Mountain Valley Pipeline (MVP) will soon move 2 Billion Cubic Feet per Day (BCF) of natural gas from West Virginia to southern Virginia. It will allow increased takeaway capacity from the Marcellus and Utica shale plays in Appalachia. By connecting to Transco (owned by Williams Companies) it will allow for natgas to be transported south, in some cases reaching Cheniere’s LNG export terminals in Sabine Pass, LA or Corpus Christi, TX.

MVP will play a small but important role in getting US natural gas to our friends and allies around the world. It will enable buyers to reduce their dependence on coal for power generation, lowering GreenHouse Gas (GHG) emissions and local pollution. It will offer improved energy security to its buyers. If you’re a strategic environmentalist or climate advocate – and few are – MVP is part of the solution to how we reduce CO2 emissions.

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Instead, MVP will probably be the last greenfield natgas pipeline attempted in the US. This is mostly because we have the network we need, but also because navigating the US permitting process is more torturous than being stranded on a desert island indefinitely with that wretched little girl Greta.

Planning for MVP began in 2014. RBNEnergy.com, which publishes regular informative blog posts on US energy, has 19 articles dedicated to MVP and mentioned it in at least 37 different posts this year alone. MVP became a victim of climate extremists who learned how to weaponize the judicial system to insert uncertainty and delay into any project they dislike.

While Equitrans was pressing on with MVP, several other projects to move Appalachian natural gas to the US east coast were dropped. These included Enbridge’s Access Northeast expansion of its Algonquin Gas Transmission pipeline, which had already obtained FERC approval. Kinder Morgan’s Northeast Energy Direct expansion of Tennessee Gas Pipeline is another. These and other pipeline companies concluded that permits didn’t assure completion, perhaps anticipating the travails of MVP.

By May 2021 the 303-mile pipeline was 90% completed. The last thirty miles would average less than one mile per month. MVP required permits from numerous government agencies, including FERC, the US Bureau of Land Management (BLM), the US Army Corp of Engineers and the Virginia State Water Control Board. To cite just two examples, in 2018 a judge on the 4^th Circuit struck down Nationwide Permit 12, which had been granted in 2017 by the Army Corp of Engineers and reissued in 2018.  The court acted because stream crossings need to built within 72 hours to limit environmental damage, and it was believed MVP was not complying. The court also annulled MVP’s right of way through Federal lands that had been previously granted by the BLM.

Constructing infrastructure projects is often disruptive to the local community, and society is unlikely to accept unquestioned Federal permits allowing work to move forward. But under the current system, a company can acquire all the needed approvals and move forward in good faith, only to find work halted by a court. In effect, a permit issued by a government agency can’t be relied upon.

Equitrans (ETRN), which owns MVP as part of a consortium, has been struggling to complete the late, overdue project for years. They finally reached the goal line when Senator Joe Manchin (D-WV) insisted on Congress by-passing any remaining challenges as part of the increase in the debt ceiling in the summer. MVP was deemed by Congress to be in the national interest (see A Pipeline Win From The Debt Ceiling).

Even then the Court of Appeals for the 4th Circuit blocked construction to allow the Department of the Interior to assess construction through Jefferson National Forest. In August the Supreme Court finally weighed in and progress resumed. In an October 17 SEC filing, ETRN warned of further added costs because, “The ramp up of MVP’s contractor workforce has been slower and more challenging than expected, due to multiple crews electing not to work on the project based on the history of court-related construction stops…”

The permitting uncertainty isn’t limited to fossil fuels. The SunZia Wind and Transmission project filed for permits in 2006 and is only now starting construction. Navigator CO2 Ventures recently canceled a proposed pipeline aimed at supporting carbon capture because of “unpredictable state regulatory processes”.

Every infrastructure project faces opposition, and climate extremists are far from a homogeneous group with a coherent set of strategic objectives. Communities on the Jersey shore, where we have a summer home, are the red part of a blue state and their opposition to Orsted’s proposed offshore wind turbines helped scupper that project (see Windpower Faces A Tempest).

We concluded years ago that the impossibility of building new pipelines in the US would improve Free Cash Flow (FCF), because with less capex companies would return more cash to shareholders. This is what’s happening. As climate extremists learned how to use legal challenges to further their aims, “Hug a climate protester and drive them to their next protest” began to make sense.

But the tool of limitless court challenges knows no political ideology, and it’s being used against projects that seek to build more intermittent energy (solar and wind) as well as carbon capture. It no longer affects the midstream energy infrastructure sector – the present pipeline network is going to have to be adequate, because there’s little industry appetite to endure another MVP. Ironically, liberals convinced the planet is burning up should be the most vocal supporters of the permitting reform that MVP shows is so sorely needed.

Last week ETRN said they were considering selling themselves, and the stock duly rose. MVP should go into service next quarter, years late and at more than double the initial estimated cost. According to analysts at Citibank, the list of potential buyers includes Williams Companies, Kinder Morgan and Energy Transfer. Some potential acquirers dropped plans years ago to build pipelines adding natural gas takeaway capacity out of the Marcellus. One of them will likely conclude that it’s better to buy a finished project and avoid the painful construction process.

Last year NextEra Energy, an owner of the MVP JV, wrote down their interest in the pipeline. Earlier this year, ETRN’s market cap ascribed zero value to MVP. Consensus among investors was that the project would never be completed. Now that it is, there will be multiple suitors. It shows that climate extremists don’t just support the pipeline sector’s FCF, they also make existing infrastructure more valuable.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Bonds had a great month in November. The Bloomberg Agg was +4.5%. Ten year yields dropped 50 bps. Indications that the Fed will pause again were extrapolated into easing expectations as soon as next quarter. Lower yields help the relative valuation of equities, although Factset earnings forecasts are no longer trending upwards. Consequently, the rally in stocks in November offset the improved relative pricing created by lower bond yields. The Equity Risk Premium (ERP) continues to suggest that there’s little need to rush into stocks. It’s now below the average since 1962 and substantially below the average of the past two decades. Fixed income is becoming competitive once more.

The interplay of price and earnings forecasts leaves the energy sector with the most upside according to analyst forecasts, a position it’s held for much of this year. Midstream energy infrastructure yields of 6-8% are attractive. Nonetheless, we’ve often been challenged on this by financial advisors noting that riskless three month t-bills yielding 5.4% seem better.

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The obvious response is that t-bill yields may fall – the rally in bonds shows the market expects as much within the next couple of quarters. Pipeline dividends are unlikely to fall – JPMorgan is forecasting median dividend increases of 5-7% for large cap US midstream corporations and MLPs. They expect more modest 3% growth for Canadians (Enbridge just raised their payout 3.1%). But their yields are higher.

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Falling yields without a recession may be the most positive environment for this sector. Investors searching for income should increasingly be drawn to investment grade names with dividend yields above treasuries and the ability to raise them as well as repurchase shares. The American Energy Independence Index returned +8.1% in November, bringing its YTD return to +15.9%.

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We’ve also fielded questions on the impact on natural gas of Israel’s invasion of Gaza in response to the October terrorist attack by Hamas. It’s understandable given that Russia’s invasion of Ukraine last year sent European gas prices skyrocketing. This created profitable opportunities for US LNG shippers such as Cheniere to arbitrage between cheap domestic prices and Germany’s need to replace Russian supplies.

By contrast, offshore natural gas production in the eastern Mediterranean has continued although it was briefly halted by the Israeli government at the outset of hostilities. Israel has one Floating Storage and Regasification Unit (FSRU) six miles offshore. Last year Germany scrambled to lease most of the world’s available FSRU’s so they could import LNG. Until then they had none. But there’s been no disruption to Israel’s gas supply.

More meaningful to Israel’s ability to supply it armed forces is crude oil, 60% of which comes from Kazakhstan and Azerbaijan. These two Muslim countries have shown little inclination to curb supplies out of solidarity with the Palestinians. In any event, other producers would surely step in if needed, including the US.

The outlook for global natural gas demand remains constructive. Cambodia just canceled a planned coal-burning power plant and intends to substitute with natural gas power supported by LNG imports, a first for the country.

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Cheniere continues to sign long term LNG contracts. They minimize commodity risk, providing gas at whatever is the prevailing US market price and concentrating their economics on charging for liquefaction services. But last week they agreed to provide LNG to Austria’s OMV at a price linked to the European TTF benchmark. If you’re wondering how LNG tankers reach land-locked Austria, the answer is that OMV operates an LNG terminal in Rotterdam. Canada’s ARC Resources will supply the natural gas, also at a price linked to the TTF which will limit Cheniere’s risk.

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Attendees at the COP28 climate conference reading the EIA’s Today in Energy last Thursday will be dismayed to learn that global CO2 emissions from coal, oil and natural gas are all likely to be higher by 2050 in spite of the UN’s goal that they reach zero. This is based on existing policies and represents a base case. But in their 2023 International Energy Outlook, even the most optimistic scenario which they call the Low Zero-carbon Technology Cost Case, fossil fuels represent 66% of primary energy. Today it’s 80%, and the Reference Case assumes 70%. While the EIA expects growth in renewables like every serious forecaster, fossil fuels will need to grow as well to meet higher overall energy consumption. CO2 emissions in the optimistic case are still higher by 2050, at 38 Billion Metric Tonnes (GigaTonnes, or GTs), versus 41GTs in their base case and 35.7GTs today.

Part of the problem is that consumers are balking at the cost of the energy transition. Unsold electric vehicles sitting on dealer lots and multi-billion-euro losses on wind turbines are examples. Democrat political leaders starting with Biden have emphasized jobs, but it’s becoming increasingly clear, as it always was to us, that reducing CO2 emissions is worthwhile but also very expensive.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

COP28, the annual UN climate conference, starts tomorrow in Dubai in the United Arab Emirates (UAE). It’s easy to criticize the world’s efforts at reducing global Greenhouse Gases (GHGs). They over-emphasize intermittent solar and wind instead of going all in on nuclear and should replace coal with natural gas.

China gets a free pass to increase emissions through at least 2030 so their living standards can modestly catch up with the west. The US didn’t impose the decades of growth-stultifying communist central planning in 1949 that caused their living standards to fall behind. But we’re supposed to cut GHGs while theirs grow. President Biden and Xi Jingping, leaders of the world’s top two emitters, the US (6.4 billion Metric Tonnes (MTs) of CO2 equivalent and falling since 2007) and China (14.4 and rising) won’t be attending. The UAE, OPEC’s third biggest producer of liquid fuels, is planning to use the presence of so many energy executives in Dubai to discuss oil deals.

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The US just auctioned 35,000 acres of Wyoming land to oil and gas drillers, demonstrating that the White House is acting with more pragmatism and less emotion than left-wing Democrats might like. As St. Augustine might have said, “Give me 100% clean energy (chastity), just not yet.”

3,700 US auto dealers are calling on the Administration to slow regulations requiring two thirds of new cars to be battery electric by 2032. Electric Vehicle inventories in the US are up fivefold over the past year, according to digital listing platform CarGurus.

Climate extremists despair at the apparent lack of progress. But there is plenty of evidence that the world’s energy producers are adapting to the energy transition.

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Global investment in fossil fuels has yet to recover to pre-pandemic levels in real terms, while renewables investment has increased by around half in five years. Given the long lead-time in developing new oil and gas reserves, caution around capital commitments that require a decade or more to deliver a return is prudent. By most measures the world is going to be short of crude oil since demand continues to grow. The Energy Information Administration (EIA) sees global liquids consumption rising by 1.4 Million Barrels per Day (MMB/D) next year to 102.44 MMB/D, 0.4 MMB/D faster than production. China’s oil consumption grew at 3.5% annually over the past decade.

Nonetheless the price of crude has confounded many bullish oil forecasters this year.

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Carbon capture received a big boost from last year’s Inflation Reduction Act (“Green Spending Act”). With tax credits for Direct Air Capture (DAC) of CO2 rising to $180 per MT, private sector investment is picking up. More than half the new capital dedicated to the sector over the next three years is expected to be in the US. The power sector, where concentrated emissions of CO2 can be sourced, will receive around half of planned investment over that time. Removing CO2, long criticized as impractical and ruinously expensive, is becoming an important tool (see Carbon Capture Gaining Traction).

American Airlines is buying carbon credits from a company that turns sawdust and tree bark into compressed bricks that are then coated and buried. This prevents the biomass from otherwise decomposing and releasing CO2 into the air. American Airlines is paying $100 per MT for the credits. Burying sawdust seems an unlikely way to reduce CO2 levels, but Graphyte’s backers include Bill Gates’s Breakthrough Energy Ventures. The company expects to start producing the bricks next month and believes their technology is cheaper than other types of carbon capture.

It’s likely that innovation in this sector, spurred by the Green Spending Act, will continue to lower costs while adding new methods.

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Federal support is also stimulating new investment in pipelines to move hydrogen and CO2. Hydrogen offers promise when blended with natural gas at low percentages but generates Nitrous Oxide (NOx) at higher concentrations, as noted in this comment on a previous blog post.

The US is leading the world with new investment and innovation in reducing emissions from today’s energy and removing CO2 from the atmosphere. We’re also exporting increasing amounts of natural gas to our trading partners and allies, enabling them to use less coal for power generation. The US has a great story to tell on climate change and the energy transition, one that is underpinned by today’s midstream infrastructure companies. Climate extremists are wrong to focus their criticism on rich countries. The path of emissions in China and whether they eventually peak and then fall, will determine global levels.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Media coverage of reliable energy tends to focus on oil and gas. Oil comes in hundreds of different grades of complex hydrocarbon molecules. Natural gas, methane, is the simplest hydrocarbon of them all with a molecular formula of CH4. In between methane and crude oil lie Natural Gas Liquids (NGLs) – successively more complex combinations of carbon and hydrogen. Methane, also known as “dry” gas, is measured in cubic feet or BTUs. NGLs are measured in Millions of Barrels per Day (MMB/D). When NGLs are found with methane, it’s called “wet” gas.

NGLs don’t get much attention, but they should because their growth over the past decade has been more impressive than for either of their better known cousins. Over the past fifteen years, US NGL production has tripled, to 6.5 Million Barrels per Day. This growth in output has fueled a big jump in exports, up more than 10X since 2010. Just under 40% of our NGL production now goes overseas, up from 10% in 2010.

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One of the important roles played by midstream energy infrastructure companies is to separate these hydrocarbons from impurities present when they’re extracted, and from one another. They also make money storing, moving and exporting NGLs, creating multiple opportunities to “touch a molecule” as the vertically integrated companies often point out.

Ethane (C2H6) is used in the US for the production of ethylene from which most plastics are made. In many other countries plastics are made from Naphtha, which is derived when crude oil is refined. The abundance of ethane in the US has supported increased plastics production and foreign direct investment in new petrochemical facilities from companies seeking to benefit from US NGL growth

Ethane production has tripled since 2010. Propane has increased by 3.6X. Most of us are familiar with propane from its use in outdoor grills for barbequing. Propane is also used by farmers for drying crops. In regions not supplied with piped natural gas, such as SW FL, restaurants often cook with propane which is delivered in large upright cylinders.

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Butane is sometimes blended with propane or gasoline. Isobutane is used in refining. Pentane is used to make polystyrene foam.

NGL prices typically move together, and for the most part they’re all more valuable than natural gas on an energy equivalent basis. The chart shows prices expressed in this form to equalize for the fact that each NGL has a different energy content, measured in Millions of British Thermal Units (MMBTUs).

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Ethane occasionally dips below methane, which can lead to more of it being left in the natural gas stream that is delivered to homes and businesses. This is known as “ethane rejection” when the ethane isn’t valuable enough to justify separating it out from the methane.

Crude oil (not shown in the chart) is currently 5-6X more expensive than US natural gas on an energy equivalent basis. Crude oil is much easier to handle and transport, with transatlantic shipping costs of 3-7% of the price of the commodity. By contrast, converting natural gas to LNG so it can be moved by tanker can cost as much or more than the value of the commodity itself.

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This also explains why, unlike crude oil, regional natural gas prices vary so widely around the world. It’s easier for price discrepancies to prompt oil arbitrage than for natgas. For example, US gas is among the cheapest in the world, but we have 12 billion cubic feet per day of LNG export capacity via liquefaction plants, so exports are capped by this physical constraint regardless of relative pricing.

January natgas futures for Dutch TTF, the European benchmark, are $14.50 per MMBTUs. January futures for the JKM benchmark used in Asia are $17.10. US Henry Hub January futures are $3.00. This is why US LNG export capacity is set to double over the next four years. The world wants more US natural gas, which will underpin prices here somewhat as more liquefaction plants come online.

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In reviewing the many uses of NGLs, it’ll be clear that few of them can be replaced by renewables. Plastic bags, synthetic rubber, refrigerant, polystyrene and lubricants don’t lend themselves to being provided by solar panels or windmills. Climate extremists will argue that we should use less of all these products, but there’s little evidence of public policy embracing such a view. New Jersey outlawed plastic bags last year so we keep several cloth bags in the car for grocery trips. The United Nations Environmental Programme reported in 2020 that a cotton bag needs to be used 50-150 times before it has less climate impact than a plastic bag.

In 2018 the Danish Environmental Protection Agency suggested it was 7,100 times.

Nonetheless, I still carry my cloth bag conspicuously in the supermarket parking lot, especially when I see a Tesla driver. We both look disingenuously green. But I think our investments in natural gas infrastructure are more helpful to the planet than reusable grocery bags or electric vehicles, because they help reduce coal demand.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Next month VettaFi, which owns the Alerian indices, will announce a rebalancing of the Alerian MLP Infrastructure Index (AMZI). This will impact the Alerian MLP ETF (AMLP) which tracks AMZI. For an index fund it does a poor job of keeping up with its index – ALPS Advisors, who runs it, reports alpha of –3.03% over the past three years. That’s mostly due to the two tax restatements they made (see AMLP Has Yet More Tax Problems). Over the past year AMLP’s NAV has been adjusted down by 6%. ALPS wisely warns that, “…the daily estimate of the Fund’s deferred tax liability used to calculate the Fund’s NAV could vary significantly from the Fund’s actual tax liability.” It’s currently $329MM, around 4.3% of NAV.

AMLP’s fiscal year-end is November 30^th, so investors will be hoping for no further tax revisions like the one that was released that time last year. December 15^th is the next hurdle, because that’s when VettaFi will rebalance AMZI. It could use it. Currently, the top five names are 72% of the portfolio. Energy Transfer (ET) is over 18%. Just ten names constitute 97% of the portfolio.

AMLP is for those who like their market exposure concentrated.

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Morgan Stanley recently pointed out that ET’s weight is more than 6% over the normal 12% cap. It’s not an easy problem to solve. The number of MLPs is declining – ET’s recent acquisition of Crestwood removed another one. Being an MLP-dedicated fund means to love an ever-decreasing number of names.

ET has performed well this year, with a YTD total return of 25%. ALPS didn’t decide to overweight the name, it’s a consequence of their index construction. Morgan Stanley points out that if VettaFi decides to bring ET back to 12% in their December rebalancing, that could put downward pressure on the stock.

AMLP’s distributions are also now classified as 100% income. This is a change from prior years when they were almost always a return of capital, passing through the tax deferred benefit of MLPs to AMLP holders. Evidently the tax review that led to the cumulative 6% NAV adjustment also reclassified the tax nature of their distributions. It’s unlikely many AMLP investors are aware of this, but those holding it in taxable accounts will receive another unpleasant surprise when they file their 2023 tax returns.

There is so much wrong with this fund.

It is a great example of investor inertia. At $7.5BN in AUM, financial advisors who still use AMLP draw false comfort from knowing that legions of their peers are passively accepting a pool of fewer names and uncertain tax treatment. Investment performance and portfolio construction would render this fund unable to pass the most cursory due diligence of any investment firm’s review process. Its longevity and size substitute for careful analysis.

If your financial advisor still has you in AMLP, your portfolio isn’t receiving the attention it deserves. Ask why not.

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Fundamentals for midstream energy infrastructure continue to be supportive. 3Q23 earnings were generally good. The US Energy Information Administration recently noted that North American LNG export capacity is on track to at least double over the next four years, from 11.4 Billion Cubic Feet per Day (BCF/D) currently to 24.3 BCF/D. As well as five additions in the US, Mexico is adding three and Canada two.

US natural gas is among the world’s cheapest. The constraint on selling more is the capacity of the liquefaction plants currently in operation. Ramping up is a slow process, but as the chart illustrates export growth is coming. US natural gas will contribute to reduced global emissions by allowing more LNG buyers to rely less on coal.

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Earlier in November Williams Companies (WMB) confirmed they’d be moving forward with their Southeast Supply Enhancement project which will increase natural gas takeaway capacity out of the Marcellus shale via their Transco pipeline network. This will increase the volume of natural gas able to go south, potentially supplying our growing LNG export capacity along the gulf coast.

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RBN Energy, a research firm that provides many useful insights, noted the trend towards more investor-friendly allocation of cash flow. Last year the 13 biggest midstream companies (seven c-corps and six MLPs) returned 43% of cashflow to investors via dividends and buybacks. Add in retained cash of 6%, and this equaled the 50% share spent on capex and acquisitions.

In 2019 dividends were 48% of cashflow (there were no buybacks). Capex plus acquisitions was 83%. The difference was financed with increased debt (34% of cashflow).

Energy is a cyclical business, but the increasing dedication of cashflow to investor returns is becoming a welcome habit.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Carbon Capture and Sequestration (CCS) faces daunting Math. Mike Cembalest,  JPMorgan Asset Management’s Chairman of Market and Investment Strategy, publishes a well-researched and insightful annual energy paper. In the 13^th edition last March, he provided the sobering CCS math that sequestering just 15% of the US’s annual CO2 output would involve the same volume as all the oil moving through our distribution and refining system. That’s a lot of infrastructure. He has good reason to be a skeptic on the ability of CCS to have much impact – research shows that many projects fail to complete or fail to deliver their promised volumes.

Nonetheless, commercial involvement in CCS is growing, helped in the US by last year’s mis-named Inflation Reduction Act and its tax credits for carbon capture. Because there’s no cap on the 45Q credits, private estimates of their cost are substantially higher than the $3.5BN provided by the Congressional Budget Office. Goldman Sachs projects them to be 10X more costly. The Brookings Institute thinks the overall legislation will cost $1TN in direct spending and tax credits, more than 3X government estimates.

America prefers tax credits to reward emissions reduction, whereas many other countries impose taxes on those who generate them.

Occidental (OXY) is leading the charge to scoop up Federal handouts. They’re spending $1.3BN to build the world’s biggest Direct Air Capture (DAC) facility in west Texas, called Stratos. Blackrock recently agreed to invest $550 million in the project. Stratos is expected to be in operation by 2025. They’ve already sold carbon credits to Amazon and All Nippon Airways and have sold 65% of the plant’s capacity through 2030. Many companies are concluding that it’s more impactful to pay for offsetting carbon credits rather than trying to curb their own emissions.

Stratos will remove 500K Metric Tonnes (MTs) of CO2 annually, insignificant versus US annual emissions of 6.3 billion MTs of CO2 equivalent. But OXY CEO Vicki Hollub has big plans for DAC. She thinks OXY could build up to 100 plants similar to Stratos and by licensing the technology out enable perhaps thousands more.

Exxon Mobil is partnering with Indonesia’s state oil company Pertamina to invest $2BN evaluating a potential storage site in the Java Sea.

The infrastructure challenge Mike Cembalest cited above assumes that CO2 has to be transported to permanent storage, which usually means finding a place underground with the right geology. But CO2 in the ambient air has a fairly uniform concentration throughout the world’s atmosphere of around 417 parts per million (0.04%). This means that DAC plants can be located above the storage location, eliminating the need for pipeline infrastructure to transport the CO2 and improving feasibility. Often the best rock formations are the same ones that held hydrocarbons previously, which creates the beautiful symmetry of returning carbon atoms to their point of origin, just as a different molecule.

Enlink (ENLC) and BKV Corporation just announced the successful sequestration of CO2 in a well in the Barnett Shale in north Texas. The CO2 was captured from a natural gas processing facility where concentrations can be 1,000X or more the 0.04% in the atmosphere.

ENLC plans to build a CCS business in Louisiana, capturing emissions from petrochemical customers supplied with natural gas via ENLC’s pipelines. Given their $6BN market cap, they offer more concentrated CCS exposure than many larger companies in the sector.

Climate extremists, rarely accused of serious thought on the subject, generally oppose carbon capture as prolonging the world’s reliance on fossil fuels. They should welcome anything that cost-effectively removes CO2 from the atmosphere. Instead, they throw paint at priceless art, proving both that they’re Philistines and that the UK criminal code has been hijacked by liberals. You don’t see that behavior in the US, nor the traffic disruption they cause by marching in the road. American drivers so delayed would naturally hit the gas, reducing the odds of repeat offenders. Throw in the disgusting marches in support of Hamas and Britain, where I grew up, is sliding towards left-wing sponsored anarchy.

Following up on last week’s blog (see Will We Use More Hydrogen?), Germany is planning a 6,000 mile hydrogen pipeline network costing around €20BN ($21BN) by 2032. Encouragingly for US natural gas pipeline owners, 60% of this network will repurpose existing natgas pipelines, showing their versatility during the energy transition.

Germany has had a bad energy transition so far, marked by great expense and huge strategic errors (reliance on Russian natural gas; eliminating nuclear power; industry fleeing to cheaper energy such as in the US). They offer little to emulate – the technical adaptability of gas pipelines is the main positive in their hydrogen story. Germany will be producing more hydrogen than they can use domestically so plan to export 70% to neighboring countries. Let’s hope there’s demand.

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Finally, I spent last week seeing clients in Arizona and had the opportunity to play golf with two long-time investors. It was warm, sunny and welcoming. Scottsdale is mercifully free of the homeless drug addicts that disgrace so many downtowns, even though China’s premier is not scheduled to visit. At least one city government has its act together.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Steven D King is not as famous as his namesake, but for an economist can still write a spine-tingling book. Prompted by the inflation that followed the pandemic, King walks us through past episodes of inflation and their causes, and offers some clues as to whether it’s persistent or transitory.  

Moderate inflation of 2% or lower had become so entrenched that by 2020 the Federal Reserve adopted an asymmetric policy of tolerating inflation above target in order to allow the long run average to reach 2%. Policymakers worried about a Japan-style deflation as much as they fretted over inflation, and when Covid uber-stimulus caused it, the Fed maintained that it would not persist. Hence “transitory” became a flip criticism of Fed chair Jay Powell. 

Until the last hundred years or so inflation and deflation were equally likely. Although citizens in the Roman Empire suffered disastrous inflation during the third century CE, over the next fifteen hundred years or so centuries passed with little inflation and sometimes deflation. During the 15th century the British pound is estimated to have gained 11% in purchasing power. The 20th century up until today is more notable for the absence of any serious deflation. Avoiding deflation at all costs “is likely to end up delivering an inflationary bias.”  

The US 1930s depression was the most economically destructive period in the country’s history. By contrast, Germany’s experience with hyperinflation under the Weimar Republic led to the catastrophe of Hitler. Economic policy in both countries is biased to avoid a repeat – hence the Fed targets maximum employment consistent with stable prices while for decades the Bundesbank’s mandate was simply price stability.  

Quiescent inflation from the late 1980s perhaps led to central bank complacency that their credibility largely assured price stability. But some economists think globalization allowed a one-time enormous increase in the supply of cheap labor and improved supply chains. Central bankers were less important than they thought.  

The aftermath of the US Civil War saw the Federal government fear a repeat of the inflation that followed both the US and French revolutions. But northern financiers had provided extensive credit to southern farmers. The debtor benefits from inflation through a devalued obligation as much as the creditor loses out. Therefore, the deflation that followed the end of hostilities had the effect of making the South poorer while the North got richer, “…a mechanism to ensure the economic costs of the war were imposed on the former Confederate states.” 

King draws an interesting analogy with the periodic debt crises in the Eurozone, during which heavily indebted southern countries like Greece and Italy would benefit from inflation while trapped in the same currency as northern creditors such as Germany. A fracturing of the Euro was only avoided when ECB central bank head Mario Draghi pledged to do “whatever it takes” to preserve the Euro, which eventually included buying Italian and Greek sovereign debt.  

Modern Monetary Theory (MMT) receives a brief and disparaging mention, one with which we heartily agree (see The Death Of Modern Monetary Theory). MMT holds that because a government can never default in its own currency, expansionary fiscal policy should be run to maximize employment. This relies on governments constraining themselves only when forecast inflation shows the limits of productive capacity have been breached. The flaw is in expecting any government to honestly forecast inflation. Even the Fed is bad at it.  

Perhaps the biggest change in central banking in our lifetimes has been the granting of independence from political interference, at least over the short to medium term. During the late 1970s and early 1980s high inflation was a political issue and elected leaders accepted that it was their responsibility to tame it. Paul Volcker could never have driven interest rates to 21%, helping cause two recessions, without support from President Reagan and Congress. 

Central bank independence frees monetary policy from political interference, but it also frees governments from responsibility. The massive fiscal stimulus following the pandemic soon turned out to be excessive. The Fed and other central banks were rightly criticized for reacting late, but few called for the fiscal drag of spending cuts or tax hikes to offset the earlier mistake. Quantitative Easing has blurred that independence. Even wildly imprudent fiscal policy can always rely on the QE bailout. Now that excessive government debt is increasingly financed by central banks, the conduct of monetary policy is more complicated. The unfortunate milestone of $1TN in annual interest expense on Federal debt was brought two years closer, from 2030 to 2028, because the Fed raised rates.  

King offers a four-point test to see whether an uptick in inflation will be persistent or not. The Fed’s asymmetric tolerance for higher inflation, attributing it to external shocks such as covid and Russia’s invasion, and trade tensions that are constraining supply chains are three indicators of persistence. The absence of monetary excess (M2 has been shrinking for over a year) is the only one to provide comfort. King concludes that recent inflation “has been the most worrying since the 1970s.” 

His lessons from past bouts of inflation and warnings about the future make this a book worth reading for every investor.  

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Investors often ask what are the prospects for hydrogen as an energy source. In spite of Jeff Sommer’s conclusion that the market doesn’t think much about the future (see Priced For A Pragmatic Energy Transition) we think about it all the time.

Hydrogen is appealing because when it burns it combines with oxygen to release harmless water vapor. There’s no CO2. There’s a place for hydrogen in industries such as steel and cement where production requires fossil fuels – although electric arc furnaces are increasingly used for certain types of steel, and 43% of planned new capacity will use this method. Currently steel production generates 7-9% of CO2 emissions.

Hydrogen is difficult to handle and expensive to produce. Prolonged contact with steel tends to make the pipeline and welds brittle. Hydrogen molecules are small enough to permeate the steel itself, which over time can cause leaks. Solutions include building pipelines with fiber reinforced polymer, and also blending it in with natural gas to run (up to 15% hydrogen) through our existing pipeline network. Since hydrogen has about one third the energy density of methane (natural gas), delivering the same energy content with a hydrogen blend requires the pipeline to operate at higher pressure, which may require modifications to the pipeline. There are currently 39 pilot projects across the US exploring the hydrogen/methane blend for natural gas distribution. Dominion Energy’s plant in Utah is an example.

There are currently around 1,600 miles of hydrogen pipeline in the US. For reference, we have 305,000 miles of natural gas transmission lines with a further 2.2 million miles of distribution pipes to customers.

Air Products, Linde and Air Liquide produce most of the US’s 10 million tons per annum (MTpa) of hydrogen. It’s produced via Steam Methane Reforming (SMR), which reacts methane with steam at high temperature, producing hydrogen and carbon monoxide, which then combines with oxygen and is released as CO2. If the CO2 is captured this is called Blue hydrogen.

Although hydrogen burns cleanly, its current production requires more energy than the resulting hydrogen contains and generates emissions.

The US recently awarded $7BN in grants to help fund hydrogen hubs that will produce green hydrogen. This will be produced via electrolysis that separates hydrogen from water, and if the power is derived from renewables there are no emissions. The aim is to produce 10 MTpa, (ie double what we do now) by 2030. This is equivalent to around 3 Billion Cubic Feet per Day (BCF/D) of natural gas on an energy equivalent basis, roughly 3% of US production. If this was all blended into our natural gas supply, we’d theoretically reduce emissions from burning natural gas by 3%.

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Cleveland Cliffs has tested using hydrogen in steel production and is planning to use some of the green hydrogen that will be produced from one of the aforementioned hydrogen hubs.

The world uses fossil fuels for around 80% of our primary energy because they’re convenient and not subject to interruption from cloudy or calm days like renewables. They’re dispatchable, as is hydrogen, meaning they’re available whenever needed. Directing the electricity from solar panels and windmills towards the production of green hydrogen seems to me a better use than connecting them to customers via the grid, because the intermittency won’t matter much.

Cost estimates of hydrogen vary widely, but on an energy-equivalent basis green hydrogen is 5-10X the cost of US natural gas. As is often the case with the energy transition, it’s technically possible to reduce emissions but expensive. Climate extremists and liberal politicians continue to assert that renewables are cheaper – meanwhile fossil fuel use keeps growing, as if the world is stubbornly denying itself the opportunity to get more energy for less.

The UN projects oil production will reach around 114 Million Barrels Per Day (MMB/D) by 2030 and 116 MMB/D by 2050 versus 102 MMB/D today. This is based on analyzing the twenty largest producing countries. The International Energy Agency sees demand peaking within a few years. Their forecasts look increasingly political and less grounded in reality.

There are many policies and technologies available today that can be harnessed to reduce emissions. These include phasing out coal in favor of natural gas, dramatically increasing nuclear power, carbon capture and deploying hydrogen as described above. Anybody who describes themselves as worried about climate change but doesn’t support these isn’t interested in solving the problem. Claiming the world should fully rely on solar and wind because they’re cheaper betrays an absence of thought about how we use energy.

We feel pretty good that natural gas infrastructure will continue to support a substantial part of America’s energy needs.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

The other day a NYTimes columnist contrasted the relative outperformance of oil stocks with plunging solar and wind. He concluded that the stock market is oblivious to the threat of climate change whereas the UN and other scientists believe we must reduce Greenhouse Gas (GHG) emissions to zero by 2050. The writer, Jeff Sommer, briefly contemplated who was right – the market’s apparently sunny outlook or the scientists’ dour one. He quickly concluded that the market was wrong. Well, he is a journalist. At the NYTimes.

Sommer thinks energy investors are focused on the short term and ignoring climate change. I’m an energy investor, and I think about the energy transition all the time. If you invest in this sector you have to have a perspective on how the world’s use of energy will evolve. The International Energy Agency believes the world will eliminate GHGs by 2050, but all the data points to global energy consumption increasing and emissions maybe falling by then but certainly not reaching zero. It’s the difference between what some people think should happen and what others think will likely happen.

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Energy stocks began pricing for the risk of climate change and the energy transition many years ago. The fear that crude oil reserves and natural gas pipelines would become stranded assets, abandoned well short of their useful lives, has been steadily gaining importance for at least the past decade.

The S&P Energy index, which is dominated by Exxon Mobil and Chevron who together represent 45%,  has lagged the S&P500 for seven of the past ten years and three of the past five. Along with the American Energy Independence Index (AEITR), both have underperformed the market over ten years but are approximately even over the past five. This reflected investors’ discounting the impact of the energy transition.

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In 2020 investor excitement about the prospects for renewable energy peaked. The S&P Clean Energy index (“S&P Renewables”) had a huge year but has since lost half its value. That’s because many of these companies aren’t doing that well. Orsted, one of its top ten holdings, is likely to book a $5BN+ loss on its US offshore wind business. First Solar swung to a $281MM operating loss last year on revenues of $2.6BN. Over the past five years, an investment in pipelines has outperformed renewables.

But it’s not true to suggest energy investors aren’t considering climate change. It’s foremost in the thinking of most who have exposure there, and one of the top reasons for those who avoid the sector.

This is most visible in valuations. Midstream energy infrastructure corporations yield over 6% with a Distributable Cash Flow (DCF) yield of 11%, forecast to rise to 12% next year (JPMorgan). Large MLPs yield 8% with DCF yields of 14%. These are attractive valuations by most historical standards, and they’re only available because many investors still assume fossil fuels are going away within the next decade or so.

Political soundbites matter. Just over four years ago, candidate Biden said, “I guarantee you. I guarantee you. We’re going to end fossil fuel.” He wasn’t specific about when, and in a more sober moment during February’s state of the union he conceded, “We’re still going to need oil and gas for a while.”

The market is priced for his first statement and only warily acknowledges the second.

S&P Renewables soared on the election rhetoric and has plummeted on the financial results, reflecting Ben Graham’s quote that in the short run, the market is a voting machine but in the long run it is a weighing machine.

Renewables stocks have continued falling this year, even though the 2022 mis-named Inflation Reduction Act provided huge subsidies. First Solar (FSLR), the biggest component of S&P Renewables, is down by a third since March. It trades at around 18X 2023E earnings, modestly less than the S&P500 at 19.8X, so even now hardly looks out of favor. JPMorgan rates it “Overweight” calling it a “safe haven”. They have a $220 one-year price target, which is up 50% from here, and forecast 2024 EPS at $14, up from $8 this year.

Wells Fargo rates FSLR overweight with a $215 price target. They expect EPS to double next year.

This does not look like a stock short of love from sell-side analysts.

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Often long term energy forecasts confuse aspirational with likely. This natural gas chart shows both. The IEA Net Zero is not in our future. Their Stated Policies one is plausible. Making such projections objective draws the ire of climate extremists. You have to screen out the hyperbole.

Jeff Sommer of the NYTimes is confusing recent market performance with valuations. Energy stocks, especially midstream, are cheap. They’ve been cheaper to be sure, especially during the first few months of the pandemic in 2020. But they are still priced defensively in our view.

The FSLR example shows a bullish outlook for solar panels. It’s just no longer priced as if Biden’s election rhetoric was anything more than a soundbite to pick up some gullible far-left votes.

The energy transition is clearly priced into energy stocks. What’s not priced in is the certainty of the world eliminating GHGs by 2050 (“Zero by 50”). That’s an extreme forecast, and while theoretically possible it’s becoming steadily less plausible every day. By their actions, people around the world are showing concern about emissions while stopping short of economic suicide by following the most extreme policy prescriptions.

Zero by 50 is intended to limit global warming related to human sources of GHGs to 1.5 degrees C above 1850. Temperatures today are already 1.1 degrees warmer than that benchmark. We’re living with it, not yet extinct.

Cost-effective emissions reduction looks like smart risk management of our only planet. Reducing living standards around the world with impetuous choices does not.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Targa Resources provided one of several bright spots among pipeline earnings last week with a 50% increase in their dividend planned for next year. Their cashflows are increasing strongly. JPMorgan projects a Distributable Cash Flow (DCF) yield of 14% for this year, rising to 16% in 2024 and almost 18% in 2025. The new $3 per share dividend yields 3.3%. The company also bought back $132MM in stock during 3Q. Both JPMorgan and Wells Fargo see around 25% upside over the next year.

Irrational exuberance has been missing from midstream energy infrastructure for almost a decade. 25% 12 months’ upside on a stock that’s returned 32% over the past year may remind grizzled MLP veterans of 2014, when the structurally flawed Alerian MLP ETF (AMLP) peaked. It currently trades at half its value back then, missing stocks like TRGP which long ago shed the MLP structure in search of a broader investor base. The years that energy has been out of favor have served to improve the valuations of TRGP and its peers. Leverage of 3.6X Debt:EBITDA this year is projected to decline to 3.3X next year. Along with Its dividend coverage and buybacks, TRGP reflects the lower risk profile and improved shareholder returns that continue to propel the sector higher.

Energy Transfer (ET), widely owned among financial advisors we talk to, has been repaying that faith with a 26% total return YTD. 3Q23 EBITDA beat expectations handily by 7%, and they raised full year guidance (midpoint went from $13.25BN to $13.55BN). Management is still negotiating with the US Department of Energy (DoE) over a permit extension for their Lake Charles LNG project. They reported that some potential buyers have been lobbying the DoE directly to let it go ahead. It’s unclear why the DoE won’t extend an approval they previously issued. But they should. Exporting cheap US natural gas will improve energy security for our friends and allies around the world as well as offering a cleaner substitute to coal for power generation.

Cheniere expects to be at the high-end of guidance for 2023 and more importantly now expects first LNG production from Train 1 of Corpus Christi Stage 3 by the end of next year, six months ahead of prior expectations. This creates the potential for their marketing arm to sell into an elevated spot natural gas market in 2025 before contracts start.

Other good news came from MPLX which beat EBITDA expectations, Pembina who raised full year guidance by 4%, Western Gas who repurchased another 5.1 million shares from Occidental and Enlink who spent $50MM buying back shares during 3Q23.

Oneok raised 2023 guidance and expressed optimism about identifying further synergies from their recent acquisition of Magellan Midstream. Equitrans, owner of the perennially delayed Mountain Valley Pipeline (MVP), said they expect most construction to be completed by year’s end and to be in service by January.

It was another solid quarter of earnings to soothe the purchase decisions of investors committing capital to the sector.

Your blogger spent last week traveling across the southeast US seeing clients. Stops were made in Dallas, Houston, New Orleans and Miramar Beach, FL. As always, it was thoroughly enjoyable to reconnect with old friends and make some new ones. The pipeline sector’s fundamentals have been relentlessly positive. This continues to move stock prices higher which is overpowering skepticism around traditional energy.

Houston’s Red Lion British Pub serves that quintessentially English dish – Chicken Tikka Masala. Fellow Brit Geoff Lanceley and I both enjoyed it. This Indian dish is now more popular than fish and chips in the UK.

In New Orleans I saw Keith Laterrade, a long-time investor with us who in the late 1990s played professional (English) football in England. This included one game as goalkeeper for current Premier League champions Manchester City. He progressed substantially farther than me in the world’s favorite sport, and we always compare notes on the latest results before moving on to pipelines.

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Keith suggested dinner at Bayona which is owned by his long-time client Regina Keever in the French quarter just a block from Bourbon Street. It must be New Orleans dining at its best. If you can visit, you won’t be disappointed. Keith doesn’t just manage money for clients, he supports them across a wide range of financial interests. He’s currently helping Ms Keever who, after 30 years of providing a high-end dining experience is looking to sell.

If you’re interested in buying a restaurant at the top of its game, let me know and I’ll connect you with Keith.

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Miramar Beach in Florida’s panhandle is known as the Emerald Coast because of the color of the water which beautifully offsets the white sandy beaches. Long-time client Rob Coletta suggested  Bijoux for dinner. This similarly beat expectations, just like the pipeline companies that occupied our convivial dinner together.

Throughout my meetings everyone was pleased with how the fundamentals are playing out and surprised that retail buyers have not yet warmed to the sector. Although our investor base tends to vote Republican, there is an appreciation if not gratitude towards the climate extremists whose opposition to new projects has improved free cash flow, helping create the positive circumstances for today’s investors in reliable energy. My admonition to “Hug a Climate Extremist” always draws a smile.

It’s not just tongue in cheek. By investing in natural gas infrastructure, we’re supporting the source of America’s biggest success in reducing CO2 emissions by displacing coal. By investing in LNG export terminals, we’re helping provide the same opportunity to buyers around the world. Practical solutions are the best.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund