Vaclav Smil is often described as a polymath. His website says he does interdisciplinary research in the fields of energy, environmental and population change, food production, history of technical innovation, risk assessment, and public policy. He is Distinguished Professor Emeritus at the University of Manitoba.

I first came across his books when Bill Gates described Smil as his favorite author. His 2022 How the World Really Works: The Science Behind How We Got Here and Where We’re Going is one of his best.

.avia-image-container.av-pwo0h9-eddcca399d52eba514b64686ee41aad9 img.avia_image{ box-shadow:none; } .avia-image-container.av-pwo0h9-eddcca399d52eba514b64686ee41aad9 .av-image-caption-overlay-center{ color:#ffffff; }

Mike Cembalest is JPMorgan’s Chairman of Market and Investment Strategy for Asset Management. He’s a highly skilled investment writer via his Eye on the Market series and annual energy papers and engaged Smil as technical advisor on energy topics for years. Smil is now 80 and has a less formal role. Cembalest says, “the opportunity to learn from him is one of the highlights of my 36 years at JP Morgan.”

For my part, both continue to be a vital source of information and insight via their writing.

We spend a lot of time thinking and reading about climate change. In a recent essay, Smil provided a dispassionate assessment of the energy transition grounded in facts.

Simply put, the world has no chance of reaching the UN’s goal of eliminating CO2 emissions over the next quarter century.

In 2018 when “zero by 50” was first articulated as a goal, UN scientists concluded that emissions needed to decline by around 45% from 2010 levels by 2030. Today that means eliminating nearly 16 billion tons of CO2 over the next six years, close to what China and the US generate today. Zero by 50 requires cutting almost half of India’s emissions every year, assuming no net growth anywhere else.

Global energy demand is generally forecast to rise by 10-15% by 2050.

Emissions haven’t even peaked yet.

Zero by 50 means replacing all thermal power generation capacity (currently 4 terawatts); converting 1.5 billion combustion engines including 50 million tractors; upgrading half a billion natural gas furnaces, 120,000 merchant ships and nearly 25,000 airplanes.

Smil often reminds how long previous energy transitions have taken. Coal surpassed wood in 1900 and didn’t peak until the 1960s. Then there’s the growth in developing world economies. Wood, charcoal, straw and dried dung provide around 5% of the world’s primary energy for 3 billion people, mostly for cooking. These people aspire to use natural gas.

Over the past quarter century combusted fossil fuels have increased by over half.

Many processes can’t be easily electrified. These include cement manufacture which requires high heat; fertilizer production which is a chemical conversion of methane (natural gas) into ammonia; and aviation because battery-powered planes defy aerodynamics. Smil also points out that a transition to solar and wind power means accepting less efficiency because renewables are low density (need large amounts of space) and intermittent (it’s not always sunny and windy).

The additional materials needed for EVs, solar and windpower and the rest of the energy transition are inconceivable. Smil estimates between now and 2050 we’ll need an extra 150 millions tons of copper (seven years of current production) just for EVs and 600 million tons in total; 40X as much lithium as is currently mined and 25X as much graphite and cobalt; 5 billion tons of steel (2.5X annual output).

All these minerals and inputs will have to be mined and produced without generating any new CO2.

Smil calculates that rich countries like the US would need to dedicate 20-25% of GDP to the energy transition through 2050, a level of commitment to a cause we achieved only once before, for less than five years during World War II.

When you look carefully at history, consider politics and add the desire of most of the world’s population to improve their living standards, only one conclusion is possible.

There’s no realistic likelihood of this goal being achieved.

Scientists, politicians and climate extremists have raised awareness but failed to inspire popular support for the policies they prescribe. This is democratic. It involves a substantial economic sacrifice by people today to benefit future generations. Democracies aren’t good at that. We can’t even embrace measures to curb our looming fiscal catastrophe even though America’s soaring debt is plain to see and not subject to any scientific uncertainty. Climate change and the deficit share this common challenge – getting today’s voters to care about generations not yet born is not a winning political message.

Vaclav Smil explains why we should stop worrying about climate change and plan on dealing with the consequences.

To turn it back to investing: the desire of so many to raise living standards has to be good for US natural gas, especially once the pause on LNG exports is lifted. And as it becomes clear that the solar/wind obsession is not making much impact, more pragmatic solutions are likely. A serious effort that is success-oriented instead of aspirational includes fast-tracking nuclear power and a worldwide coal-to-gas switch, emulating America’s biggest success in reducing emissions.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

JPMorgan’s 14^th Annual Energy Paper (subtitled “Electravision”) is as always packed with data and insights. Mike Cembalest has few peers among investment writers. Two themes, the slow electrification of western economies and the challenges of Electric Vehicles (EVs) stood out.

As Cembalest has noted before, renewables are gaining market share of power generation faster than electricity is growing its share of primary energy use. Around a fifth of US electricity generation comes from solar and wind. Texas is about a quarter of US windpower (see Windpower Stumbles On Unique American Mineral Rights) and Iowa relies on wind for over half of its electricity (See Offshore Wind vs Onshore). Wind’s market share doesn’t appear to correlate with electricity prices in states, but solar does.

.avia-image-container.av-u4yp0i-7fe2568d0e515076d9ba2b39dd9ba076 img.avia_image{ box-shadow:none; } .avia-image-container.av-u4yp0i-7fe2568d0e515076d9ba2b39dd9ba076 .av-image-caption-overlay-center{ color:#ffffff; }

The growth in renewables is exposing more grids to intermittency, since it’s not always sunny and windy. Battery storage is expected to be the major solution, but so far it’s made few inroads. Pumped storage relies on using electricity when it’s cheap (ie midday solar) to move water uphill, releasing it to generate power when demand exceeds renewables supply (breakfast and dinner time). It’s low tech, and yet this still represents 70% of utility scale storage.

Therefore, existing dispatchable power (usually natural gas, sometimes coal) is being retained. Because renewables operate at much less capacity than natural gas plants (typically 25-35% vs >90%), adding 1MW of solar capacity does little to reduce the need for the traditional energy it’s supposed to replace.

The result is adding renewables means carrying ever more redundant dispatchable capacity. Regional grid operators report that new renewables lead to only 10-20% of equivalent capacity reduction of coal or gas. It’s why solar and wind aren’t as cheap as their proponents like to think (see Renewables Are Pushing US Electricity Prices Up).

It also means capacity buffers are falling. New England expects peak summer generation capacity to drop below 10% within a decade, from over 25% currently. The recent surge in data centers to support AI is putting further pressure on power supply.

We tolerate power outages which rarely last more than a few hours. We haven’t had any natural gas outages, which would occur if, for example, very cold weather interrupted production. We’ve had some near misses, including in New York on Christmas Eve morning in 2022. If gas supply was cut, technicians would need to visit every building to ensure no residual gas had leaked while the pilot light was out. Frozen water pipes would presumably be common.

Engineers estimated that restoring service to 130,000 customers could take five to seven weeks. Let’s hope none of us ever lives through that.

On Electric Vehicles (EVs), estimates of their carbon impact usually rely on a grid’s average emissions intensity based on its mix of power. But Cembalest argues that it’s the marginal source that is more important. For example, if most drivers charge their cars overnight, a grid’s heavy reliance on solar power won’t help. The grid may be relying on fossil fuels or even have to invest more in storage. Bad news for EVs is that marginal emission rates are 1.5X average ones, reducing the carbon benefits of EVs.

Cembalest recounts the sorry tale of the new owner of a Ford F-150 Lightning EV who encountered many non-working EV chargers on a trip north from the Bay area. Tesla owners still report very good experience with charging.

Hydraulic fracturing produces over half of America’s primary energy. This technique remains almost exclusively American although Argentina’s Vaca Muerta shale play is a rare foreign example. It’s hard to conceive how the US economy would look without fracking. We’d face higher energy prices, slower growth and continued reliance on foreign imports. The shale revolution has been an enormous benefit to Americans and our trade partners.

JPMorgan’s Annual Energy Paper is full of interesting facts. Europe is colder than the US, because it’s farther north. How much farther? The 44^th parallel north runs through upstate New York and across the Atlantic, passing just north of San Marino. 92% of Americans live below this line, while 82% of Europeans live above it. This is why 10% of European households have air conditioning vs 90% in the US. The increasing use of heat pumps in new European dwellings is making a/c available, since all that’s required is to run the heat pump in reverse on warm days. This will offset some of the efficiency benefits that come with heat pumps.

Mike Cembalest is in that rare category of writers whose output informs, surprises and is always worth reading.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

By Henry Hoffman, Partner, SL Advisors

In the realm of global energy, 2024 was heralded as a landmark year for the expansion of liquefied natural gas (LNG) projects, particularly for America. Optimism was buoyed by the prior year’s achievements, wherein American enterprises reached Final Investment Decision (FID) on the equivalent of 5 Billion Cubic Feet per Day (BCF/D). That’s one third of the amount of gas Europe was importing from Russia before the invasion of Ukraine! 

However, a regulatory interlude, specifically the temporary suspension of non-Free Trade Agreement (FTA) export licenses coupled with more stringent criteria for extending project in-service dates, has precipitated a recalibration of expectations. This pause has advantaged international competitors, notably with Qatar announcing a 16-MMt/y expansion. Consequently, the landscape for 2024’s FIDs is now markedly altered, favoring projects beyond American shores. 

According to the leading LNG experts at Poten & Partners, only a few domestic endeavors are still poised for progress. These include NextDecade’s (Symbol: NEXT) Rio Grande LNG Train 4, a notable candidate for a 2024 FID. Poten notes they have their DOE approvals in hand and Middle East buyers (Reuters has previously reported this is ADNOC) are in advanced discussions for offtake of 2-3 Million Tonnes per Annum (MTPA), enough to commercialize the project with TotalEnergies exercising its option for 1.5MTPA. NextDecade is targeting FID on T4 by the end of 3Q 2024.  

Nonetheless, the overarching sentiment within the industry is one of restraint, as projects that once seemed imminent now grapple with uncertain timelines. This unforeseen stasis extends beyond the U.S., affecting Mexican projects reliant on American natural gas, thereby creating a ripple effect that benefits international ventures in the UAE, Mozambique, and Papua New Guinea. 

In the intricate tapestry of global energy dynamics, the recent recalibration of the United States’ regulatory stance on non-FTA LNG export licenses has precipitated a notable shift. Asian buyers, initially on the cusp of cementing long-term procurement deals with U.S. LNG developers in the first quarter of 2024, find themselves at a crossroads, compelled to reconsider their supply strategies in light of these regulatory adjustments.  

.avia-image-container.av-2husk3-6fce623dafaa4b042b5f81c6bb4fed71 img.avia_image{ box-shadow:none; } .avia-image-container.av-2husk3-6fce623dafaa4b042b5f81c6bb4fed71 .av-image-caption-overlay-center{ color:#ffffff; }

This pivot is not merely a transient phase but a reflection of a deeper reevaluation of supply chains amidst evolving policy landscapes. Poten highlights that Energy Transfer’s (Symbol: ET) Lake Charles LNG project epitomizes the challenges and resilience within this sector. The project has faced renegotiation barriers with potential buyers due to the uncertainty surrounding its non-FTA permit extension, essential for meeting its proposed in-service deadline of December 2025.  

This situation is further exacerbated by the U.S. Department of Energy’s stringent criteria for permit extensions, adding layers of complexity to an already intricate negotiation landscape. As a result, Energy Transfer’s attempts to amend pricing structures with buyers have encountered significant headwinds, underscoring the delicate balance between regulatory compliance and market competitiveness.  

Poten notes that Japan’s Kyushu Electric has delayed converting its Heads Of Agreement (HOA) with Energy Transfer into a binding Sales and Purchase Agreement (SPA) as one example of the effects of this disastrous policy. Conversely, Tellurian’s (Symbol: TELL) plagued Driftwood project may have received a lifeline, enabling it to capitalize on the current regulatory pause that has beleaguered competitors like Energy Transfer. 

The implications of this regulatory hiatus extend beyond mere project delays. It underscores a burgeoning competition for market share in the LNG sector, with other nations benefiting from America’s masochist behavior. This political maneuver disadvantages our allies in Europe and Japan while aiding rivals in the Middle East and Russia, manifesting significant and concrete impacts.  

Fortunately, in contrast to the partisan DOE, the American spirit lives on in domestic LNG developers, who, despite the current impasse, continue to forge ahead with negotiations and project planning. 

The Magnificent Seven may be shrinking to the Fab Four as the number of AI-linked market leaders diminishes. Tesla and Apple are down on the year while Alphabet lagged the S&P500. That leaves Nvidia, Meta, Amazon and Facebook leading. As with the dotcom bubble 25 years ago, if you can link your business to the new craze your stock will soar. 

Natural gas driller EOG Resources was relying on “machine-learning” at least seven years ago to optimize their E&P operations. Devon Energy uses AI to help achieve “sustainable growth.”  

Natural gas has a stronger link to AI than the examples above. Given the substantial increase in electricity needed to power new data centers, the efficiencies promised by the AI revolution won’t be achievable without it. Executives are becoming increasingly bullish in their outlook. “It will not be done without gas,” says Toby Rice, CEO of EQT America’s biggest producer of natural gas. Growth in data centers has led to sharp upward revisions in forecast electricity demand, now 3-4% pa versus just 1% a year ago (see AI Boosts US Energy). Microsoft is opening a new data center somewhere in the world on average every three days.  

US data centers are forecast to consume a tenth of US electricity by 2035, up from an expected 4.5% next year.   

“Intermittent renewables is not going to cut it.” warns Enbridge EVP Colin Gruending. 21st century technology relying on weather-dependent seems incongruous.  

Using more electricity will limit the market share gains of renewables. The slow pace at which we’re adding high voltage transmission lines is already impeding the hook-up of new solar and wind farms (see Renewables Confront NIMBYs).  

Many IT companies have made their own carbon commitments, and some worry that they’ll insist on zero-carbon energy. This sounds prosaic for revolutionaries, and it’s likely they’ll find creative ways to meet those obligations. Natural gas generated power with carbon capture technology is one possible solution. Or companies could simply buy carbon credits, a demand Occidental Petroleum is preparing to meet (see Carbon Capture Gaining Traction).  

US natural gas remains very cheap. The Henry Hub benchmark trades at under $2 per Million BTUs. In west Texas, gas is often produced along with oil. The shortage of infrastructure to move the gas has pushed prices negative at the Waha hub, meaning buyers get paid to take it.   

The US was the world’s biggest exporter of Liquefied Natural Gas (LNG) last year, averaging 11.9 Billion Cubic Feet per Day. We eclipsed Australia and Qatar who have been vying for top slot in recent years. The world wants more of what we have in abundance. LNG exports will double over the next four years. The Biden administration’s recent pause on new LNG permits threatens to halt further growth, harming efforts to reduce CO2 emissions elsewhere (see LNG Pause Will Boost Asian Coal Consumption).  

Energy executives have roundly criticized the pause. Our aging president is desperate to excite young progressives about four more years. It’s a bad policy likely to be rescinded after the election regardless of the victor. Surging power demand from data centers may lift domestic natural gas prices without additional LNG exports.  

.avia-image-container.av-tdmwde-a6f63002de64039f2a588762edb0eb3a img.avia_image{ box-shadow:none; } .avia-image-container.av-tdmwde-a6f63002de64039f2a588762edb0eb3a .av-image-caption-overlay-center{ color:#ffffff; }

In other news there’s an absorbing interview between BBC journalist Stephen Sackur and Guyana’s President Irfaan Ali as this South American country prepares to exploit its offshore oil reserves. The Stabroek Block is a prolific region, with Exxon announcing a new discovery earlier this year (Bluefin).  

The BBC’s Sackur tried to put President Ali on the defensive over Guyana’s plans to export more fossil fuels, counter to the UN’s objective to eventually limit their use. The optics of a wealthy journalist from a rich western nation berating the leader of a poor country whose citizens aspire to higher living standards was powerful. In one interview it encapsulated the entire climate change conundrum. OECD countries have generated most of the world’s excess CO2 and want to reduce them. This will disproportionately benefit poorer countries like Guyana who are less able to afford climate change mitigation.  

And yet the president of Guyana (GDP per capita $25K) tells a reporter from the UK (GDP per capita $52K) that they’ve preserved a rainforest the size of England and Scotland combined which acts as a carbon sink. Where is the money from rich countries to pay for that, asks President Ali.  

Guyana wants to use its oil reserves to create wealth and reach western living standards. This will be an enduring problem unless OECD countries provide substantial financial incentives to induce the actions they’d like to see. 

The interview clip is the global climate conundrum.  

Indonesia and Malaysia are apparently among the few places on earth with geology suited to hold CO2. This has drawn the interest of Exxon Mobil among others, who recently secured “exclusive rights to CO2 storage” according to CEO Darren Woods. Meeting the “Zero by 50” goal requires burying 1 billion tons of CO2 annually by 2030, 25X today’s capacity.  

Schlumberger is investing as much as $500MM to buy Norway’s Aker Carbon Capture Holding. And Occidental is building the world’s biggest carbon capture facility in Texas.  

These are all examples of how the energy sector is positioning to continue providing reliable energy while also helping mitigate CO2 emissions.  

Policymakers have an ambiguous posture towards energy companies. They like to blame them for producing fossil fuels but want them to continue so that prices on 80% of the world’s energy don’t shoot up. There’s little support nor technical capability to stop using what moves the world’s economy.  

This shows up in myriad ways. A UBS banker recently complained about having to align financing decisions with a world warming by 1.5 degrees above 1850 levels. We’re already at 1.1 degrees, so almost there. Judson Berkey, group head of engagement and regulatory strategy, noted that more realistically we’re “hurtling towards a 2.8 degree warming.”  

“Banks are living and lending on planet earth, not planet NGFS,” added Berkey, referring to the Network for Greening the Financial System.  

If companies aren’t running their businesses consistent with Zero by 50, how is a bank supposed to make lending decisions under this more onerous constraint? 

JPMorgan Asset Management and several other big firms withdrew from Climate Action 100+ because they concluded their interests weren’t properly aligned. Political leaders haven’t been effective in persuading voters to accept higher energy prices to speed the transition.  

So the world follows ambiguity – not confronting China as it ramps up coal consumption; ignoring the boost to emissions to increase their living standards; pressing banks to pretend there’s no demand for traditional energy financing. Coal finance is among the most controversial areas for banks, because the world is supposed to be phasing out its use albeit with varying degrees of commitment.  

.avia-image-container.av-20peazf-a48b6e61cd482dacfe9acee7a9fa77b0 img.avia_image{ box-shadow:none; } .avia-image-container.av-20peazf-a48b6e61cd482dacfe9acee7a9fa77b0 .av-image-caption-overlay-center{ color:#ffffff; }

The US Energy Information Administration in last year’s International Energy Outlook shows 2050 coal demand flat in their Reference Case and little changed in their six other scenarios. 

By contrast, the International Energy Agency (IEA) recently published Accelerating Just Transitions for the Coal Sector. As is common nowadays, the IEA’s forecasts are aspirational and routinely show fossil fuel consumption peaking at the time of publication. There’s no IEA scenario in which coal demand rises, even though last year saw record consumption. 

.avia-image-container.av-1kmiji3-738d063bdfb7e83c88cdfeffbe63b4cd img.avia_image{ box-shadow:none; } .avia-image-container.av-1kmiji3-738d063bdfb7e83c88cdfeffbe63b4cd .av-image-caption-overlay-center{ color:#ffffff; }

Markets are looking through this. Midstream energy infrastructure, as defined by the American Energy Independence Index continued to outperform utilities. That’s because NextEra and their peers are responsible for delivering the energy transition. On one side sits the unappealing economics of renewables which push up power prices. This is in part because increased solar and wind use raises the amount of redundant capacity needed to back up weather-dependent electricity.  

.avia-image-container.av-zoamd7-0b68337566a2a448978c9008c0748ac2 img.avia_image{ box-shadow:none; } .avia-image-container.av-zoamd7-0b68337566a2a448978c9008c0748ac2 .av-image-caption-overlay-center{ color:#ffffff; }

On the other side sit political and regulatory pressure to decarbonize the grid.  

Clean energy is also a huge investment disappointment. The sector’s operating margins are often unattractive and sometimes negative.  

According to Wells Fargo, Ohm Analytics revised down their forecast of residential solar installations to –19% versus last year. Wells Fargo is at –25%. One reason is that installers are going bankrupt.  

Ohm retains a positive longer-term outlook on residential solar for two reasons that are heavy in irony: (1) rising utility bills, and (2) increasing grid instability. Data center build-out is a recently appreciated area of demand growth following decades of no growth in electricity consumption.  

Higher prices and reduced peak demand buffers are a consequence of greater reliance on renewables. As power grids operate with diminished excess capacity the risk of a power outage rises. This will play out over the next several years.  

In brief, Ohm is forecasting increasing residential spending on solar panels because increased utility spending on solar panels is raising prices and reducing the flexibility of the grid. If too many households become self-sufficient in electricity generation and unplug from the public system, the substantial fixed costs of maintaining and building distribution infrastructure will get spread across a declining set of customers.  

That’s a problem for another day.  

The energy transition is an engrossing story, but we believe the best returns will continue to come from traditional energy and midstream infrastructure which continues to allocate capital based on IRR with limited impact from ESG-type influences.  

.avia-image-container.av-jkc9zv-60cf05aa4257cb55c1de134534687c68 img.avia_image{ box-shadow:none; } .avia-image-container.av-jkc9zv-60cf05aa4257cb55c1de134534687c68 .av-image-caption-overlay-center{ color:#ffffff; }

Last week a Federal judge blocked completion of the Cardinal-Hickory Creek high-voltage transmission line. The 102-mile project linking Dubuque County, Iowa, to Dane County, Wisconsin has one mile remaining. Three environmental groups opposed its construction through a Mississippi River wildlife refuge. It’s needed to upgrade an existing transmission line built in the 1950s, add capacity, and bring new solar and wind power to Madison, WI.

Environmentalists are far from one homogeneous group. Locally, they can oppose infrastructure enabling the energy transition they support nationally. An FT video on the Cardinal-Hickory Creek website shows an environmentalist holding a feather (“I found five today”) lost by a bird unsuccessfully navigating the pylons.

Power lines are an unfortunate ugly corollary to electricity use. Because solar and wind need large spaces, their output must travel long distances to customers.  Climate extremists wishing to project a coherent view must reconcile the two. Nuclear and natural gas take up less room so can be placed nearer their customers.

The big problem with energy infrastructure isn’t the opposition from environmentalists. It’s the legal process that allows last-minute delays to projects that are almost complete.

Cardinal-Hickory Creek was first conceived in 2011. Public engagement began in 2014, authorizations were in hand by 2020 and construction began in 2021. 115 renewables projects with 17 gigawatts of capacity depend upon its completion. Nobody will build anything that can be derailed at the finish line when capital has been long committed and spent. But this is America’s process today.

.avia-image-container.av-1gfpfy0-f0f3a41551dd90d42852b16c91b4b3b3 img.avia_image{ box-shadow:none; } .avia-image-container.av-1gfpfy0-f0f3a41551dd90d42852b16c91b4b3b3 .av-image-caption-overlay-center{ color:#ffffff; }

We’re suddenly moving into a period of high demand growth for electricity following decades of flat demand. Electrification, including increased use of EVs was expected to add 1% pa to demand. Data centers are suddenly the new power hogs.

Wells Fargo estimates that AI will add 16% to US power demand by 2030. In less than a year, 1% annual demand growth has become 3%+.

For some this will increase the urgency to add even more solar and wind, although it’s hard to imagine that we could be doing any more. Therefore, it will boost natural gas demand.

Last year the Energy Information Administration (EIA) projected natural gas use in electricity generation was about to peak. The EIA produces unbiased research, unlike the International Energy Agency (IEA) whose publications are mostly fantasy appealing to climate extremists.

.avia-image-container.av-18zly8o-e352283c5693579874e58b81bc9da2d1 img.avia_image{ box-shadow:none; } .avia-image-container.av-18zly8o-e352283c5693579874e58b81bc9da2d1 .av-image-caption-overlay-center{ color:#ffffff; }

This loss of demand will be made up for elsewhere in industry and via LNG exports once the pause on new permits is lifted. But now the trajectory has changed. Wells Fargo estimates that AI will boost natural gas by 7 Billion Cubic Feet per Day (BCF/D) in order to meet just 40% of the incremental power load. Their upside case is 16 BCF/D. Last year the US produced 105.5 BCF/D from the lower 48 states.

This analysis only considers US data centers. But they’re being built all over the world. The AI revolution is global. Projected increases in electricity generation will add to global LNG demand. US natural gas prices are cheap. Chad Zamarin, a senior vice president at Williams Companies (WMB) says, “Domestic U.S. markets are oversupplied.”

Companies that produce electrical equipment should do well. Transformers are on a two year backlog. But assuming this will be good for renewables is to bet on a transformation of how infrastructure gets built.

.avia-image-container.av-poxdlk-d7e831a57a4494c62bf63b42e0659324 img.avia_image{ box-shadow:none; } .avia-image-container.av-poxdlk-d7e831a57a4494c62bf63b42e0659324 .av-image-caption-overlay-center{ color:#ffffff; }

America’s regional grids are increasing spending. But we’re adding the fewest miles of transmission in a decade. This is the morass into which investors in clean energy and utilities are jumping. Regardless of how strongly you believe in renewables and how sleepless rising sea levels make you, financing solar, wind and new power lines looks like a good way to lose money.

Morocco’s Noor Ouarzazate solar complex, operated by Saudi Arabia’s ACWA Power International, has had to shut down for most of the year because of problems at its storage unit. The facility has suffered repeated problems. A government agency called for its closure in 2020 because of high cost.

Morocco has a goal of getting renewables to half its power capacity by 2030. Their primary energy consumption is 7% renewables, with the balance from fossil fuels. Give them credit for trying. Many Moroccans would likely prefer adding cheap energy over green energy to raise living standards. Per capita energy consumption is a tenth of the US.

It seems increasingly clear that the AI revolution is going to boost natural gas consumption. Adding new pipelines is no easier than adding power lines. But pipeline operators can add small amounts of capacity at the margin. They don’t face any new competitors. Toby Rice, CEO of EQT, said, “Our pipeline infrastructure is maxed out.”

Rather than being compelled to deliver the energy transition, natural gas pipelines are positioned to compensate for the transition’s inability to deliver what politicians have promised.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Treasury bills yielding 5.3% are not the worst place to put some cash. Long term expected returns on US large cap equities are generally 5-7%. Schwab expects 6.2%. JPMorgan is at 7%. The Equity Risk Premium is the lowest it’s been in over two decades. S&P500 earnings projections for this year and next are roughly unchanged over the past three months, but stocks are +10% driven by the AI boom.

The Fed doesn’t target asset prices, but the release of the FOMC’s projection materials last week confirmed that they expect to cut rates later this year. Stocks duly rose.

.avia-image-container.av-l5512o-aa493c5d7380595b9d5231596daa9ea2 img.avia_image{ box-shadow:none; } .avia-image-container.av-l5512o-aa493c5d7380595b9d5231596daa9ea2 .av-image-caption-overlay-center{ color:#ffffff; }

The Fed is walking a precise path. FOMC forecasts for the Fed Funds rate are aligned with the market. December SOFR futures are at 4.5% versus the median blue dot at 4.6%. Policymakers can be forgiven a degree of immodesty. They have quelled inflation without causing a recession.

On the back of this success, they now plan to cut rates with inflation still above their target and the unemployment rate below their projected equilibrium. This drew criticism from Larry Summers who thinks they’re too eager to cut rates. The counter argument is that current Fed policy is restrictive, and having avoided a recession to this point they don’t want to stay too tight for too long.

The economy is doing well, and the margin for error is on the side of slower rate cuts or none this year. If the unemployment rate dropped back to 3.7% the 4.6% year-end projected Fed Funds rate would look optimistic.

With stocks historically expensive against bonds, which themselves don’t look that cheap, there shouldn’t be any great rush among investors to commit new cash to equities.

The exception is midstream energy infrastructure, which has quietly been delivering strong returns for over three years and is drawing the attention of more buyers.

Williams Companies CEO Alan Armstrong told the CERAWeek energy conference that the need for permitting reform has made building infrastructure more difficult. This has reduced competition within the midstream sector, leaving incumbents in a strong position. Climate extremists (hug one) have done this. Armstrong said Boston burns garbage, oil and coal to generate electricity rather than allow pipelines to bring in natural gas from Pennsylvania.

We agree with Armstrong that any serious effort to reduce emissions should exploit cheap natural gas to displace coal. As the world concludes that the UN IPCC “zero by 50” goal is out of reach under current policies, pragmatism will favor solutions like this.

In 2017 we wrote about Stanford University’s Tony Seba (see A Futurist’s Vision of Energy). Seba tells you what the future will look like. His presentations are engaging and his forecasts far from mainstream. This makes them exciting, by forcing the viewer to contemplate a world very different from today.

Seba’s not the only person to have made spectacularly wrong energy forecasts. Vaclav Smil is a brilliant writer on energy whose many books include How the World Really Works. Smil eschews long term forecasts, recalling a 1983 meeting of the Internation Energy Agency (IEA) where he drew some comfort because his, “was less ridiculous than that of the World Bank’s chief economist.”

In 2017, Tony Seba opened his presentation with a photo of horse-drawn carriages in New York’s 1900 Easter parade followed by a 1913 photo of Fifth Avenue with all cars and no horses. It’s great theatre and draws the audience to embrace the notion that dramatic change is all too common.

At the time of that presentation, Seba forecast that by 2030 EVs would be 100% of US auto sales and that global oil demand would be 70 Million barrels per Day (MMB/D). We’re halfway to that deadline. Today US EVs are 10% of sales if you include hybrids. Global oil demand is at a record 103 MMB/D and the IEA regularly revises its forecasts up.

Seba’s website still uses the 1913 photo labelled “Where is the horse?”

Unbowed by the improbability of the 2017 forecasts, Seba currently expects 95% of US passenger miles to be “served by on-demand autonomous electric vehicles owned by fleets, not individuals.” Never mind that the average US car is over 12 years old and that today fleet-owned autonomous cars are limited to a few experiments in places like Tempe, AZ.

Change is coming, and sometimes it’s faster than expected. Tony Seba is not short of invitations to speak at events. However, profits do not come to those following his vision.

Seven years ago, Exxon’s US EV forecast was a 10% market share by 2040, likely to be a big miss. They also forecast 115 MMB/D of global crude oil demand at that time, which is quite possible given recent trends.

Aramco CEO Amin Nasser told CERAWeek that the “current transition strategy is visibly failing” and that emissions will increasingly be determined by the “global south” (meaning the developing world including Asia). He’s right.

This energy transition will last decades as did previous ones from wood to coal to oil and gas. Futurists are fun but the incumbents are where the money is.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

The Artificial Intelligence boom means the need for vastly more computing power. This is leading to a sharp jump in data centers, with a consequent increase in projected electricity demand (see AI Boosts US Energy). Elon Musk noted the pressure this is putting on the supply of electric infrastructure. Electricity is stepped up to very high voltage for transmission before being transformed back down to the familiar 110V we use. For example, generator transformers now have a two-year waiting list.

Most regions of the US are planning for increased power demand. The PJM region attributes it all to data centers. Virginia has added 75 since 2019. Microsoft plans to use dedicated nuclear fusion plants to power its growing AI business.

Shifting to increased use of electricity is a key pillar of the energy transition, since in theory an EV run on solar or windpower generates no CO2 emissions (although its manufacture does). Utilities are at the forefront of delivering more electricity from renewables. This is part of decarbonizing our economy.

The US Energy Information Administration (EIA) published their 2023  Annual Energy Outlook (AEO) almost exactly a year ago. In it they projected a 0.7% annual increase in power consumption. By July they had concluded that their models needed an overhaul to better model hydrogen, carbon capture and other emerging technologies. So they’re skipping this year’s AEO while they do that and will return next year with the 2025 AEO.

In January last year PJM forecast 1.4% annual demand growth for electricity over the next decade. Two months ago, they raised this to 2.4% over their ten-year planning horizon. It’s safe to assume that next year’s long term outlook from the EIA will assume faster demand growth.

NextEra Energy (NEE) says it “has a plan to lead the decarbonization of America.” On their most recent earnings call, management’s enthusiasm about growth opportunities in renewables reminded me of pipeline companies 7-10 years ago during the dash for growth that was the shale revolution. There’s an unfailing confidence that growth is good. For investors that requires that projects will earn a risk-adjusted return above the company’s weighted average cost of capital.

Alot of shale revolution capital was poorly allocated. Too many projects, both upstream and midstream, failed to generate a return above their cost of capital.

The energy transition and build-out of renewables originally came with much excitement and enthusiasm. Democrat political leaders were partly to blame. Joe Biden promised cheap reliable electricity along with well-paid union jobs. Climate extremists have long misrepresented the actual cost of intermittent solar and wind power.

.avia-image-container.av-1kts11i-33d195f54eeeb42aedc9b7e5ba740106 img.avia_image{ box-shadow:none; } .avia-image-container.av-1kts11i-33d195f54eeeb42aedc9b7e5ba740106 .av-image-caption-overlay-center{ color:#ffffff; }

US electricity prices are climbing. Over the past five years they’ve increased at a 4.9% annual rate, 0.7% faster than the CPI. Renewables’ share of US power generation has been climbing for two decades and is now around 22%. It’s not a coincidence.

.avia-image-container.av-164se1y-2b0210ea37c35f290d7dea77241bc199 img.avia_image{ box-shadow:none; } .avia-image-container.av-164se1y-2b0210ea37c35f290d7dea77241bc199 .av-image-caption-overlay-center{ color:#ffffff; }

The S&P Global Clean Energy index peaked in late 2020. NEE peaked a year later. US electricity prices had long fluctuated between 13.0 and 14.5 cents per Kilowatt Hour (KwH), but around the time that inflated renewables expectation began to sag, power prices rose.

.avia-image-container.av-pbnesm-b2dbbab23a418483c2a5d133df026023 img.avia_image{ box-shadow:none; } .avia-image-container.av-pbnesm-b2dbbab23a418483c2a5d133df026023 .av-image-caption-overlay-center{ color:#ffffff; }

Fortunately we’re nowhere close to Germany, proud leader of the energy transition, where wholesale electricity is around US0.55 per KwH.

This blog is in favor of reducing CO2 emissions. As we tirelessly point out, replacing coal with natural gas remains America’s biggest success on this score. But few consumers want to pay more for energy – and who can blame them when climate extremists have long asserted with no evidence that renewables are cheaper as well as better for the planet. As a result, few expect to pay more for the energy transition.

Climate extremists have overpromised on the solution.

This puts utilities in an unenviable position. They’re at the forefront of what many believe is a vital mission to reduce greenhouse gas emissions, but investors are souring on them. NEE management conceded on their recent earnings call to be disappointed with their stock performance, which is 2.2% pa over the past five years.

The sudden growth in data centers will likely put further upward pressure on electricity prices, since for most utilities at the margin adding new capacity is likely to cost more than their current average cost. Socializing the cost of added data center demand across all their customers will be unpopular, and it will also require more traditional energy. Natural gas infrastructure will benefit, and planned coal plant retirements might be delayed. JPMorgan expects Williams Companies (WMB) could see 0.75 billion cubic feet per day of incremental throughput on their natural gas pipeline network, and projects, “the total national opportunity potentially multiples of this figure.”

Where the pipeline sector differs from utilities is that they’ll often meet incremental demand with small additions to existing capacity, usually funded organically. They don’t have the same pressure to deliver the energy transition at a cheap price.

Utility investors are learning to be less enthusiastic about capex-funded growth.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

In recent years the International Energy Agency (IEA) has moved from providing objective forecasts to championing the world’s shift away from fossil fuels. In embracing a liberal political stance they’ve lost relevance to companies and governments making investment decisions to meet future demand. For example, the IEA projects peak oil demand within the next few years, whereas OPEC sees no visible peak. The IEA’s base case for energy consumption sees annual demand growth of less than 1% even though the past decade was 1.4% pa.

One result is that the IEA often revises its near tern forecasts higher. They now see 2024 global crude oil demand at 103.2 Million Barrels per Day (MMB/D), up 1.3 MMB/D from last year. Although the IEA has raised its growth forecast by half since it was first released last year, they’re still behind others such as OPEC which expects 2.2 MMB/D of growth.

Analysts have long warned that underinvestment in new oil production would push prices higher. Russia’s invasion of Ukraine two years ago briefly took prices near $110 per barrel, but a porous sanctions regime has allowed Russian oil to find its way onto the market. However, over the past month oil futures have edged higher as traders digested the upward revisions to demand forecasts.

It’s part of a growing pattern whereby traditional energy consumption is proving more resilient than many forecasts project.

An example is Shell, which has moderated its carbon intensity targets to incorporate the sale of its retail renewable power business. Investors are rewarding companies that prioritize returns, which for companies like Shell come more reliably from oil and gas. In explaining their changed goals Shell cited, “uncertainty in the pace of change in the energy transition.”

.avia-image-container.av-12o8iae-b455cc8c74ce8287cd0928ef1d365f10 img.avia_image{ box-shadow:none; } .avia-image-container.av-12o8iae-b455cc8c74ce8287cd0928ef1d365f10 .av-image-caption-overlay-center{ color:#ffffff; }

Another area of surprising demand growth is in US power. For over a decade, electricity consumption has hovered just below 4 Trillion Kilowatt Hours. But utilities across the country are preparing for a surge over the next five years. Electric Vehicles (EVs) are only a small part of this. Indeed, Tesla is losing its stature as a growth stock with sales volumes being revised down weekly.

The increased need for US electricity is driven by data centers. Since last year, five year growth in power demand has been revised up by 80%. Virginia has added at least 75 new data centers since 2019. Most regional grids expect increased demand from data centers. California is the exception – the home of computing is a hostile place to build anything.

The Boston Consulting Group expects power demand from data centers to triple by 2030.

In a recent interview, Elon Musk said that AI computing power was increasing at a staggering 10X every six months. Obviously, this isn’t sustainable, but he described it as the fastest growth in a new technology he’s ever seen. Musk has long been optimistic about autonomous driving. He believes Tesla is very close to delivering, although he has said that often over the past several years. He expects self-driving cars using AI to allow much greater utilization of automobiles in the future. While the average car is used for ten hours per week, he expects autonomous cars to move people 50-60 hours a week as they operate like taxis.

Manufacturing is also benefiting from cheap, reliable US energy. New plants to build automobiles and batteries are adding to demand. In the past three years $481BN in new commitments for industrial and manufacturing facilities have been announced. Some of this is the beneficiary of Germany’s slow de-industrialization, caused by years of their disastrous energy policies (see Germany Pays Dearly For Failed Energy Policy).

California, where EVs are popular, expects charging them to consume up to 10% of peak power demand by 2035.

.avia-image-container.av-smue3a-025bc369547a6d524efc71a689058031 img.avia_image{ box-shadow:none; } .avia-image-container.av-smue3a-025bc369547a6d524efc71a689058031 .av-image-caption-overlay-center{ color:#ffffff; }

The increased capex among utilities should give investors in that sector pause. But the consequent demand for additional natural gas will further boost utilization of pipelines.

Reducing emissions relies on electrification of activities where it results in a switch to low emission energy. However, renewables are in many cases inadequate to meet this new demand. Georgia, North Carolina, South Carolina, Tennessee and Virginia are planning to add dozens of new natural gas power plants over the next fifteen years.

A challenge to adding renewable power capacity lies in transmission lines. Because solar and wind power require large open spaces, their power must be transmitted often over long distances to population centers. Adding grid capacity is proving difficult. The legal system has been turned into a weapon by climate extremists opposed to traditional energy, but interminable lawsuits are also delaying new power infrastructure.

GridStrategies reports that the U.S. installed 1,700 miles of new high-voltage transmission per year on average in the first half of the 2010s but dropped to only 645 miles per year on average in the second half of the 2010s.

Oil and gas demand remain strong, with many companies finding them the most reliable source of investment returns in the energy sector.

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

Energy Mutual Fund

Energy ETF

Inflation Fund

Last week I saw some investors in Florida before joining my partner Henry in Puerto Rico at the national sales conference for Catalyst Funds, our mutual fund partner. The warm, sunny weather and ocean breeze stimulated much useful interaction with clients and salespeople about midstream energy infrastructure. It’s always helpful to hear firsthand the questions and concerns investors voice about what we believe is the most attractive sector in the equity markets today.

The Catalyst crowd is one that, as CEO Jerry Szilagyi said, plays hard and works hard. Like at my golf club, the average age keeps getting younger. Following each day of intensive meetings, the local nightlife was fully experienced, albeit not by your blogger whose postprandial preferences exclude casinos and value sleep over shots.

.avia-image-container.av-cfdl8c-a49db9a6a098b5015867659ed52aa853 img.avia_image{ box-shadow:none; } .avia-image-container.av-cfdl8c-a49db9a6a098b5015867659ed52aa853 .av-image-caption-overlay-center{ color:#ffffff; }

During several roundtables with groups of salespeople we were often asked how the election will impact the sector.

During his 1984 re-election campaign, then 73 year-old President Reagan quipped that he wasn’t going to make an issue out of 56-year-old Walter Mondale’s youth and inexperience. Similarly, we’re not too worried that a Trump presidency will once again decimate energy investors.

Huh?

.avia-image-container.av-33mwoxo-66e12cf42c01fac3b0efdac3e03ed68b img.avia_image{ box-shadow:none; } .avia-image-container.av-33mwoxo-66e12cf42c01fac3b0efdac3e03ed68b .av-image-caption-overlay-center{ color:#ffffff; }

Democrats don’t like traditional energy, and left-wing progressives would return us all to living standards from the 19^th century if their energy policies were followed. Therefore, it’s to their great dismay that pipelines have returned a sparkling 32.1% pa since Joe Biden won the 2020 election. Trump’s time in office was –6.2% pa.

Energy executives cheered when Trump surprised many by beating Hilary Clinton in 2016. They expected a lighter, pro-business regulatory touch. Capital flowed into the ground and hydrocarbons gushed out. The shale revolution was good for consumers but not investors as prices sagged under increased supply. Too often, capital was allocated on optimistic assumptions. And then came covid, with its short but dramatic collapse in economic activity and briefly negative oil prices.

A newly elected President Biden adopted the hostile posture he promised during the campaign, immediately canceling the Keystone XL pipeline. The post-pandemic economic recovery was by then well underway, and a superficial interpretation of the pipeline sector’s performance might conclude that the Democrats have provided benign policy support allowing energy investors to profit.

Pipeline executives understand the reality is more nuanced. Democrat politicians planning to stay in office offer progressives enough to keep alive their dystopian vision of nothing but renewables while ensuring reliable energy remains fully available. Capital expenditures have remained at half the levels of five years ago partly because companies are more focused on returns versus growth. But they’re also wary about making long-term capital commitments that future policy changes may render unprofitable.

Climate extremists have helped create the present cautious attitude towards capital allocation. Hug one and drive them to their next protest.

Trump wasn’t bad for energy any more than Biden has been good. Presidents have less influence over the sector than is sometimes believed. We think midstream energy infrastructure is attractive regardless of who wins in November.

.avia-image-container.av-2crfaws-83b690959f4d76c9db38f15672ac282a img.avia_image{ box-shadow:none; } .avia-image-container.av-2crfaws-83b690959f4d76c9db38f15672ac282a .av-image-caption-overlay-center{ color:#ffffff; }

We were asked about the pause on approving new LNG export terminals. US export capacity is set to double over the next four years. The permit pause only affects projects beyond that, where construction hasn’t yet begun. See Struggling To Justify The Pause and LNG Pause Will Boost Asian Coal Consumption. The pause is poor policy and will likely be lifted after the election regardless of who wins. It does remind that Democrat energy policies are always at risk of pandering to left-wing extremists.

Sales of Electric Vehicles (EVs) have been flattening. I regularly hear from happy Tesla owners, all of whom own a second car for long journeys. I also have frequent conversations with investors and others who can’t see the point in dealing with the inconvenience of charging. This view seems to be ascendant. Some states are increasing fees on EV owners to compensate for foregone taxes on gasoline. US crude oil demand looks stable, and globally it’s still rising.

Below are some of the slides we use to highlight the attractive positioning of pipelines today. Dividend yields of around 6% are growing, with buybacks further augmenting the total return of cash to shareholders. While midstream capex is constrained, among utilities it’s being boosted. The energy transition must be paid for, and delivering increased electricity from renewables is their job. It’s not easy to reconcile political promises that solar and wind are cheap with the immutable reality of miserable returns on clean energy.

.avia-image-container.av-njtqpo-8f567ef0daea9af14132caf0653b46d9 img.avia_image{ box-shadow:none; } .avia-image-container.av-njtqpo-8f567ef0daea9af14132caf0653b46d9 .av-image-caption-overlay-center{ color:#ffffff; }

.avia-image-container.av-1p1u4ws-08f07015a6eb6a91123c863a2321b0cc img.avia_image{ box-shadow:none; } .avia-image-container.av-1p1u4ws-08f07015a6eb6a91123c863a2321b0cc .av-image-caption-overlay-center{ color:#ffffff; }

.avia-image-container.av-11ekk64-e1d02d77d1e42eb5e78bfd669085816c img.avia_image{ box-shadow:none; } .avia-image-container.av-11ekk64-e1d02d77d1e42eb5e78bfd669085816c .av-image-caption-overlay-center{ color:#ffffff; }

Energy returns have been the best of all eleven S&P sectors since 2021. Yet the sector still looks cheap, midstream especially so. Many investors already agree.

.avia-image-container.av-otdeho-9cf85c3c1fa31f5c40cc4132ebb230f4 img.avia_image{ box-shadow:none; } .avia-image-container.av-otdeho-9cf85c3c1fa31f5c40cc4132ebb230f4 .av-image-caption-overlay-center{ color:#ffffff; }

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

Energy Mutual Fund

Energy ETF

Inflation Fund