SL Advisors Talks Markets

AI Demand Ramps Up

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On Monday Energy Transfer announced the first Behind The Meter (BTM) agreement of the AI era. They’ll provide up to 450 Million Cubic Feet per Day of natural gas to a data center being built by CloudBurst Data Centers in central Texas.

This represents 0.45 Billion Cubic Feet per Day (BCF/D), almost 0.5% of US gas production and a staggeringly large amount for a single location.

As we noted recently (see Hyperscalers Plow Ahead), BTM arrangements don’t spread the cost of new power infrastructure across existing users. This avoids triggering a political backlash since data centers generate few jobs.

A couple of weeks ago DeepSeek cast doubt on the forecast increases in power demand that have helped boost natural gas infrastructure stocks (see Pipelines And The Jevons Paradox). Since then, companies such as Meta and Amazon have reaffirmed their capex budgets on data centers.

Morgan Stanley estimates that the first data centers to support the $500BN Stargate project that President Trump recently announced with require 0.66 BCF/D if fully supported with natural gas driven electricity.

Most observers have concluded that ten-year energy forecasts are uncertain and therefore not much different. Just the Cloudburst and Stargate deals could consume 1% of US gas output and suggest that natural demand forecasts could be revised higher.

The climate extremists’ view of the energy transition is undergoing a reassessment. The Army Corp of Engineers has temporarily paused 168 permits for renewables projects. Total CEO Patrick Pouyanne stopped investment in offshore US wind following the election, although allowed that it could resume after four years.

Shell recently wrote off their investment in the Atlantic Shores wind project that was planned off the coast of New Jersey. Even though New Jersey is unfortunately a very blue state, offshore wind turbines are wildly unpopular with Republican residents of the Jersey shore. Their complaints include the spoiled view and the construction required for high voltage cables to bring the power through beachfront communities.

Atlantic Shores now looks unlikely to progress, cheering the red part of the garden state where we have a summer home. Newark Airport’s Terminal A still sports ads promoting the project. I expect they’ll soon be removed.

We don’t make a living forecasting EV sales, but if pressed would suggest they’re going to be soft. The rollout of charging stations funded under the Inflation Reduction Act has been slow, with only 176,000 in place by October, just 22% more than a year earlier.

The White House wants to stop building new charging stations. Withholding funding may ultimately be over-ruled by the courts, but the uncertainty about charging availability is likely to dissuade many potential EV buyers since range anxiety is one of their biggest concerns.

Volkswagen is slashing capacity at its EV factory in Zwichau, Germany only five years after it was hailed by former Chancellor Angela Merkel for being an EV-only facility. Meanwhile BMW plans to continue investing in internal combustion engines, hedging its bets.

Last year Ford lost $5.1BN on EVs and expects this year to be worse. Western auto companies are switching to EVs faster than consumers, with deleterious financial results.

Many Republican voters were drawn to Trump’s promise to “drill baby, drill” during the election. Energy investors are less enthusiastic. They remember the poor returns under Trump 1.0 that were reversed under Biden, even though in 2019 he pledged to end fossil fuels.

So it was mildly surprising to see Enterprise Products Partners (EPD) cancel their plans to build the Sea Port Oil Terminal (SPOT) off the coast of Texas. This would have accommodated some of the largest crude tankers, but EPD found insufficient customer interest to proceed.

Energy infrastructure usually gets built only when firm commitments to use it are in hand. This shows that in spite of Trump’s pledge to boost oil output, financial returns need to be there. E&P companies are less enthusiastic. Financial discipline continues, which should appeal to energy investors.

Finally, a follow-up to our recent video (watch Why Not Nuclear?). The International Energy Agency found that nuclear plants delivered since 2000 in the US and Europe were on average eight years late and cost two-and-a-half times their original budget.

The nuclear industry desperately needs to settle on standard designs that will allow economies of scale in components and simplify the regulatory process. Britain’s Sizewell C plant is designed to match as closely as possible the Hinckley Point C reactor where construction began in 2016.

US nuclear manufacturer Westinghouse was forced into bankruptcy in 2017 because of cost overruns at its Vogtle plant in Georgia, where completing units 3 and 4 took twice as long at double the projected cost.

Having learned from this experience, newly capitalized Westinghouse is negotiating to build plants in Ukraine, Poland and Bulgaria based on its AP1000 design. No modifications are allowed. Determined to control costs by sticking with what they know works, CEO Patrick Fragman says, “Basically, you can choose the color.”

The nuclear industry needs more of that.

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

SL Advisors Talks Markets

Bond Buyers And Tariffs

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Although the US is energy independent and a net exporter of petroleum products, we still import certain blends of crude. Canadian tar sands oil is the heavy type for which American refineries are configured as is Mexican oil. Shale oil is lighter. So we buy what we are set up to handle and sell what we’re not. This is just one example of the complex set of trade ties that bind the North American continent together.

There’s unlikely to be any economic benefit from tariffs, which can also correctly be termed import taxes. They can further non-economic goals, such as Mexico’s agreement to station 10,000 troops on our border to prevent illegal immigration. Opinions vary as to whether they’re inflationary, although most analysts agree that they’re a net negative on GDP growth. Much depends on whether retaliation leads to a ratcheting up and extended period of trade friction.

Based on the rhetoric leading up to Saturday’s announcement, they’ll be more impactful on Canada and Mexico than the US. Both countries’ currencies initially weakened vs the US$. Theoretically our trading partners could fully absorb the cost of the tariffs. In practice, as with sales taxes, it will be split between producers and consumers.

Goldman Sachs estimates that the 10% import tax (ie tariff) on Canadian crude will be 2/3rds absorbed by Canadian producers and 1/3^rd by US refineries which will presumably pass this on to consumers via price hikes for gasoline and other refined products. Last year we imported 3.8 Million Barrels per Day (MMB/D) of crude and 0.3 MMB/D of refined products from our northern neighbor. Mexico provides just under 0.5 MMB/D of oil.

Canada has long struggled to get its crude oil from Alberta to export markets. They don’t have any good alternatives to shipping to the US for now. The Keystone Pipeline which runs south to the Gulf of America (Chevron recently adopted this new name) runs at close to 100% capacity. It’s why TC Energy tried for years to build the Keystone XL, which Biden ultimately quashed when he took office in 2021.

The Transmountain pipeline runs west to British Columbia. Its expansion project was completed in 2024 at substantial increased expense and after long delays by the Canadian federal government who bought it from Kinder Morgan in 2018 (see A Closer Look At Canada’s Newest Pipeline). This also operates at close to full capacity. Crude oil can move by rail, but that’s substantially more expensive and not as safe. In 2013 a train carrying crude exploded in Quebec, killing 47 people (see Canada’s Failing Energy Strategy).

Canada’s crude oil options are limited.

The Administration’s goals with tariffs aren’t completely clear. Canada’s not a big source of illegal immigration or fentanyl, and there’s zero chance Canadians want to be the 51^st state. Trump has claimed that we subsidize Canada in the form of our deficit with them, but that’s not the right way to think about the purchase of goods in a free market.

If the US is pursuing a narrower trade deficit, a consequence not so far considered publicly is its impact on our fiscal deficit. Over the past twelve months our trade deficit is $879BN. Those US$ that foreigners accumulate have to be invested back in the US, and a significant portion wind up in treasury securities. Canada owns $374BN. Japan owns $1.1TN and China $769BN. If our trade deficit shrinks, foreign countries will have fewer US$ to invest back in the US.

Absent a lower fiscal deficit, US savers will need to provide more of the financing which will require higher bond yields. Today’s interest rates are inadequate to induce sufficient domestic saving. Coupled with this is that an extended period of trade conflict intended to reduce our trade deficit will probably cause some countries to deem US bonds less attractive anyway for political reasons. China has been lowering its US holdings in recent years as trade tensions have risen.

There’s little reason to expect any improvement in the fiscal outlook. Elon Musk’s Department of Government Efficiency will hopefully uncover some savings, but nothing is likely to change about the trajectory without policy changes. Strong GDP growth is our best near term option.

A weaker economy due to trade friction might lower bond yields. Tariffs might be inflationary. But we’ll need people to buy our bonds, and if there are fewer foreign buyers we’ll need to own more here, which will require lower consumption and more saving by US households.

In an unintended consequence, it may turn out that running a trade deficit keeps interest rates lower than they would be otherwise. We may be on track to find out.

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

SL Advisors Talks Markets

Pipelines And The Jevons Paradox

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

AI is far from the whole story.

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

SL Advisors Talks Markets

The Energy Story’s Trifecta

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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