2022 should have been a great year for renewables. The prices of fossil fuels, which they are supposed to replace, have jumped. Russia’s invasion of Ukraine has heightened the importance of energy security, which solar panels and windmills offer because most countries can find places to build them. And global Green House Gas emissions (GHGs) have rebounded following the dip caused by the pandemic. So why aren’t renewables stocks riding high?

One reason could be that some of them had benefited from the long rally in tech stocks. Investors in both sectors are typically relying on high growth rates which means years of waiting for a reasonable free cash flow yield. Rising interest rates put a higher discount rate on those delayed future earnings.

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A more likely answer is that investors are becoming more realistic about the profitability of renewables. Germany’s north coast is windy, but they and others scrambling to replace Russian natural gas did not bid up the price of windmills. Instead, they hoovered up every available Floating Storage and Regasification Unit (FSRU) on the planet. The onshore pier, pipelines and electricity lines for the first one were completed last week in a brief 194 days in Wilhelmshaven on the North Sea. They’re also planning to build onshore import terminals for LNG, which have greater capacity than FSRUs.

European LNG prices famously reached ten times the US price earlier in the summer before dropping back to around 5X now. European storage is full in preparation for winter. Dozens of LNG tankers are idling offshore waiting for better prices before they unload their cargoes. Many analysts expect it’ll be harder to replenish stocks for next winter, since Russian gas was flowing west through Nord Stream 1 for the first half of this year.

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Coal prices have soared as developing countries have been deterred from competing with Europe’s new appetite for LNG. Among non-OECD (ie developing) countries coal provides 46% of their power, versus only 19% in the rich world. And developing countries are where energy demand is growing.

China burns half the world’s coal and relies on it for 63% of their electricity.   They’ve even justified new coal plants as necessary for energy security (what’s Chinese for chutzpah?). Egypt is making government buildings and shopping malls turn their air conditioning up to 77° F, thereby reducing domestic demand for natural gas so they can export more.

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Coal and gas together provide 59% of the world’s electricity, and both are much more expensive than a year ago. It’s as if the world had agreed on carbon taxes to improve the economics of renewables. There are numerous articles stating that solar and wind are cheaper than reliable energy, most of which pre-date the run-up in coal and gas. Renewables stocks should be soaring.

But they’re not. Danish wind turbine manufacturer Vestas expects a profit margin this year of minus 5% and recently reported a bigger 3Q loss than expected. They are optimistic that they can boost prices over the long run.

The CEO of Siemens Energy reminded viewers on CNBC that, “renewables like wind roughly, roughly, need 10 times the material [compared to] what conventional technologies need.” Current fiscal year EBITDA is down 42% and the company isn’t planning to pay a dividend.

UK solar operator Toucan Energy has gone bankrupt, with debts including £655 million ($779 million) to Thurrock Council, the local government where it operates. Neighboring London averages 1,481 hours of sunshine a year, which is 17% (Tampa, FL is 33%). 48% of UK electricity comes from natural gas. Although solar is 7%, UK solar farms can expect 83% or more downtime. Combined cycle natural gas power plants are typically down 5% of the time for maintenance. That’s why Toucan borrowed money from a local government rather than return-oriented investors.

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The five biggest renewables ETFs are beating the S&P500 but lagging the American Energy Independence Index (AEITR). The global economy is rebounding from Covid, apart from China. Relying on foreign countries for energy is suddenly riskier. Fossil-fuel inputs for almost 60% of the world’s electricity have jumped in price. All these factors should have made renewables a hot sector.

Instead, a weary realism has cooled belief in a rapid energy transition. Developing countries are looking for very large payments from the rich world to help them invest in cleaner energies. This challenges the claims of those who argue that solar and wind are already the cheapest way to generate electricity.

The International Energy Agency (IEA) forecasts 0.5% annual production growth in natural gas through 2030 in their Stated Policies Scenario (STEPS). This is the most plausible one because it doesn’t assume every government’s climate pledges will be fulfilled. In their 2022 World Energy Outlook the IEA expects unconventional gas production (ie shale, overwhelmingly US) to grow at 2% annually. They estimate 750 million people don’t have access to electricity, and 2.4 billion don’t have access to clean cooking (meaning they cook using fuelwood, charcoal, tree leaves, crop residues or animal dung). Getting these families onto natural gas would improve their lives and leave the planet better off as well.

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Bitcoin could be poised for another ascent. Bulls will be encouraged that Jim Cramer advised holders to sell following the collapse of FTX. Few readers would have been surprised when this blog first expressed crypto-skepticism in December 2017. Its return since then is 1.7% pa, substantially behind the market and, naturally, midstream energy infrastructure.

But annualized returns are too pedestrian to be the metric of choice for crypto-traders. They prefer “X”, as in “I made 3X on crypto so far this year.” For them, red is the new black.

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Bitcoin is too volatile to be a store of value. Exchanges are routinely hacked. And the government can seize it. So what’s the point of it? You don’t have to short bitcoin to be unconvinced – avoiding it is sufficient. It has always looked like a modern Dutch tulip bulb craze. Not everything that changes in value is an investment or needs to be traded. Many investors in FTX were proponents of decentralized finance (“defi”), valuing the freedom to operate outside existing regulatory structures. Now as many as a million creditors are relying on regulators and national justice systems to salvage value for them.

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The long term bull case for bitcoin sees it assuming the role of a widely-held currency, with a yield curve reflecting interest rate expectations set in the absence of a central bank. For now the US$ is not threatened with a loss of dominance. Fed funds futures project a cycle peak of just under 5%, sooner and higher than a few weeks ago. Like the FOMC, the market expects rates to begin decreasing a few months later. Fed chair Jay Powell did suggest rates could peak at a higher level than previously expected, but that was before the benign CPI number.

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Investors sometimes ask us about the exposure of pipeline companies to rising interest rates. The chart from Wells Fargo is informative and shows the preponderance of fixed rate debt across the sector. Wells Fargo estimates that a 1% increase in short term rates would reduce free cash flow by a similar percentage. With around half the industry’s EBITDA subject to inflation-linked tariffs, elevated PPI and interest rates is preferable short of causing a recession.

The COP27 is notable for more realism (see Energy Pragmatism Is Beating Extremism) and the presence of traditional energy companies. EQT is the biggest producer of natural gas in the US. Their CEO Toby Rice has been vocal in making the case for natural gas as a substitute for coal. “The most important thing is for people to see America’s largest natural gas producer here at COP27 as a symbol that we’re going to be a leader in energy transition,” said Rice on the sidelines of the conference.

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Coal power plants produced a fifth of global greenhouse gas emissions in 2021, more than any other single source, according to the International Energy Agency. China consumes half the world’s coal. Their representatives at COP27 offered the novel argument that Russia’s invasion of Ukraine justifies this. China is building coal burning power plants roughly equal to what the US has operating, but this is apparently to improve energy security and does not represent a shift in emissions policies. Do residents of California or Germany, where expensive electricity comes with high renewables penetration, grasp this? Should we believe it?

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The White House has been frustrated that US E&P companies haven’t responded to higher prices by increasing drilling. Few are surprised given the hostile posture the Administration has towards the energy industry. It’s imperceptible on the chart but Drilled Uncompleted wells (“DUCs”) increased for the first time in over two years. The steady decline in DUCs has long frustrated Joe Biden, who has excoriated companies for not producing more oil in between promising no more fracking.

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Meanwhile, natural gas production continues to move higher. The US Energy Information Administration noted that natural gas is providing 38% of US electricity, up from 37% last year. In recent months the power sector has taken record amounts, consuming about a third of total US output. The EIA projects a slight drop next year, although that was once their 2022 forecast as well.  Along with renewables, growth is at the expense of coal.

The industrial sector and exports of Liquefied Natural Gas (LNG) have both been growing in recent years. There’s little doubt that LNG will continue to rise, providing energy security and a cleaner alternative to coal for its buyers. Crypto investors probably regard pipelines as boring, but tangible assets have their place too.

As the world’s leaders meet in Egypt at the COP27 climate change conference, there are reasons for optimism among those who yearn for a pragmatic approach to reducing global Green House Gas emissions (GHGs).

The Economist magazine front covers over the past couple of years provide an evolving perspective from one publication that likes to think of itself as a thought leader. In 2020 clean energy was expected to remake geopolitics; the energy shock of 2021 was well underway before Russia invaded Ukraine. Notwithstanding the White House narrative, high gas and gasoline prices are not solely Putin’s doing.

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Today there’s a growing recognition that the extremist approach championed by left-wingers and the Sierra Club is an abject failure. The purist solution of having the world transition rapidly to solar and wind is being shown to be a technical and commercial impossibility. Developing nations, responsible for all the growth in global energy consumption, and thereby emissions, aspire to western living standards more than they worry about climate change.

The loss of Russian natural gas exports to the EU did not cause a dash for more windmills. Instead, Germany has snapped up all the available floating storage and regassification units available worldwide to import Liquefied Natural Gas (LNG). The construction of permanent onshore facilities with greater capacity is underway.

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The rich world’s desire for lower GHG emissions hasn’t been matched by promised cash payments to help developing nations upgrade their energy infrastructure. Since the 2015 Paris agreement OECD nations have failed every year to deliver $100BN in promised climate finance. It shouldn’t be a surprise; US politicians have rightly concluded there are few votes in writing big checks to China and India where official policy is to maintain GHG growth at least until 2030.

As Namibia’s petroleum commissioner, Maggy Shino, said, “If you are going to tell us to leave our resources in the ground, then you must be prepared to offer sufficient compensation, but I don’t think anyone has yet come out to make such an offer.”  Speaking on the sidelines of the COP27 in Egypt, Saudi Arabia’s energy minister Prince Abdulaziz bin Salman said: “The world is hoping to crucify us.

Reliable energy is well represented at this year’s conference, with a record 636 lobbyists registered to attend. This is a positive development, because the industry best positioned to help guide the energy transition is the one that provides 80% of the world’s energy today. Nowadays, The Economist talks of adapting to climate change as much as mitigation. An increasingly pragmatic assessment will lead to increased use of natural gas at the expense of coal, the dominant fuel for many poorer countries because it’s easily burned for power generation. Growth in demand to support rising living standards also means that coal plants in developing countries are younger and have a longer remaining useful life.

3Q22 earnings for pipelines included strong natural gas results. Last week, TC Energy’s natural gas segment was largely responsible for their beating expectations. They raised full year EBITDA guidance to C$9.76BN. Although the midstream sector’s footprint is almost entirely in US and Canada, TC Energy has partnered with Mexico’s Comisión Federal de Electricidad to build the $4.5BN Southeast Gateway pipeline along the Gulf of Mexico coastline. It will move 1.3 Billion Cubic Feet per Day, helping increase Mexico’s use of natural gas.

Mexico also has ambitious plans to become an export hub for LNG, the supply for which will be US since Mexico produces almost no natural gas of its own. Six of eight proposed export terminals are located on Mexico’s Pacific coast where they would offer sharply reduced travel time to Asia compared with Cheniere’s terminals in Louisiana and Texas. Opposition to proposed LNG export terminals in California and Oregon spurred renewed interest in Mexico. Pembina dropped plans to build Jordan Cove in Oregon following local opposition.

The two-day market rally following Thursday’s better than expected CPI report took the S&P500 6.5% higher. Equity buyers eagerly await anything that suggests the Fed may moderate its tightening cycle. FOMC members were quick to welcome the news, showing that they also would like the data to allow a policy shift.

However, inflation remains a long way from the Fed’s target. The most recent Employment Cost Index is increasing at a 5% annualized rate. Persuading workers to accept 2% raises is critical to getting inflation back to that level, although this means millions of people accepting a drop in real living standards. The pipeline sector may offer a way to protect against inflation that remains stubbornly high.

Recent 3Q22 earnings reports for pipeline companies have been confirming the predictable nature of their business models. Dividend hikes have been common. Growth capex generally remains cautious.

Cheniere’s $2.8BN in EBITDA was close to consensus, and they reaffirmed their full year 2022 guidance of $11.25BN having revised it higher three times this year. They paid down $1.3BN in debt. The Stage 3 expansion of the Corpus Christi LNG export facility is on track with first shipments expected in three years. Eventually more US natural gas will be available to buyers in Europe and Asia, but construction takes longer than popularly believed.

Cheniere also noted that Asian buyers continue to negotiate 20-year contracts while European buyers are not. Countries like Germany are relying on being able to buy what they need in the spot market to avoid long term commitments and maintain their goal of reducing fossil fuel use. It’s another example of the EU pursuing green ambitions while developing countries prioritize growth, which relies on increased energy consumption.

Morgan Stanley believes Cheniere is on track to deliver at least $25 per share in Distributable Cash Flow within several years, a >14% yield based on the current stock price.

Williams reaffirmed their previous EBITDA guidance of $6.1-6.4BN with bias towards the upside. They’re also planning to invest in a Carbon Capture and Sequestration (CCS) facility in the Haynesville. The poorly named Inflation Reduction Act raised the 45Q tax credits for CCS, and Williams is one of several companies planning to take advantage. They raised their dividend by 3.7%.

Energy Transfer missed expectations in part because of a one-time $128MM legal expense related to a prior class action suit and 130MM hedging loss caused by difference in timing recognition between inventory and hedge instrument. Setting these two items apart, their results were in line with consensus. They are targeting Debt:EBITDA leverage of 4.0 by the end of next year – still a little higher than peers which we estimate will be around 3.5X by then. Management now expects to make a Final Investment Decision (FID) on their Lake Charles LNG export facility during 1Q23. 2022 EBITDA guidance was raised for the third time this year, now $12.8-13.0BN.

Enbridge, North America’s biggest pipeline company by market cap ($80BN), reported 3Q EBITDA of $3,758MM, 4% ahead of expectations. They raised their dividend by 3%. Enbridge has a C$17BN (US$ 12.75BN) backlog of growth projects, up from C$13BN the prior quarter. This includes C$3.6BN to expand the southern segment of their British Columbia gas pipeline system. This is a response to strong demand from LNG customers presumably in Asia. New England and California are impeding natural gas supply to their citizens, while Canada is preparing to increase exports.

Interestingly, Enbridge’s Renewable Power Generation segment reported $113MM, 32% ahead of JPMorgan’s estimate.

Enterprise Products Partners reported $2,258MM, meeting expectations, and raised their distribution 5.6%.

Plains All American reported $623MM vs expectations of $562MM. They raised their distribution by 23% and expect 10% growth going forward.

Results like these should continue to attract investors because of steady and growing cash flow generation. Meanwhile, President Biden reaffirmed that he is against any oil drilling just days after criticizing oil companies for not producing more oil. Even Democrats must agree the White House has no visible energy strategy.

The Financial Times published an interview with EQT CEO Toby Rice in which he said, “Sending US LNG to China and India is going to be the biggest decarbonizing thing we can do as a country,” Rice is promoting coal to gas switching as the most effective way to curb CO2 emissions. We believe this represents a big opportunity for US natural gas investors.

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Finally, the US Energy Information Administration (EIA) reported that capacity of Combined Cycle Gas Turbines (CCGT) will reach 24% of total US power generation by year’s end. Last year CCGT generated 32% of our electricity, ahead of coal (22%) and nuclear (19%). CCGT’s share of actual power generation is bigger than their share of capacity because solar and wind typically operate at only 20-35% of their capacity. It’s not always sunny and windy.

Around a quarter of US coal-burning power capacity is scheduled to be retired by 2029, continuing a trend that has been the main source of falling CO2 emissions over the past couple of decades.

Midstream energy infrastructure is well placed to support the continued growth in global demand for US natural gas.

Fed chair Jay Powell and the American worker do not have an alignment of interests. In his remarks, following another 0.75% rate hike, Powell said the FOMC is, “acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation.” He always says that, so as to remind that some must sacrifice their jobs due to the Fed’s pursuit of higher unemployment. This will cool the labor market, and inflation, for the rest of us.

The Fed’s inability to engineer a million or two lost jobs renders Powell’s warnings anodyne, because so far the tightening cycle hasn’t claimed any casualties. Reducing inflation requires taming wage growth. The US Employment Cost Index (ECI) for all civilian workers is increasing at 5.0%, the highest since 1984.

This is marginally below the Personal Consumption Expenditures (PCE) deflator which is increasing at 6.2%. For now, the American worker is accepting a 1% drop in real purchasing power. It probably feels worse. CPI inflation is 8.2%. PCE is a more accurate measure because its weights update dynamically, but CPI is more widely used, including for the social security cost of living adjustment which will be 8.7% next year.

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It’s unclear why anyone should accept a pay raise below inflation. Why should firefighters, teachers or indeed any worker whose annual income doesn’t include a healthy dose of variable compensation accept reduced purchasing power? Workers didn’t cause inflation. Supply disruptions due to Covid lockdowns, the excessive $1.9TN Democrat stimulus early last year and the Fed’s ponderous restoration of monetary normalcy all played a part. Action and inaction by government agencies are to blame, with reduced real living standards the result. The White House hasn’t articulated the case for restraint in pay negotiations. It’s not an easy one to make. But as long as pay raises are running at 5%, restoring the Fed’s 2% inflation target will be hard.

Powell noted that, “the labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies still very high, and wage growth elevated.” This empowers union negotiators to demand more, and they are.

For example, President Biden recently approved a 4.6% raise for Federal employees, more than two times the Fed‘s inflation target.

San Antonio is raising pay for city workers by around 7%, although some will receive raises of up to 20%.

NJ is increasing the minimum wage from $13 an hour to $14.13 (8.7%).

Teachers in many states across the country are receiving their biggest raise in decades. For example, in New Mexico base salaries are going up by 20%.

Railroad workers are threatening to strike, even though the Presidential Emergency Board, which is trying to mediate between the union and the railroad companies, recommended a 24% increase over the next two years.

Europe, as is often the case, is worse. Workers on London’s subway system (“the tube”) have scheduled a series of strikes over a 3% proposed pay raise and pension cuts. Transport For London, which oversees the city’s public transport, sent out an email one day last week that breezily reminded that there are “lots of public transport options” if you have weekend travel plans but went on to warn of “some planned strikes taking place.”

In France, demonstrators have clashed with police as they protest about inflation.

It’s easy to understand why workers left worse off by rising prices are fighting back. The US job market remains very tight. Unless you work at Twitter, it’s reasonable to expect your pay to at least keep up with the general price level. Unions are negotiating higher pay on behalf of their members. But employers are also often having to raise salaries to compete.

This is making it harder for the Fed to bring inflation back down. Unless inflation starts to fall rapidly and soon, it’s likely to strengthen the conviction of workers determined to maintain living standards.

The Fed needs job market softness now, in order to temper the trend towards higher wage increases. Jay Powell has been equivocal in his warnings, but on Wednesday he allowed that, “we may ultimately move to higher levels than we thought at the time of the September meeting.” When asked about the window for a soft landing, he said, “I would say the path has narrowed over the course of the last year.”

While it’s impossible to be confident about the rate cycle peak, continued low inflation expectations present the Fed an ever-present exit ramp. But for now, rates look set to keep rising. Friday’s strong employment report didn’t help. The dynamics of wage negotiations are adding to upside risk for rates.

New England’s largest utility, Eversource, is worried about a looming shortage of natural gas. CEO Joseph Nolan has publicly asked the White House to make plans for emergency supplies in the event of a severe cold spell this winter.

North America has abundant supplies and export volumes will grow. Europe is gearing up to increase its imports of Liquefied Natural Gas (LNG). Germany expects to begin taking deliveries at its first Floating Storage Regasification Unit (FSRU) in Lubmin by the end of the year. Britain has just officially banned Russian LNG although in practice this happened in February when Ukraine was invaded. 1.2 million tonnes of LNG (58 Billion Cubic Feet, equivalent to around 60% of US daily production) is in ships offshore Europe awaiting delivery to the few import facilities available (mostly in Spain).

Prices have slumped recently, with the US Henry Hub benchmark at $5, having briefly reached $10 during the summer. The world is not short of natural gas, although global prices remain several multiples of the US. Why is Eversource worried? Why aren’t there enough windmills in Massachusetts to plug the gap?

In 2016 Kinder Morgan abandoned its proposed North East Direct pipeline that was intended to link Boston with the enormous reserves in Pennsylvania’s Marcellus shale. Opposition from environmental extremists was led by Senators Elizabeth Warren and Bernie Sanders. Since then New England has suffered from inadequate pipeline capacity linking it to cheap, domestic reserves. Democrat opposition to reliable energy rarely confronts demand, relying instead on the misplaced conviction that solar and wind will provide cheap power along with well-paid union jobs.

As a result, in order to keep the lights on companies like Eversource have resorted to seaborne imports of LNG, the only place in America compelled to do so. Now that Europe no longer buys from Russia, there’s new competition for supplies. The Jones Act, which restricts trade between US ports to US-owned, built and crewed vessels, forces Boston to import LNG from places such as Trinidad and Tobago instead of Louisiana or Texas. In the past they’ve even bought from Russia.

Energy policies that resemble anything New Englanders have adopted should be firmly opposed by those of us who value reliable energy at a reasonable price. The virtue signaling that leaders in Massachusetts embrace has had no discernible impact on China, consumer of half the world’s coal where Green House Gas (GHG) emissions (28% of global total) remain on an upward trajectory. US GHGs have been falling for over a decade, mostly through painlessly using more natural gas (New England take note) and less coal. Should China follow through on its commitments to manage peak GHGs in 2030, masochistic energy policies in Boston will have simply enabled a later enactment of such pledges. And should developing countries’ GHGs (and therefore global) keep rising, climate extremists will have achieved nothing at great expense.

The cancellation of the PennEast pipeline last year that was supposed to bring cheap Pennsylvanian gas to New Jersey was celebrated by climate extremists and Governor Phil Murphy. It is an example of New England energy policies polluting New Jersey. It’s why people with money and limited family ties are sensibly moving south. New Jersey would be better off if the Democrats moved north.

The energy sector has benefitted from the more extreme policy prescriptions of the Democrats and the ESG movement (watch ESG is a scam). The American Energy Independence Index (AEITR) continues to make up ground on the S&P500, with their five year trailing returns now almost the same. We think circumstances continue to support outperformance of North American midstream energy infrastructure.

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Some places embrace pragmatic energy policies. Poland is building its second nuclear power plant, eventually helping replace Russian gas and reducing reliance on coal. This is a climate-friendly and sensible decision.

In the US the Tennessee Valley Authority (TVA) is planning to add 20 small modular nuclear reactors by 2050. TVA president Jeff Lyash thinks several hundred similar reactors will be needed across the US to deliver carbon-free power. Nuclear power is reliable and has a small footprint, the antithesis of solar and wind.

I have an erudite friend whose text messages send me to Dictionary.com so I can understand them. We’ll call him The Scouser, whose command of the English language belies this moniker. He recently lamented the peripeteia currently endured by English Premier League club Liverpool, who languish at midtable in a sharp reversal of fortune compared with last season. This blog is dedicated to helping inflict an overdue peripeteia on misguided climate extremists. Their policy prescriptions underpin today’s energy crisis.

A few weeks ago, my wife and I were fortunate enough to attend a wedding quite literally next door at our neighbors’ house. Freed from any concern about driving us both home safely, I was already in a mildly ebullient mood when I met Australian Stephen Turner. Now I may be promoting a stereotype and therefore betraying my absence of woke-ness, but I have yet to meet an Aussie who isn’t worth hanging out with over a couple of drinks. Call it positive profiling.

Upon meeting, we Brits comment on their lineage from 19^th century convicts dispatched to Australia’s penal colony. They immediately remind us of Australia’s persistent cricket victories over England (“the Ashes”). We both chuckle at this predictable introduction and a thoroughly enjoyable evening follows.

Stephen Turner managed to make a discussion of seaweed interesting without in any way shaking my association of Aussies with conviviality. Steve is Chair of Sea Forest, an Australian start-up founded in 2018 that aims to use seaweed to combat global warming. Efforts to reduce Global Greenhouse Gases (GHGs) generally focus on CO2.

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Solar power and windmills, electrification of the transportation sector, carbon capture and myriad other efforts are intended to reduce CO2 levels in the atmosphere. But methane (natural gas) is also a potent GHG. Per molecule, it is far more potent than CO2 over a few years, but over decades it decomposes. Scientists generally assume twenty year equivalency between the two, meaning they assume the potency of methane after two decades before converting it into CO2 equivalent.

Methane is around 11% of US GHG emissions, with CO2 the biggest at 79%. The main source of methane is from wetlands through the decay of organic waste, but it also comes from landfills and methane leaks in the handling of natural gas. The US Environmental Protection Agency estimates that over a quarter of US methane emissions come from enteric fermentation – that is to say from ruminants (mainly cows and sheep) burping and farting. The UN estimates that global livestock is responsible for 14.5% of all anthropogenic (human-based) GHG emissions.

In early 2019 we pondered the impact on GHG emissions of a worldwide phasing out of cattle – not slaughtering them but simply stopping their breeding (see The Bovine Green Dream).  We were prompted by material supporting Progressives’ “Green New Deal” which conceded that “…we aren’t sure that we’ll be able to fully get rid of farting cows…” within a decade.

Sea Forest is developing a more practical and humane solution. Asparagopsis is an edible red macroalgae, or seaweed. It is highly invasive and attaches itself to other forms of seaweed such as in the Mediterranean and other warm climates. Hawaiians eat it in fish salad.

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Asparagopsis is known to inhibit methane production in ruminants (mainly cattle and sheep). Sea Forest harvests it and produces a form (called SeaFeed) that can be given to farm animals as a feed supplement. It is native to the waters of Tasmania, where Sea Forest aims to cultivate it on a commercial scale. They have found that added in very low quantities (0.2%) it can reduce ruminant methane emissions by up to 98%.

As Sea Forest’s Steve Turner explained, “It works thanks to bioactive compounds that inhibit the enzymatic pathway producing methane at the last stage of ruminants’ digestion. When more energy is available to the animal, instead of being spent in the digestion process, it grows faster and the whole process is more efficient, e.g., less feed is needed.”

SeaFeed customer trials are ongoing with Australian beef producer AA Co, Kingston Wool whose sheep supply MJ Bale’s Tasmanian Merino wool suits and New Zealand dairy co-operative Fonterra.

MJ Bale is an Australian menswear business that promotes its “carbon-neutral fashion brand” because the sheep whose wool the company turns into clothes have processed Asparagopsis added into their feed.

It’s easy to see how this could have broad appeal. Organic food already has a strong following. Many consumers pay more for smaller vegetables because they like to eat food that wasn’t produced using man-made chemicals.

Steve told me one of their challenges is convincing farmers that SeaFeed isn’t harmful to their very valuable herds and flocks. But assuming farmers can be convinced that SeaFeed won’t kill off their assets, “climate-friendly” beef and lamb could become popular. Sea Forest estimates that at commercial scale SeaFeed would cost roughly A$1 per cow per day.

For beef cattle, they calculate that 25% of the cost of SeaFeed would be offset by the GHG tax credit if farm animals qualified (assume A$50 per tonne). More efficient conversion of nutrition into energy means 20% fewer days in the feedlot. The nutrition benefit for dairy cattle is around 11%.

The result is an inconsequential 0.2% increase in the cost of beef. So the economics don’t sound insurmountable. They estimate the total addressable market worldwide at 1 billion cattle generating methane equivalent to 3 billion metric tonnes of CO2.

Although solar panels and windmills gain most of the attention when it comes to reducing GHGs, there is far more going on than simply increasing our dependence on unreliable, intermittent power generation.

Sea Forest is another example of an innovation that may change the world. They have received numerous awards and grants in recognition of their work so far. All of us have a stake (no pun intended) in their success.

Electric Vehicle (EV) penetration in the US is slower than many other countries. Sales of EVs and hybrids reached 5% market share last year, compared with 16% in China and 17% in Europe. US auto ownership is among the highest in the world, at 875 per 1,000 people.

But relatively cheap gasoline weakens the cost competitiveness of EVs, as well as enabling Americans to average twice the annual miles as Europeans and over three times Japan.  In addition, Americans favor bigger vehicles. with light trucks and SUVs around three quarters of sales. California dominates US EV sales, with almost 40% of US-registered EVs.

Charging is an impediment to faster adoption – both access to charging stations and the time required. Oasis Microgrids is a start-up co-founded by a former colleague of mine at JPMorgan who believes they have a solution.

We have no investment in or affiliation with Oasis – it’s just interesting to see the range of initiatives that are being pursued in support of the energy transition. Here we are, as described by co-founder and CEO Michael Lawson in his own words:

Oasis Microgrids has a game changing plan to revolutionize the Electric Vehicle (EV) fast-charging model currently in place in the United States. Able to produce its own Direct Current (DC) electricity independent from the electric grid, our prototype design can power multiple DC fast charging stations, up to 300 Kilowatt Hours (kWh) each, concurrently.

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DC power is produced using natural gas, or renewable natural gas where adequate supplies are available, via patented technology. We expect California will maintain support for natural gas where it supplies industries that are hard to electrify. When combined with carbon capture, we envision our carbon neutral fast-charger offering will proliferate nationally, supporting higher EV adoption rates. Carbon credits should offset the costs of capture and sequestration.

At Oasis we believe that locally produced DC using natural gas will be a cost-effective solution to compete favorably with utility connected and renewables-based EV fast-chargers.

The outputs of the Oasis design are DC power, CO2 and almost pure distilled water.  Oasis Microgrids anticipates that a single 6.5 Megawatt Hours (mWh) facility will produce about 1,500 metric tons of CO2 for sequestration and over 140-acre feet of water, enough to supply around 75 households.

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Most EV owners state slow public charging with uneven availability as the reason their next auto purchase will not be an electric vehicle.  As we see it, the headwind against fast charging is clearly the limitation of the electrical grid. A single DC fast charging station comparable to our 300 kWh fast charger requires a 600-amp service which is radically challenging when the grid barely has enough electrical capacity to keep industry and air conditioners running right now.

California recently passed legislation that eliminates sales of internal combustion engine cars by 2035. Experts agree the state will need to at least double the current electric power supply to meet the increase in EV charging alone.  Pursuing total electrification in the residential sector will require further expansion of the electrical grid – a most costly endeavor.

Every community and lifestyle will benefit from our network of green, convenient, reliable and grid-independent DC fast charging stations.  And with our plan to include food, services and amenities in these stand-alone locations we plan to recharge you while your car is recharging too.

Fleet charging for companies with large distribution networks, including Amazon, Walmart, FedEx and the USPS, are another potential source of demand for Oasis.

We thought this presented an interesting perspective of the type of innovation that is going on in support of electrification.

To learn more, visit their website (oasismicrogrids.com)

Poland has stopped producing fertilizer. Natural gas is a key input into the production of nitrogen-based fertilizers such as urea and Urea Ammonium Nitrate (UAN). The European energy crisis has rendered their manufacture uncommercial because of high natural gas prices, which are likely to persist for at least another year or so. Poland produces 6 million tons annually. Elsewhere in eastern Europe another 3 million tons of capacity is idle. In aggregate, 20% of Europe’s fertilizer production is shut down.

That fertilizer production will still be needed. Last year Russia was the world’s biggest exporter of fertilizer, with a 15% market share. That should presumably drop with sanctions, although countries like India (#3 importer) will probably value feeding their population more highly.  The US was #5 exporter with a 5% market share.

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CF Industries has been a beneficiary of America’s comparative advantage in energy availability.

Zinc production throughout the EU has ben curtailed or stopped completely. Dutch company Nyrstar, the world’s biggest producer of zinc, has stopped output. 50% of primary aluminum production has ceased. Goldman Sachs estimates that 40% of Europe’s industry, “is at risk of permanent rationalization.”

Arcelor Mittal, Europe’s largest steelmaker, is idling blast furnaces in Germany. Alocoa has cut a third of its aluminum production in Norway. Hakle, a German makes of toilet rolls, is insolvent.

European winter storage levels of natural gas are on pace to be normal, thanks to conservation and increased shipments of Liquefied Natural Gas (LNG). But analysts warn that replenishing stocks next year will require 20% more natural gas than usual. This will present a potentially bigger challenge, since the partial supplies received from Russia in 2022 won’t be repeated in 2023.

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This is why the EU is scrambling to add LNG import capacity. Germany has leased its fifth Floating Storage and Regassification Unit (FSRU). These vessels convert LNG from the chilled form in which it’s transported back into a usable state. They can be deployed relatively quickly, but have less capacity than a land-based, permanent LNG import facility. These can take three years or more to build. Italy hopes to build one by next year, with the government bypassing the normal permitting process, provoking fierce opposition from the local community.

The approach of EU policymakers to the energy crisis continues to regard it as a brief diversion on the way to a 55% reduction in greenhouse gas emissions (versus 1990). As a result, they have been reluctant to sign the 20-year LNG supply agreements that are common in the industry. Asian buyers have not hesitated, spurred on by the recognition that they face a new competitor.

Morgan Stanley calculates that agreements totaling over 60 Million Metric Tonnes per annum (MTpa) have been signed since Russia’s invasion in February. European buyers represent just 11 MTpa of this. The Dutch gasfield in Groningen is still scheduled to close by 2024, even though analysts believe it could provide up to half the gas Russia used to supply.

European manufacturers will respond to the energy crisis by overhauling their operations to use less energy. The region’s shift to renewables will receive a further boost from improved relative pricing. But manufacturing will also leave for other parts of the world where energy is cheaper and policies more supportive.

Svein Tore Holsether, chief executive of Norwegian fertilizer giant Yara International ASA, likes the “lower energy prices or green incentives currently offered in the U.S.”

Dutch chemicals firm OCI recently announced plans to expand its ammonia plant in Texas. They plan to use “blue” hydrogen, which is derived from natural gas. They further intend to capture the CO2 emitted in the process, claiming tax credits in the recently passed Inflation Reduction Act (IRA).

No Republican voted for the IRA in either the House or Senate, where VP Kamala Harris had to vote to ensure its passage. It’s ironic that many corporations believe the 45Q tax credits for carbon capture and sequestration are enough to pursue new business initiatives. This includes several midstream companies, generally a group that votes Republican (see Earnings and Pending Legislation Good For Pipelines).

The US stands to benefit from Europe’s energy crisis. It’s likely that manufacturing will receive a boost in parts of the country that offer easy access to energy and a pro-business climate. New England, whose energy policies look decidedly European, is unlikely to be a sought-after destination. Opposition to natural gas pipelines means they regularly import LNG at global rates, now enduring further competition from new European buyers (see Incoherent Energy Policies).

But many other parts of the US including southern states are set to benefit. This should add to demand for domestic natural gas. It shows that energy policy can make a difference.

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UK Prime Minister (PM) Liz Truss has reached “in office but not in power” in record time. On September 6^th she met with Queen Elizabeth II and formally became PM. Two days later the Queen died, commencing a period of mourning that ended with the monarch’s funeral on September 19^th. Practically speaking, that’s when Liz Truss’s hold on power began. Four days later her government shocked markets by announcing £45BN ($50BN) in tax cuts funded with borrowing.

Sterling collapsed and by September 28^th the Bank of England had abandoned its balance sheet reduction (Quantitative Tightening, or QT) in order to urgently restore financial stability. In the UK bond market pension funds were dumping thirty-year gilts, driving the yield from 3.5% to (briefly) 5%. Conservative party MPs are already discussing ways to dump their new PM.

By Friday self-preservation and market turmoil had forced her to abandon most of the plan, firing her Chancellor of the Exchequer Kwasi Kwarteng for good measure. Truss will henceforth be dodging political regicide following her disastrous start. As the Economist devastatingly observed, her shelf life is about the same as a lettuce.

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UK residents are pondering how governmental ineptitude on an epic scale has raised interest rates and made foreign trips more expensive. The rest of us are wondering if it could happen here.

Pension funds and leverage are a poor combination. The solemn trust imposed on those that manage people’s retirement savings requires ensuring market volatility never interferes. Therefore, Liability Driven Investing (LDI), the proximate cause of the turmoil, is worthy of examination. Anytime you see Value at Risk (VaR) included in marketing literature aimed at pension funds, as is the case with LDI, there’s a problem lurking.

Defined Benefit (DB) pension funds are obliged to meet certain obligations in the future, often linked to salary at retirement. Defined Contribution (DC) plans (like 401Ks) are becoming increasingly common, because employers prefer shifting the investment risk to plan participants. The UK has around 5 million people covered by DB plans with assets of £1.8TN ($2TN). For comparison, the US has $16.8TN in DB plans but $13.1TN is in Federal, state or local plans, many of which are underfunded with unclear ultimate outcomes for retirees.

DB pension funds compare their assets with the Net Present Value (NPV) of their obligations to figure out if they have a surplus or deficit. Pensions are among the longest liabilities around, and their NPV is acutely sensitive to changes in the discount rate.

Because US public pension funds follow Governmental Accounting Standards Board (GASB) rather than GAAP, they calculate the NPV of their liabilities oddly, in that they use the rate of return they think they’ll earn on their assets. It creates the perverse incentive to add risky investments since they’ll generally have a higher return, which in turn depresses the NPV of their obligations (see Through the Looking Glass into Public Pension Accounting). The average assumed return on US public pension assets, and therefore the discount rate on their liabilities, is just under 7%. Even though this has been falling, it’s still wildly optimistic.

The UK government issues guidance for DB plan discount rates – currently much lower than the US at  around 2.5% depending on the specifics of the plan.

Treasury Inflation Protected Securities (TIPs) offer a return linked to inflation and are appealing to pension funds with their long liabilities. In the UK index-linked gilts are called “linkers.”

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Real yields have been falling for years, and on US government debt have at times been negative. The UK is a more extreme version, presumably reflecting a relatively greater appetite of UK pension funds to immunize inflation risk compared to their US counterparts. The dearth of choices available to UK pension funds is apparent in the 1.5% coupon with which the now plunging 30 year gilts were issued just last year.

Investing at negative real yields guarantees reduced purchasing power. Falling long term rates have hurt UK pension funds by increasing the NPV of their liabilities. In theory equities, which represent a perpetual claim on company profits, ought to compensate. A 1% drop in a thirty year discount rate increases the NPV of a payment due in thirty years by 30% (ie the duration of a 30-year zero coupon bond equals its maturity). Unfortunately, you can’t rely on stocks going up by 30% at the same time.

UK pension plans sought advice on managing their exposure to falling rates, and it was helpfully provided by firms such as Russell Investments in the form of derivatives. Simply put, LDI is a derivatives contract that generates a profit for the pension fund when long term rates fall, the point being that falling rates will lead to a lower discount rate and therefore a bigger NPV of their pension obligations. LDI behaves like an investment in long term bonds, but without the need to spend cash to buy the bonds.

Derivatives contracts, like futures, require counterparties to post margin to one another depending on which side of the contract is in the money. The LDI models on which advice is based are naturally complex and proprietary. Pension funds probably relied on the assumption that losses on their LDI trades would be offset by a reduced NPV of their liabilities, and they could use pension contributions to provide additional margin if required. VaR analysis from their consultants would have provided reassurance.

Two things went wrong. One is that UK linker real yields fell to deeply unattractive levels, causing pension funds to explore risky alternatives. The second is that the new PM’s ill-considered fiscal expansion caught the market off-guard, driving yields up sharply. This in turn shredded VaR assumptions, requiring untimely sales of securities by pensions to cover margin calls on LDI losses. Derivatives create leverage. On one level this is another story of too much risk.

However, the underlying problem is low/negative real yields, and these are caused in large part by Quantitative Easing (QE). Society generally likes low borrowing costs, but every borrower has a lender and pension funds are clearly QE-losers. Central banks have been quicker to grow their balance sheets with QE than to shrink them with QT.

Ironically, the Bank of England provided updated guidance on QT on September 22, the day before Kwasi Kwarteng dropped his fiscal bomb. Six days later they were buying again to mop up the mess.

Buying bonds is now part of the central bank toolkit, and in the US it’s virtually certain that the next recession will be upon us before the Fed has shed its excess $TNs. Although real yields have moved up recently, there’s little reason to think their long term decline has ended. The problems of DB pensions haven’t been solved. But the UK does seem like a unique case of poor investment choices and an impetuous new PM.

Meanwhile the Fed is singularly focused on inflation which increases the odds they’ll make another mistake, upon which they’ll switch back to employment. QE will begin again, becoming a permanent form of debt monetization. 2% long term inflation is a poor bet. This FOMC shuns multi-tasking and fixates on one metric at a time. That will be Jay Powell’s legacy.