Every Issue Is Linked To Trade

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July was action-packed for LNG names. On July 11 Morgan Stanley raised their price target on NextDecade (NEXT) to $15, having last moved it to $10 in October 2022. The stock rose 18% to $10.77 on the news and added further gains during the month. Morgan Stanley’s upgrade was the only news of note, but their more bullish view on the company led the market to reprice.

Venture Global (VG) traded up in sympathy with NEXT, but since it wasn’t mentioned in the Morgan Stanley report, its gains slipped away.

Cheniere’s price target was left unchanged at $255. But following the International Court of Arbitration’s July 18th ruling that Chevron’s acquisition of Hess could proceed, Cheniere rose as traders bet it would finally be added to the S&P500 by replacing Hess. It fell when Block was chosen instead.

The US-EU trade agreement boosted LNG stocks because of the commitment by Europeans to buy $750BN of US oil and gas over three years. This was quickly derided by analysts. Criticisms included (1) the EU doesn’t buy oil and gas, private companies do, so it’s unclear what mechanism they would use to meet this commitment (2) no written agreement was released, so there are no visible consequences for failure, and (3)  US oil and gas exports in total are currently around $150BN.

Reaction to the trade deal across the EU has been negative. Europe’s Summer of Humiliation in the Financial Times Op-Ed section reflected widely-held sentiments.

The deal exposed Europe’s negotiating weakness. With no one in charge, their decision-making process is necessarily slow and defensive, which dilutes the heft their economy might otherwise wield. They’re scrambling to develop a military capability to confront their aggressive eastern neighbor.

These issues clearly played a role, which is why the Euro sank 3% in the days following the deal. The White House linked trade and national security to exploit these weaknesses to America’s advantage.  It’s hard to think of a previous Administration that took such a stance.

How investors think about the prospects for increased US energy exports to Europe has been a hotly debated topic among your blogger’s investment team. It’s easy to conclude the numbers are implausible.

The EU commitments on oil and gas purchases can be dismissed as aspirational given the figures outlined above. But the trade deal showed who holds the cards. Trump is likely to abruptly rescind any agreement with little warning.

When Cheniere or VG are negotiating a long-term LNG supply contract with a big European buyer, they’re likely to complain to the White House if unable to reach a conclusion. If EU rules rather than commercial terms are the sticking point, “temporary punitive tariffs” may be needed to induce a more co-operative EU regulatory structure. If European buyers don’t sign some additional long-term LNG contracts in the months ahead, there are likely to be consequences.

The US has already introduced tariffs into relations with Brazil to halt the prosecution of right-wing former President Jair Bolsonaro. The 35% tariff on Canadian goods announced Friday is in part because PM Mark Carney showed he is “tone deaf” by recognizing Palestinian statehood, according to Commerce Secretary Howard Lutnick.

Trade issues are being linked like never before to promote US interests.

So far, tariffs have been less disruptive than many expected. One might even say that those who understand economics forecast a dire outcome, while those who don’t just went ahead and implemented them. The net result looks like a Federal sales tax applied to imports. It’s running close to $30BN per month. Even for the US-sized budget deficit this is real money – equal to more than a third of our defense spending.

State-level sales taxes are uncontroversial, and most states have one. We now have a Federal sales tax applied selectively on foreign goods. Implementation has been capricious, inducing equity market volatility. Some industries such as autos with their cross-border supply chains have absorbed big losses. There may yet be an uptick in prices, although few would worry that a sales tax is inflationary.

The world hates the re-ordered trade system. Swiss lawmakers were left “in shock” at the abrupt imposition of a 39% tariff on Friday.

America, objectively, seems to be doing fine. The outlook for growth in US LNG exports continues to improve.

We’re modifying the current Sunday/Wednesday twice-weekly blog schedule to be weekly, on Sundays, with opportunistic updates during the week as market events dictate. We think this will improve the quality and relevance of this blog’s output.

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

Energy Mutual Fund Energy ETF

 

Trade Deals Boost LNG Stocks

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European Commission president Ursula von der Leyen described the US-EU trade agreement as “huge”, demonstrating a helpful grasp of President’s Trump’s lexicon. The imposition of tariffs and the threat of punitive ones has gone remarkably smoothly. That may not always be so, but for now markets are buoyant and inflation only modestly higher.

The White House is linking trade with defense, at least implicitly. Reports suggested that von der Leyen had to consider the continued security umbrella via NATO that the US provides as well as ongoing support of Ukraine. With a trade surplus of almost €200BN in goods last year, she conceded that, “We have to rebalance it.”

Weakness in the Euro FX rate, down 2% in the subsequent two days, confirmed the view of many observers that the EU got the worse end of the deal.

Analysts were quick to point out that the EU will struggle to buy $750BN of US energy exports (mostly oil and gas) over the next three years, even though that is part of the agreement. US total exports of oil and LNG are around $150BN, with about half of that going to the EU, so we will also find it challenging to provide that much. But we can expect US-EU trade to expand in that direction. This will pressure Europeans to source less gas from Russia, which is surely in their best interests as well as ours.

LNG stocks initially reacted strongly to the trade news but then slipped as traders contemplated that the path to increased gas exports is pretty much set for the next few years based on projects already under construction. Price differentials are already sufficient to induce flows from the US to Asia and Europe.

Venture Global (VG) announced Final Investment Decision (FID) on Phase 1 of CP2 LNG. They estimate the project will cost $15.1BN to complete and will make them the #1 LNG exporter in the US. VG has developed a reputation for relatively fast construction of LNG terminals, aided by their modular design. Along with Cheniere they dominate LNG exports, with each leapfrogging the other to be the biggest as they announce new projects.

The prospects for export volumes to double within five years are good, and it’s possible they could increase further still. Export terminals take several years to build, so we have good visibility over that time frame.

The continued promotion of oil and gas exports as a way for foreign countries to reduce their trade surpluses with us is consistent. It means we should expect ongoing regulatory support for increasing our LNG export capacity.

Growing even faster than LNG export capacity is that for Floating LNG (FLNG). Shell’s Prelude FLNG vessel off the coast of NW Australia gave the sector a bad name because of construction delays and downtime which led to enormous cost overruns.

But technology has improved, with former LNG tankers in some cases being converted into liquefaction vessels. The large spherical storage tanks they come with make the conversion relatively straightforward.

Rystad Energy estimates that global FLNG capacity will triple over the next five years.

Enterprise Products Partners (EPD) reported earnings that came in as expected. They spent $170MM repurchasing stock in 1H25 compared with a full year range of $200-300MM. They raised their dividend by 4% year-on-year. At $0.545 per quarter it yields 7%.

A couple of weeks ago I asked my accountant to estimate my tax bill if I was to sell any EPD. As an MLP, the portion of my past EPD distributions that were defined as Return Of Capital (ROC) would be “recaptured” or taxed upon sale. This large tax bill is often a painful experience for the investor.

Oneok’s (OKE) 2023 acquisition of Magellan Midstream (MMP) was treated as if MMP unitholders (which included me) had sold their units. This was one of the reasons we were unhappy about the transaction (see Oneok Does A Deal Nobody Needs). I did get a big tax bill, but OKE’s deft integration of their target has more than compensated.

The taxes owed and tax benefits of MLPs are impenetrable to all but a very few highly skilled tax experts. My friend Elliot Miller is one and he may add a comment to this post when he reads it.

I have owned EPD for close to twenty years and it’s almost tripled since my first purchase. My cost basis has gone negative due to years of the ROC portion of distributions. Nonetheless, I was surprised to learn that for each $100 of EPD I might sell, I’d owe the Federal government $16 which was less than I expected. New Jersey was more than I expected, at $10, so a 26% total tax hit.

The Garden State’s tax code is ruinously high, illogical in ways that always favor the state and doesn’t allow tax-loss carryforwards which is why you should never come to NJ to start a business.

EPD’s yield of 7% is high because of the MLP discount – most investors don’t want a K-1. Even though those distributions are now taxed as ordinary income, it still looks like an attractive yield to me so why sell it?

I’m currently reading Jon Meacham’s American Lion, a Pulitzer Prize winning biography of President Andrew Jackson. His absence of links to the establishment, rejection of constitutional norms and desire for political fights which he invariably won are all reasons he’s compared with Trump, not least by the President himself.

For those who fear the country can’t survive a second four years of Trump (and among this blog readership you are few), draw some comfort from the fact that America survived Andrew Jackson’s two terms (1829-37).

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

Energy Mutual Fund Energy ETF

 

Another Power Auction Hikes Electricity Prices

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PJM Interconnection announced the results of their capacity auction last week. This is where suppliers of electricity quote prices to provide surge capacity for periods of high demand (typically hot summer days). It used to be uneventful until last year, when the clearing price was 9X higher than before. This led to the price hikes now rolling across PJM’s region, which saw your blogger’s bill rise 35% (see Power Auctions Are Getting Interesting).

The clearing price of $329.17 per MegaWatt Day was +22% from last year, and would have been higher except for the price cap imposed by FERC. Without the cap, PJM indicated the cleared price would have been $388.57, +44%. PJM expects this to translate into 1.5-5% price increase for consumers.

PJM also noted that this only covers about half the new power demand they expect to see, because of growing data centers.

JPMorgan wrote a cheery research note on the auction (“PJM Paranoia proves perilous”). I was initially confused by this, wondering why higher electricity prices could be good. It soon became clear that power providers such as Talen Energy and Constellation Energy were the auction beneficiaries. Talen reported that this would add $805 million to capacity revenues. Its stock rose 8% on the news.

This is capitalism at work, ensuring that electricity will be available when needed by discovering the price necessary for that to happen. The mix of this guaranteed surge capacity is: 45% natural gas, 21% nuclear, 22% coal, 4% hydro, 3% wind and 1% solar.

Over three quarters of this power is from dispatchable sources (gas and coal) that can be ramped up when needed. 4% is weather-dependent. Demand from data centers is rising.  Supply isn’t keeping up and state policies are increasing the share of intermittent power that’s available.

The usual crowd of apologists for renewables complains that much more solar and wind could be connected to the grid if only PJM would move faster. The impact of each new source needs to be evaluated in terms of the impact of intermittent supply, since conventional power is available when needed rather than weather permitting.

PJM also noted that many projects applying to be connected have yet to be built and have run into problems outside PJM’s scope, such as with, “permitting, supply chain constraints and evolving project economics.”

Grid operators need to consider factors such as the Effective Load Carrying Capacity (ELCC). This contrasts with Unforced Capacity (UCAP). ELCC is typically lower than UCAP, especially for renewables. Moreover, as more intermittent power supplies are added to a grid, their low ELCC drags down the system’s overall ELCC. It means that ever more excess capacity is required as intermittent power gains market share.

This is why it’s so disingenuous for renewables advocates to claim that their solution is the cheapest. As the results of this auction and last year’s show, adding renewables to a grid increases the cost of spare capacity that must be available for when it’s not sunny or windy.

Ironically, offshore wind has been found to have a high ELCC, sometimes even as good as gas combined cycle power plants. But the US has very little offshore wind, and numerous projects have been canceled due to rising costs, supply chain issues and the new Administration’s general hostility to wind.

Surveys show that consumers value reliability and price. Climate change has been receding as a concern, as was apparent in November’s election.  But left-wing climate policies continue to have a deleterious impact.

Solar and wind can work in certain situations though. Enbridge is building a 600MW solar farm near San Antonio, TX which will be fully dedicated to supporting Meta data centers.

Puerto Rico is laboring under an impractical zero carbon mandate. The electricity supply is notoriously unreliable, and many homes have generators to compensate for regular power cuts. Consequently, a law requiring 40% of the island’s electricity to come from renewables this year is (a) not addressing their most important problem, and (b) hopelessly out of reach. Last year 62% of its power came from petroleum products, meaning diesel, 24% natural gas and 7% renewables.

New Fortress Energy (NFE) has been negotiating with Puerto Rico over a $20BN LNG contract, although those discussions have recently been broken off by the PR government. They have few good alternatives and have begun negotiations for 30-day emergency LNG supply contracts. NFE’s stock rose on the news, perhaps reflecting the market’s view that PR will ultimately have to return to negotiations.

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

Energy Mutual Fund Energy ETF

 

 

 

 

Energy Is Wall Street’s Favorite Sector

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The revenue and earnings outlook for the energy sector has deteriorated this year. Alone among the S&P 500’s eleven sectors, FactSet shows declining revenues of –9.6% when companies report for the second quarter based on bottom-up analyst forecasts.

2025 opened with high expectations following Trump’s election victory. And while the White House has followed through on pro-energy policies, these are generally targeted at boosting output, not profits.

Tariffs have also acted as a headwind to growth. The Economist recently published a podcast titled Teflon Don: can the economy withstand a Trump shock, which expressed surprise at the resilience of the global economy to the evolving regime of import taxes.

Nonetheless, crude oil is down over 10% this year. Bombing Iran did not lead to the feared yet unlikely blocking of the Strait of Hormuz. For energy investors, Trump’s second term has continued the pattern of his first one – his love for oil and gas doesn’t boost the industry’s profits.

Energy was notably weak on Monday. The only meaningful news was that S&P once again declined to add Cheniere to their flagship index when presented with the opportunity by Chevron’s acquisition of Hess.

Had they done so, energy would have become a slightly bigger component of the S&P500, potentially benefiting many more energy names not currently in the index. Betting on a corresponding lift to the energy sector was evidently a popular idea, because unwinding it caused some startling drops. Cheniere was –7.3%, reinforcing the old adage about the market being a voting machine in the short run and a weighing machine over the long run.

Cheniere’s business prospects didn’t change at all, just their stock price.

Factset expects 2025 energy profits to be down 13.3% this year, the worst of the eleven S&P500 sectors.

At the sub-sector level, four are projected to drop: Integrated Oil & Gas (-34%), Refining and Marketing (-33%), E&P (-20%) and Equipment and Services (-14%). By contrast, Oil and Gas Storage and Transportation, otherwise known as the midstream energy infrastructure sector so lovingly followed by this blog, is expected to report 2Q25 profits +14% compared with a year ago.

Next year energy sector profits are forecast to rebound, +20.5%. In spite of recent weakness, 74% of stocks carry a “Buy” rating from Wall Street analysts, the most of any sector.

Midstream businesses will perform with less drama, demonstrating the low correlation with commodity prices that is once again proving valuable to pipeline investors.

LNG exports continue to take an increasing share of total US gas production. RBN Energy reports that feedgas demand to lower 48 LNG export terminals is running at 15.6 Billion Cubic Feet per day (BCF/D), with Sempra’s Cameron LNG facility and consortium owned Freeport both back up after brief disruptions earlier in the month.

The Philippines saw its first decline in coal use for 17 years due to increased LNG imports.

Spain, which suffered a nationwide blackout three months ago because of its over-reliance on renewables, is now using more natural gas to stabilize its grid.

Later this week the White House is expected to release their AI Action Plan, which should support the rapid construction of data centers and their need for reliable power. As New Jersey residents have found, demand from data centers can drive up residential electricity prices.

The Garden State’s mandate that 100% of electricity be zero-carbon by 2035 hasn’t helped (watch Progressive Energy Policies Are Costing New Jersey). The independent watchdog for the region’s grid operator PJM says there’s no capacity available for any more data centers.

Some expect that the opening of public lands for more gas extraction will be part of the solution. Around 90% of oil and gas production takes place on private land, usually regulated by states. Trump is for energy dominance, but the Federal government doesn’t have many ways to influence output. Allowing more drilling on Federal land is one of the few.

Electrical grids are struggling to adapt to a surge in demand for electricity. Business models that spread the cost of new infrastructure across all customers are designed for annual growth of 0.1-0.3% or so. When demand grows 10X as much as in the past, spreading the costs of growth widely is more noticeable and unfair. Data centers create few jobs – indeed, some think AI may eliminate vast swathes of employment across the country.

Placing them in lightly populated regions with their own dedicated supply of energy (known as “Behind The Meter” or BTM) may be a necessary political expedient to avoid an upswell of popular opposition.

Natural gas demand will keep rising.

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

Energy Mutual Fund Energy ETF

 

Not All Growth Projects Are Good

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Kinder Morgan (KMI) kicked off pipeline earnings season last week, as they do every quarter. Their adjusted EBITDA came in a little ahead of expectations at $1.97BN vs $1.95BN. Management guidance was positive.  

LNG exports and data center power needs are the two growth drivers for natural gas pipelines. KMI’s Trident Intrastate Pipeline secured another customer for 0.5BN Cubic Feet per Day (BCF/D). Trident serves the Golden Pass LNG terminal on the Texas side of Sabine Pass, opposite Cheniere’s Louisiana-based terminal.  

KMI also registered some growth from data centers.   

The company’s backlog of projects grew by $0.5BN to $9.3BN.  

Growth projects are intended to excite investors, because they’re supposed to boost earnings. Reinvesting retained earnings into the business to earn a Return On Invested Capital (ROIC) above their Weighted Average Cost of Capital (WACC) is how companies grow their profits.  

Every year or so Wells Fargo publishes Show Me The Money in which they compare ROICs for midstream companies. Its release is probably not greeted with boundless enthusiasm by senior executives at KMI, because they have ranked poorly for years. In the most recent edition (October 2024), they were dead last, with a 25-year average ROIC of just 5.4%.  

For the 2018-23 period Wells Fargo calculates KMI’s ROIC at 3.4%, worse than all their peers except Plains All American. With a 6.3% WACC, they’re earning a –2.9% spread. This suggests that on average, KMI investors would be better served if the company hadn’t made those investments.  

It’s not a perfect scorecard. Wells Fargo notes that KMI had some natural gas pipeline contracts that matured and were renegotiated at lower rates. Maybe those projects were done twenty years ago and so shouldn’t reflect on more recent capex. Nonetheless, KMI’s returns have been consistently poor. It means that the enthusiasm with which management describes their $9.3BN backlog should not be shared by KMI investors.  

By contrast Williams Companies (WMB) has done a much better job at reinvesting earnings. Their 25-year ROIC is 12%, and 2018-23 is 22.9%. With an assumed WACC identical to KMI, that’s a 16.7% net return. The median company in the sector has an ROIC of 11.9% and a WACC of 7.2% for a net return of 4.7%.  

We’ve thought for years that KMI doesn’t earn enough on its capex. We engaged with the company in early 2020 (see Kinder Morgan Responds to our Recent Criticism). When Kim Dang became CEO in 2023 she said, “A large part of my job is going to be about continuity.” As she was previously president and CFO, Dang can’t escape responsibility for the capex decisions that led to those poor returns, and continuity might not be what’s needed to improve results. 

Since 2018, the most recent five-year period covered in Show Me The Money KMI’s stock price return of 11.9% pa has lagged both the sector’s 13.4% pa as defined by the American Energy Independence Index (AEITR) and peer WMB’s 15.2% pa.  

Over the past decade, KMI stock has returned 2.2% vs 9.4% for the sector. 

Consequently, KMI is cheaper than WMB. On an EV/EBITDA basis KMI is 11.5X and WMB 13.0X. KMI’s Distributable Cash Flow (DCF) yield is 8.7% and WMB’s is 7.1%. The market has long imposed a valuation discount on KMI because of its poor ROIC. The question investors must ponder is whether the discount is sufficient. A company that consistently earns less than its cost of capital is destroying value on new money invested.  

Investment decisions don’t have to be binary. There’s a range of possible outcomes and overconfidence is a common error. You don’t have to love a stock or not own it. Positions can be sized with precision based on your confidence and the risk/reward. We’re invested in both names but have more exposure to WMB. KMI may improve its capital allocation and it is cheaper. But WMB has a better track record. KMI is likely to trade at a valuation discount until they can improve their performance.  

In other news, Italy’s Eni signed a 20 year Sale and Purchase Agreement (SPA) with Venture Global, demonstrating continued strong demand for US LNG. It was ENI’s first long term agreement with a US LNG exporter.  

Asian buyers continue to pursue increased purchases of US LNG to reduce trade tensions. 

And NextDecade’s (NEXT) stock continued to appreciate as Morgan Stanley’s bullish report of July 11th has drawn more buyers. It shows the impact some analysts can have, because there haven’t been any news developments to affect NEXT recently, beyond Morgan Stanley’s upgrade. Nonetheless, the impact has been as powerful as any recent positive development.  

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

Energy Mutual Fund Energy ETF

 

Next Leg Up

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Morgan Stanley’s bullish report on US LNG stocks last week gave the sector a lift. The biggest impact was felt by NextDecade (NEXT), which was up 17%, bringing its market cap to $2.8BN.

NEXT is still a small cap stock with no dividend, unusual for the midstream sector which is dominated by large-cap, investment grade companies that pay attractive dividends. But NEXT generates no cashflow. They’re building their Rio Grande LNG export terminal in Brownsville, TX.

Phase1, consisting of three trains or liquefaction units, is scheduled to become operational in 2H27. NEXT made their Final Investment Decision (FID) to proceed with Phase 1 in July 2023. Like many investors, we were disappointed that they conceded so much in the final round of negotiations with their partners. The 20.8% share of the economics NEXT wound up with seemed inadequate compensation for operating the project (see Environmentalists Opposed To Windpower last three paragraphs). Phase 1 is expected to generate $200-300MM in Distributable Cash Flow (DCF).

Perhaps as a result, the market hasn’t assigned much credit until recently to Phase 2. NEXT has been negotiating supply agreements with buyers to de-risk the project. They haven’t started construction, although Phase 2 will benefit from some of the infrastructure being built for Phase 1. Management has expressed confidence that they can achieve a bigger share of the expansion, but many have been skeptical.

Although Phase 2 hasn’t yet received FID, based on the 60% share the company has said it expects, Morgan Stanley estimates it will generate $700-$1BN in DCF. This would be a substantial improvement on Phase 1, although the company may yet wind up with a reduced share than they think. Since we invested in them in 2022 it has been anything but a smooth ride.

Our first mention of the company concerned the loss of a contract with France’s Engie because of concerns about the emissions associated with sourcing natural gas (methane) through NEXT (see Making LNG Cleaner). This raised worries that European buyers of LNG would insist on low or zero emissions in its production. NEXT sought to address the issue by planning to add carbon capture to their liquefaction facilities.

Engie returned a year later and signed an off-take agreement.

An adverse court ruling came last August, when the Sierra Club persuaded a judge to vacate a previously issued permit. It’s an example of why permitting reform is needed. A legal challenge should only disrupt a construction project that has the needed government permits in hand under exceptional circumstances. Otherwise, nothing will get done. In this case the Federal Energy Regulatory Commission (FERC) had produced a supportive environmental study that the company relied upon to start construction.

Climate extremists including the Sierra Club are a destructive force pursuing nihilistic aims.

It has not been a smooth ride. There have been legal and regulatory setbacks, disappointing agreements with partners, and secondary offerings of equity at bargain basement prices. The stock has been 40% or more below its prior all-time high almost a third of the time.

The high it reached in August 2022 wasn’t even eclipsed in the aftermath of Trump’s election victory last November. When it did finally make a new high on March 25th, Liberation Day duly followed, bringing fears of reciprocal tariffs on US LNG exports. Within days it had lost 40% of its value.

In short, if volatility worries you this is not your investment.

NEXT needs around $1.2BN to finance their share of Phase 2. Fortunately, as Phase 1 progresses their financing options improve. They might issue some debt secured by the cashflows from Phase 1, or preferred securities. But even If the company makes the most dilutive choice of 100% equity and issues 120 million shares at $10 to raise $1.2BN, their share count would rise to just under 361 million.

Taking the midpoint of Phase 1 ($250MM) and Phase 2 ($850MM) sums to $1.1BN in DCF, around $3 per share.

If they FID Phase 2 in September and complete in four years, 2029 is approximately when they should approach that $3 per share in DCF.

NEXT is also developing plans for Phase 3 (Trains 6-10), which would further add to cashflow but is too far out to be reflected in today’s stock price.

Cheniere recently guided to $25 per share in DCF by 2030 and trades at a 9X multiple. They are best in class. NEXT rose over 20% during the two trading sessions following Morgan Stanley’s report. Nonetheless, at a 3-4X DCF multiple we think it still trades at a substantial discount.

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

Energy Mutual Fund Energy ETF

 

Power Auctions Are Getting Interesting

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Last Wednesday PJM Interconnection began their Capacity Auction. PJM runs the largest electricity grid in the US, extending from the east coast as far west as Illinois. The auction sources commitments for surge capacity, to ensure that even during times of high demand the system can meet the need for power.

Capacity auctions haven’t historically drawn much attention. But last year the auction cleared at $269.92 per Megawatt-Day, more than 9X the prior year’s figure of $28.92. That drew news coverage, along with warnings that this would increase electricity rates for millions of households (see The Coming Fight Over Powering AI).

PJM has 65 million customers.

The jump in price is generally regarded as being due to increased demand, especially from data centers, and declining supply as coal plants are retired, but new renewables capacity is added too slowly.

Power supply across PJM’s region has a complex structure. PJM operates the grid, but customers deal with a local utility. In our part of New Jersey it’s PSE&G. The point of a regional grid is that electricity can be transmitted across state lines where it is needed to balance supply and demand. This makes it hard to hold politicians accountable if things go wrong.

Electricity prices are about to become a political issue, especially in New Jersey which will elect a new governor later this year. Partly because of last year’s auction, prices are apparently going up by 17%. I examined my own electricity bill, which is worth doing from time to time.

The hike in rates must vary. We’re now paying 30 cents per KwH, up from 22 cents. This is among the highest in the country, almost as high as California at 32 cents. Our most recent bill is up 15% year-on-year, and we used 15% less, a 35% hike.

Outgoing Democrat governor Phil Murphy has mandated that 100% of electricity must be renewable by 2035. New Jersey currently has a splendid mix of power generation, which is almost all nuclear and natural gas. Renewables with their weather dependency are, for now, not interfering. But there’s not much point in building a new natural gas power plant, given current policy.

Because solar and wind are opportunistic, each new addition requires an engineering study to make sure grid operators fully understand the impact. Solar and wind typically work 20-40% of the time.

Left wing policies that push for 100% solar and wind are part of the problem, exacerbated by incorrect claims that natural gas is unreliable.

As they’re added to a grid, renewables increase the need for dispatchable power that can be turned on when it’s not sunny or windy. That usually comes from natural gas power plants, since their output can most easily be varied on short notice as needed.

Williams Companies, a large natural gas pipeline operator, has reported that renewables create additional natural gas demand to compensate for their inadequacy.

Josh Shapiro, the governor of Pennsylvania (the “P” in PJM) is so upset he’s threatened to withdraw his state from the PJM network. The Keystone state is the biggest exporter of electricity to the rest of the PJM system. It’s unclear how they would withdraw, but if they did, it would presumably not help the supply shortage.

What’s clear is that Democrat politicians within the PJM region are starting to realize that poorly conceived energy policies aimed at their primary voters are about to collide with Main Street.

Increased demand from data centers is part of the problem. By 2030 PJM expects 32 gigawatts of additional demand, with 30 from data centers. But they also blame insufficient new supply, including state policies that closed fossil fuel plants prematurely.

This is where assigning blame gets messy. Three years ago PJM stopped processing new applications for power plant connections after it was overloaded with more than 2,000 requests from renewable power projects.

The US Department of Energy believes Grid Growth Must Match Pace of AI Innovation in a report on grid stability published recently. They use terms like the “AI arms race” and warn that inadequate power supplies to data centers risk jeopardizing our economic and national security.

That suggests that even though data centers don’t create many jobs, they’ll have a powerful backer in the Federal government. The acceptable downtime of new data centers is around 3 seconds per year. This makes intermittent power a non-starter. Powering them will overwhelmingly rely on natural gas, and public policy will be behind them.

The results of the latest PJM Capacity Auction will be released on July 22nd. They’ll be more keenly awaited than in the past.

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

Energy Mutual Fund Energy ETF

 

Reliable Energy Is Mainstream Again

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The ending of many renewables subsidies in the One Big Beautiful Bill (OBBB) is being hailed as a win for the oil and gas industry. The WSJ wrote, The Moment the Clean-Energy Boom Ran Into ‘Drill, Baby, Drill’, suggesting that oil production will benefit.

But in reality it’s about electricity generation, and oil produced just 0.4% last year. It’s an expensive way to generate power – globally it was just 2.2%. Oil is used as a back-up in places like Boston where new natural gas pipelines have been opposed, although this may be changing (see Gas Kept Us Cool Last Week).

Saudi Arabia gets over a third of their electricity from oil, since they have it in abundance. They use natural gas for the rest.

Since renewables are all about power generation and OBBB shifted public policy support away from them, natural gas is the obvious winner. With EV sales faltering, crude oil demand may also benefit but not as much as gas.

The change in priorities reflects evolving public opinion. A majority still favors expanding solar and wind output, but according to one survey that has fallen to 60% from 79% five years ago. Unsurprisingly, red and blue respondents hold widely differing views.

The shift back towards reliable hydrocarbons isn’t limited to America. Canada’s PM Mark Carney recently said it’s, “highly likely that we will have an oil pipeline…” when asked about improving access of Alberta’s crude oil to foreign markets by adding a pipeline to Canada’s Pacific coast.

Alberta may be the only Canadian province where Trump’s disappointing references to the 51st state don’t provoke widespread anger. Carney likely believes that supporting Alberta’s energy sector will snuff out any nascent calls for secession, and the country badly needs alternative export routes for its hydrocarbons. Canadians know they’re too reliant on their southern neighbor.

Canada shipped its first tanker full of LNG last week, from Kitimat, BC. The export terminal, owned by LNG Canada, cost about C$48BN ($35BN). PM Carney said, “Canada has what the world needs.” He wants to lead “the world’s leading energy superpower.”

Until recently Canada thought of itself as a leader in reducing greenhouse gas emissions, even though their per capita emissions are among the world’s highest at 20.4 tonnes per year (the US is 17.2). They attribute this to their energy intensive industries, ironically including oil and gas extraction, and their cold climate.

The Department of Energy (DoE) just released a report evaluating grid reliability. Demand is rising at a faster rate than in the past, mainly because of data centers. The supply mix is becoming less reliable as dispatchable power from coal plants is replaced with intermittent solar and wind.

Some may find the report’s tone political, such as this sentence: The current administration has made great strides—such as deregulation, permitting reform, and other measures—to enable addition of more energy infrastructure…

But then NJ residents just saw electricity bills rise 17% which their grid operator PJM blamed on the same factors mentioned in the DoE report: data centers and insufficient new dispatchable power, which really means reliable power that’s there when needed.

The whole situation needs more natural gas power plants.

So far this year, midstream energy infrastructure is +3.5%, lagging the S&P500 by around 3%. Operating performance has remained strong, resulting in cheaper valuations for those still inadequately allocated to the sector.

Consequently, EV/EBITDA has slipped from the ten year average of 11.0X at the end of last year to 10.5X now. Dividend yields of around 4.5%, added to dividend growth of 3-4% and buybacks of 2-3% imply a prospective total return of around 10% pa (ie 4.5% + 3.5% + 2.5%). A return to 11.0 EV/EBITDA would mean a 4.76% increase in enterprise value (i.e. 0.5/10.5 = 0.0476) which given the prevailing 50/50 split between debt and equity liabilities would result in a 9-10% price increase (4.76% X 2).

In other words, pipelines are cheaper than they were following the election. White House policies have been at least as supportive towards traditional energy as was hoped eight months ago. The fundamentals support appreciation from current levels.

Retail investors remain cautious after a spurt of buying earlier in the year. Open-ended MLP funds, which confusingly includes c-corps which are now the dominant corporate form, have seen minor net inflows this year after seven straight years of outflows. This should soothe the fears of any potential buyer that it’s a hot sector. Sentiment is at odds with valuations, as is often the case.

We’re happy to report that net inflows to products managed by your blogger and partner Henry here at SL Advisors are well in excess of the $31million net adds to the sector.

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

Energy Mutual Fund Energy ETF

 

Anniversary Celebrations

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Around this time of year, I’m often asked if we celebrate July 4th. Since it is the anniversary of America’s Declaration of Independence, in Britain it receives scant attention. But I often note that had the war turned out differently I might not have emigrated to America in 1982.

We have much to celebrate in this country. As an immigrant I’ve always found America welcoming. Memorial Day weekend fell within a couple of weeks of my arrival 43 years ago, and the “new English guy” was invited to a home in Brooklyn where a friendship began that continues to this day.

I’ve never felt like a foreigner or an outsider.

The US is very good at assimilating newcomers. Beginning with reciting the Pledge of Allegiance every day, I watched proudly as our three children born of English parents grew up to be Americans like so many millions before them. Nonetheless they did receive a healthy dose of English culture. Just the other day we watched an episode of the brilliantly funny 1970s Britcom Fawlty Towers, for at least the hundredth time, so a close family friend might better appreciate our sense of humor.

Britain is a great country, but America is the greatest country. I love trips back to the UK, timed as much as possible to enable me to watch an Arsenal game. I’ll keep returning and I’m proud to have grown up in England, but America will always be my home.

We have our political differences to be sure. I once remarked to my business partner Henry, who’s from North Carolina, that the country had probably never been so divided as it is now. Henry retorted that the 1860s were worse, and of course he’s right, as he usually is. The south was more impacted by the Civil War, which is perhaps why Southerners more readily refer to it.

I have friends on both sides of the political divide, although since I predominantly interact with energy investors and golf club members my world is overweight Republicans. I think the Red tribe is fundamentally more optimistic about the future, and since I know America’s best days are still ahead, I feel comfortable there. But my Blue tribe friends correctly note our shortcomings, sometimes bitterly.

Maybe the key difference is in our assessment of whether what’s bad will be made good. Ronald Reagan was my first president. His sunny optimism was mine and remains so today. It’s always Morning Again In America.

That political ad from 1984 still gives me goosebumps.

To say we’re more united by shared values than we are divided by politics sounds uncomfortably like a campaign speech. But ahead of anything else, Americans are good, generous people. Most casual interactions with a stranger confirm that. Families across the country are raising children, instilling their values and hoping a bright future awaits them while enjoying the highest living standards in human history.

In recent weeks my wife and I attended a series of year-end school concerts and recitals. With eight grandchildren aged nine months to nine years old, the events come thick and fast.

As I watched those youngsters perform alongside their classmates, I thought how that next generation is growing up with the shared experiences and values of being first and foremost Americans. I looked at all those bright, smiling faces accepting the applause and thought about how this was happening at thousands of school halls across the country. They’ve completed another year of growing up in this great country.

Can you think of anything more powerfully filled with hope and optimism?

Every year in early July, the Queen Mary 2 operates a seven day cruise from New York up to New England and Nova Scotia and back. My wife Karen and I boarded the ship on July 1 to celebrate our fortieth anniversary.

Like America on July 4th, we also had much to celebrate on our anniversary, July 6th.

I’m sure there have been moments when it seemed to Karen we long ago passed that forty-year milestone. At such times I indulge my romantic side and note there are many oil and gas pipelines that have lasted even longer, including the original elements of the Transco network operated by Williams Companies. That such news leaves her non-plussed I attribute to poor delivery on my part, not irrelevant content.

Sometimes I think I have confirmed Warren Buffett’s advice that the secret to a happy marriage is to find a woman with low expectations. But in truth we both had high hopes when we married in 1985, and here we are still together.

Optimism isn’t always rewarded. But positivity is better for you, and life is more enjoyable if you can find it in others.

I hope your July 4th left you still feeling Ronald Reagan’s sunny optimism.

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

Energy Mutual Fund Energy ETF

 

Gas Kept Us Cool Last Week

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Our power infrastructure survived last week’s heatwave, which saw the PJM Interconnect system peak at an almost twenty year high of 160,560 Megawatts on June 23. Natural gas provided 44% of generation, with solar at 6%. The ISO-NE system that covers New England saw peak demand a day later. This was met 47% by natural gas and 4% from renewables (wind, solar and batteries).

There is a revival of interest in new pipeline projects to serve the northeast. In recent years politically motivated regulatory hurdles led to several cancellations. In 2016 Kinder Morgan (KMI) shelved Northeast Energy Direct (NED) which was to transport natural gas from Pennsylvania through New York and into New England. They were unable to obtain enough firm commitments from power companies who feared future limits from state governments on their ability to use gas.

In 2020 Williams Companies (WMB) canceled Constitution Pipeline which was to link Pennsylvania and New York because of difficulties obtaining water permits. Last year they canceled the Northeast Supply Enhancement Pipeline (NESE) that was to run from Pennsylvania through New Jersey to New York City, also because of problems with water permits.

Constitution has now been restarted, with an in-service date of 3Q27.

NESE has also been restarted, with an in-service date of 4Q27. Residents of New York and New Jersey are fortunate that WMB still has an appetite to try and complete these projects given the hostility to reliable energy from their state governments.

So far KMI hasn’t indicated they’ll restart NED. But the shift is palpable, driven by the failure of renewables to meet expectations and the Administration’s reversal of energy policies followed under Joe Biden.

JPMorgan’s Energy, Power, Renewables, and Mining Conference provided positive news for domestic natural gas demand with Exxon Mobil (XOM) confirming that Golden Pass LNG will start operations by the end of the year. The project is situated on the Texas side of the Sabine-Neches Waterway, opposite Cheniere’s Sabine Pass LNG terminal which is on the Louisiana side. XOM owns 30% of the project and Qatar Energy 70%.

Energy Secretary Chris Wright wrote an op-ed last week justifying the shift against renewables in the One Big Beautiful Bill (OBBB) currently making its way through Congress. He compared the intermittency of solar and wind with the value of an Uber ride that couldn’t commit to a pickup time or drop-off point.

Other than his support for coal, we think Wright’s energy policies are good.

The OBBB has caused some big swings in renewables stocks as traders react to changes to the draft language. The damage to renewables businesses in the US is likely to last well beyond the current Administration even if the Democrats reclaim the White House in 2028, because investment timelines are longer than the presidential election cycle.

The Texas state legislature passed a new law allowing data centers to be cut off from the grid during times of high demand. This reflects the growing electricity needs of data centers and their limited political influence. Once constructed, they create few jobs since all that’s required is a handful of IT specialists to monitor the thousands of computers supporting the AI revolution.

This will boost Behind The Meter (BTM) solutions which deliver natural gas to a dedicated power plant, bypassing the grid. WMB is developing a reputation for offering market leading solutions as they’re able to combine access to large quantities of gas through their existing pipeline system with marketing knowledge and control of relevant plots of land.

Data centers often like to connect with the grid even if their main supply is BTM because it provides back-up when their gas power plant is down, most likely for maintenance. Data centers are increasingly seeking very consistent power supply with virtually no downtime. The current standard for maximum acceptable loss of power is reported to be as little as three seconds per year.

Lastly, the President had a good foreign policy week, but the implementation of tariffs continues to create uncertainty. The US sells ethane to China, and neither side has an easy replacement. Shortly after Liberation Day analysts worried that China might impose reciprocal tariffs on US ethane but demurred since they have a petrochemical industry designed to receive it.

Then the US announced a license requirement for ethane exports and even though Enterprise Products Partners and Energy Transfer both made “emergency applications” they were not forthcoming. The latest twist in the ethane trade is that ethane tankers can be loaded and travel to China but not unload.

It’s unclear if any ethane tankers will be dispatched under such circumstances. US trade policy remains capricious.

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

Energy Mutual Fund Energy ETF

 

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