 degrees F. Minneapolis is on the 45^th latitude, over 1,000 miles farther south and has an average January low of 7F. Norway’s weather is pretty mild compared to the midwest. I don’t think I’d buy a heat pump there, although Minnesota is providing subsidies to increase adoption.

Everything to do with the energy transition is more expensive and less convenient. EVs come with range anxiety. All my Tesla-owning friends love their car but have another conventional one. Solar and wind are costly, intermittent and require lots of room and extensive high voltage transmission lines. Heat pumps are expensive to install and may need a furnace in cold climates.

European heat pump sales fell because some subsidies were ended and natural gas prices fell following the jump that followed Russia’s 2022 invasion of Ukraine. Some households embrace low carbon solutions regardless of price, but many more are sensitive to cost. Luke Sussams, an analyst at Jefferies, wrote, “If the economics do not work, the consumer will not accept it.”

An enduring theme is that all these initiatives increase demand for natural gas. 43% of US electricity comes from natural gas, so EVs drive that higher. Heat pumps also need a natural gas furnace. Solar and wind couldn’t work without gas power for when it’s not sunny or windy.

Natural gas is critical to the energy transition and unlike renewables doesn’t rely on subsidies. Its infrastructure will be in use for the foreseeable future. We think traditional energy offers the best investment prospects in the sector.

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

SL Advisors Talks Markets

Oil And Pipelines Look Less Like Fred And Ginger

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The outlook for crude prices is a frequent conversation topic among energy investors. We’re often asked for our thoughts – over the next several years we’re bullish as growing demand from developing economies competes with insufficient investment in new supply. But we don’t trade oil or reflect that outlook in portfolio construction.

Crude oil and midstream are linked in the minds of many. Over the last decade they have often moved together. The price chart shows a very close visual relationship in years past. The original appeal of MLPs a decade or more ago was that they operated a “toll model”, indifferent to commodity prices and reliant on volumes. The quantity of oil and gas consumed in America fluctuates much less than its value.

The volume of crude oil and petroleum products supplied in the US has stayed remarkably stable for decades. We use around 20 Million Barrels per Day (MMB/D) with little regard for the economy other than the brief dip during the pandemic. This is why pipeline owners don’t spend much time worrying about the price of crude. Prices respond rapidly to changes in supply and demand and bring them back into alignment without much change in volumes.

Oil is heavily used in transportation. Economic slowdowns have little impact on the movement of people and goods. Lockdowns during covid did hurt demand and caused prices to collapse, but this was rare, and we can all hope that such loss of freedom will never be revisited on us again.

Interestingly, investors rarely consider the relationship between natural gas prices and pipeline stocks. There is no relationship – natural gas consumption for power demand and other purposes has been growing for years with little impact from prices.

Crude prices and midstream stocks were searingly correlated in March 2020 when demand collapsed, oil prices went briefly negative and people stopped moving. The correlation (defined using daily changes over the prior three months) reached 0.87 on March 25^th. It was unforgettable.

That day marked a peak in the relationship. Although both crude prices and midstream stocks recovered strongly from that low, the link has steadily weakened. The 80% rally in oil when inflation jumped in 2022 was not matched by the American Energy Independence Index (AEITR) although the inflation-linked contracts widely prevalent in the industry underpinned the sector’s 21% return that year.

The relationship continued to weaken, driven by falling leverage and capex among pipeline companies. Debt:EBITDA moved from 4-5X to 3-3.5X among most investment grade companies, a substantial reduction that made the stocks less risky. Capex came down as it became clear we mostly had the pipeline network we needed. Greenfield projects also ran into opposition from climate extremists such as the Sierra Club, whose ill-conceived policy prescriptions (anti-nuclear; anti US LNG exports to displace foreign use of coal) are helping drive global CO2 emissions higher.

The past three years of strong sector returns have come with little participation from oil, and the correlation has come close to zero at times this year. The recent jump above 0.30 is more reflective of a negatively correlated period dropping out of the past three months than of a changed relationship, as a visual inspection of recent price performance shows.

The weak relationship of recent years is the new normal, because the underpinnings of reduced leverage aren’t going away. Investors are increasingly able to assess the outlook without much regard for the price of oil, because it doesn’t matter that much. Oil and gas consumption will continue to grow, driven by developing economies.

This was vividly illustrated by a recent story about Indonesia’s challenges in reducing its coal consumption. Like many countries in Asia, coal is Indonesia’s biggest source of primary energy at 43% according to the Energy Institute’s Statistical Review of World Energy. Plans to replace some of the power generation derived from coal with renewables are running into problems because the government is worried that they won’t get enough financial support from rich countries like America to offset the increased cost.

Yes, renewables cost more, as is clear wherever they’re used. This is less of a problem than its consistent denial by climate extremists and others. Renewables cost more and they may be worth it depending on the consequent reduction in CO2 emissions. But they cost more, not less than our existing energy systems. Otherwise, we’d all be using solar and wind already and there wouldn’t be any need for subsidies.

Fuzzy thinking by climate policymakers is colliding with the reality of developing countries, in that they don’t want to pay more for energy. US LNG could solve this problem for Indonesia and others if opponents would get out of the way. We think pragmatism, inspired by the failure of today’s solar/wind obsession to meaningfully reduce global emissions, will eventually prevail.

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

SL Advisors Talks Markets

Britain’s Energy Transition

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I spent two weeks recently touring southern England with my wife. It’s 42 years since I moved to the US, and I appreciate my old country more now than as a teenager itching to escape to the new world. We did some sightseeing and saw old friends. As we traveled around, the British approach to the energy transition was never far from my mind.

Despite voting for Brexit, which was a populist, right wing decision, Britain is a politically liberal country like much of Europe. Reducing greenhouse gas emissions to limit global warming is not a contentious issue. The Conservatives, who were in power from 2010 until an ignominious electoral drubbing in July, passed a “Net Zero” law in 2019 mandating zero emissions by 2050.

The UK has been surprisingly successful in heading towards this goal. Emissions are down 44% from their 2006 peak, meaningfully ahead of the EU whose equivalent reduction is 31%. Germany may be the self-styled leader of the “energiewende” but Britain has been quietly getting it done.

In 1900 coal provided 95% of Britain’s electricity. As recently as 2012 it was still 40%. The last coal-burning power plant will be decommissioned by the end of this year. They’re also planning to add more nuclear.

Renewables provide 20% of the UK’s primary energy, substantially ahead of the US (9%) and the OECD (11%). Last year wind provided 29% of their electricity, just behind natural gas at 32%. What the National Grid calls “zero carbon energy” (mis-named since manufacturing wind turbines relies on traditional energy) regularly produces most of their electricity and was 51% last year.

The North Sea is a reliably windy place, and offshore wind turbines are far less controversial than in the US. We saw them from numerous spots while traveling along the south coast. Windpower suffers from cost and intermittency, but the view of turbines miles out to sea doesn’t strike this blogger as particularly offensive.

US windpower is overwhelmingly onshore. Offshore has been plagued with cost over-runs and cancelations. Coastal residents complain about the view, and a 300-foot fiberglass blade recently shattered near Martha’s Vineyard, with jagged pieces washing up on the beach. Voters along the New Jersey shore, politically red in a very blue state, are outraged at plans for offshore wind (see Windpower Faces A Tempest).

In the UK you’re never far from a wind turbine.

Energy costs more in Britain. Electricity is around $0.40 per kilowatt hour, more than 2X the US. People commonly shut the lights off when leaving a room. One hotel we stayed at required your room key inserted in a slot for the lights to stay on, preventing guests from going out and leaving the lights on.

Gasoline (petrol to Brits) costs around twice as much as the US because of higher taxes. But the cars are smaller and the roads narrower. Even though I learned to drive there, it was over 40 years ago. Driving through the English countryside, it felt like small cars were zipping around impossibly narrow lanes. But our 800 miles of driving cost £100 ($133), just under $0.17 per mile and similar to the average for US drivers.

British drivers grumble about the cost of petrol (and the traffic) but unlike the US it’s not a political issue. Everyone knows the British government has no influence over oil prices.

Americans drive more miles per year than most countries, which is why gasoline prices get people so worked up. Moreover, Britain’s more extensive public transport system generally gets you around faster than in the US. Taking a painfully slow NJ Transit train into New York compares unfavorably with the faster commuter trains servicing London.

In Britain, it’s household heating bills that earn the public’s ire.

Natural gas is widely used, and Russia’s invasion of Ukraine boosted winter heating bills. For a couple of years households were protected from the full impact of higher gas prices, through government caps, but that costly program has ended. During our trip the new Labor government’s plan to cancel pensioners’ annual heating rebate was a leading news story.

Britain has a good energy transition story to tell. But how do people feel about making a considerable effort while developing economies led by China overwhelm their efforts? Most haven’t given it much thought, and those that have shrug and say it’s important to “do your bit.”

Young people care more. My nephew, who’s a data scientist, even considers the energy required of a data center in constructing the form of AI queries he submits.

Unquestioning fealty to green energy is common among liberals. If climate change is such an existential threat, why don’t their governments make it a priority in dealings with China? I think it’s because the politics of climate change aren’t driven by solving the problem, but rather by imposing costly and inconvenient local measures that appear effective but are globally irrelevant.

Britain is ahead of its peers in reducing emissions, but the worldwide effect is inconsequential. The 44% reduction they’ve achieved since 2006 is only 0.6% of the total. For reference, the UK is around 3% of global GDP.

Climate extremists are driving policy in the UK as elsewhere and are missing the big picture. At its worst it’s wokeness trying to impose guilt on everyone simply for being here, on Planet Earth, living.

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