It looks like a big margin call started in Japan. The Japanese Yen has become a funding currency in recent years, a source of cheap financing with the proceeds reinvested in better returning assets – such as US$ listed AI stocks. Debtors benefit when the currency in which they’ve borrowed depreciates. The Yen offered low borrowing costs and a lower value – until it didn’t.

The proximate cause of the unwinding of this carry trade was the Bank of Japan’s modest 0.15% tightening last week. Friday’s weaker than expected US unemployment report was quickly interpreted as signaling a growth scare. The subsequent Friday-Monday sell off looks far more than is warranted by the data but has nonetheless triggered calls for a 0.50% cut in September, with another by December.

Perhaps big bank economists at JPMorgan and Goldman Sachs were sufficiently shocked by the carnage that they felt compelled to align their own revised forecasts with the market drama. Or maybe they expect the Fed will feel compelled to act on the market’s sudden swing from manic to depressive.

What hasn’t received much attention is that the market was far from cheap, a state that has steadily worsened during the year.

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S&P500 earnings forecasts for this year and next have been trending sideways and are barely changed from a year ago. Stocks have risen largely on multiple expansion. The Equity Risk Premium (ERP, defined here as the S&P500 earnings yield minus the ten year treasury yield) slipped to 0.1 on July 16, when stocks made another high.

This is the lowest in over two decades, and essentially means that an investor eschewing bonds in favor of stocks with virtually no yield pick-up was fully relying on earnings growth to compensate for the increased risk.

Put another way, with forecasts of long term equity returns in the 6-8% range, riskless treasury bills yielding 5.3% look competitive.

The subsequent drop in equity prices and bond yields has improved relative value somewhat, but stocks remain historically unattractive on this measure. The great unwinding of the carry trade came, as these things usually do, at an inconvenient valuation point.

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By now long-time readers are asking themselves when your blogger will explain what this means for energy stocks, especially midstream. Those long-time readers should know that the answer will soothe any concerns they might have about retaining pipeline stocks during a tempestuous market.

Start with leverage. Pipeline stocks have been paying down debt, such that large US c-corps and MLPs have Debt:EBITDA below 3.5X, in many cases on a path to 3.0X.

Dividends are comfortably within discretionary cashflow, covered by around 2X. 2Q earnings so far have been good. Targa Resources and Plains All American both raised FY guidance. Williams reaffirmed towards the high end of their 2024 range. Oneok reported good earnings. Two weeks ago Kinder Morgan provided an encouraging update on AI-driven natural gas demand.

It’s become normal for midstream earnings to meet or gently exceed expectations, and for Cheniere to do rather better.

Over the past decade US primary energy consumption has grown at 0.6% pa. Apart from during the pandemic and subsequent rebound, year-on-year changes are 1-2% or less. Commodity prices may gyrate wildly, but volumes are remarkably stable.

The outlook for natural gas demand continues to improve. The combination of AI and increased reliance on intermittent renewables means more natural gas – both because solar and wind can’t easily provide electricity with low harmonic distortions that delicate data center kit needs – but also because as unreliable power sources infiltrate the grid, assuring 24X7 supply relies ever more on dispatchable, traditional energy. Which is gas.

The unraveling of the Yen carry trade hasn’t changed any of this. Nor has midstream been a notable beneficiary of the leveraged speculator’s buying, meaning there’s little if anything to unwind.

Over the long run stocks are far more likely than bonds to preserve purchasing power. This is especially so if inflation eventually settles closer to 3% than the Fed’s 2% target. But the ERP relative valuation suggests little need for haste in committing cash. The exception is energy, where we believe the prospects are compelling.

As a reminder of the challenges in making money from renewables, Sunpower (SPWR), once a venerated solar power company with a $9BN market cap, filed for bankruptcy. Pipeline companies keep generating cash and are benefiting from energy transition subsidies from the Inflation Reduction Act.

If you have cash ready to commit, we think now is a good time to put some of it to work in midstream.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

US natural gas is the cheapest in the world. December TTF futures on the European benchmark are $13 per Million BTUs (MMBTUs). The Asian JKM benchmark is $12.50. The US Henry Hub December futures are at $3.15. Fracking has become ever more efficient, allowing production to continue even at prices that seem ruinous.  

Range Resources (RRC), a natural gas producer in the Marcellus and Utica shales in Pennsylvania, is expected to generate net income of over $400MM this year on a realized sale price of $2.60 for its natural gas. JPMorgan forecasts $750MM next year at $3.30. A few years ago such low prices would have been thought unsustainably low.  

Cheap natural gas has been a huge boon for America. It underpins our cheap electricity, although increasing reliance on solar and wind is offsetting (see Renewables Are Pushing US Electricity Prices Up). Gas-fired power generation recently hit a new record (see Cash Returns Drive Performance).  

Gas remains our biggest source of electricity, and by displacing coal plants has been the most important contributor to falling US CO2 emissions. Cheap, reliable energy has attracted foreign investment, creating jobs while western Europe cuts emissions by de-industrializing.  

Horizontal drilling and hydraulic fracturing (“Fracking”) unlocked enormous supplies of US oil and natural gas. Kamala Harris used to be against fracking, but like Joe Biden did before, has now changed her position given the importance of swing state Pennsylvania in November. 

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How long can gas stay this cheap? Investors Leigh Goehring and Adam Rozencwajg think the turn in prices is near. Their reasons begin with declining growth in production, coinciding with some large fields having produced half of their recoverable reserves. They think the Energy Information Administration’s (EIA) production forecast of 105 Billion Cubic Feet per Day (BCF/D) next year is too optimistic.  

The demand side starts with Liquefied Natural Gas (LNG). The price gap between US and foreign markets is easily sufficient to support LNG exports – currently running at 12-13 Billion Cubic Feet per Day but soon to rise as new export terminals become operational. They see an additional 5 BCF/D within three years. Other forecasts expect a doubling by 2030.  

AI data centers’ need for power will rely substantially on natural gas. This isn’t just because it’s reliable, not dependent on sunny weather. Electricity from solar and wind includes more harmonic distortions which can be unsuitable for the sensitive hardware use by AI models. There are technologies to reduce such distortions but they add cost.  

Power demand is already increasing. The Southern Company, which supplies electricity to Virginia, reported that demand from existing data centers was up 17% in 2Q24 compared with a year earlier.  

Natural gas bulls have endured plenty of false starts in recent years, other than the spike that followed Russia’s invasion of Ukraine two years ago. But circumstances may finally be aligning to push prices higher. It looks like an appealing bet.  

Complicating this outlook is the narrowing polling gap between Trump and Harris. Betting markets still favor Trump although his lead has halved. Energy markets have been attuned to the fluctuating outlook, with the S&P Global Clean Energy index a useful barometer for the odds of a Trump victory.  

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The spread in relative performance between the American Energy Independence Index (AEITR), or traditional energy, versus renewables, peaked just before Biden withdrew from the race. Since then it’s narrowed – it’s either the Harris Honeymoon or relief that it’s no longer a duel between two old men, depending on your perspective.  

Kamala Harris is left of Biden – chosen in part to secure the votes of progressives four years ago. So she’s not obviously good for energy investors. But as with Biden, the actual effect could be nuanced. Left wing energy policies tend to focus on constraining energy supply rather than demand, with the hope that renewables will benefit. It discourages new capex as we’ve seen under Biden (hug a climate protester).  

Republican policies favor deregulation, making it easier to produce oil and gas.  

One way to think of it is that Republicans are good for domestic output while Democrats are good for prices. Crude oil is a global market and forecasting how a President Trump might affect prices means assessing policy choices towards Iran and Russia. 

But natural gas exists as regional markets, so US prices will be driven by domestic considerations. Restricting supply will be hard, but limiting demand will be harder. Owning natural gas producers, such as RRC, may be a hedge on a Harris election win. If it happens, energy investors may feel they’ll need something to cheer them up.  

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

One casualty of the shale revolution was the MLP financing model. The General Partner (GP) would typically direct its MLP to finance assets that were “dropped down” from the GP. MLP capex and M&A more than tripled from 2010 to 2015. Cash returns too often came up short of those promised, and investors lost confidence in many management teams’ ability to generate a Return On Invested Capital  (ROIC) above their Weighted Average Cost of Capital (WACC).

Stock prices fell, MLPs converted to c-corps with distribution cuts led by Kinder Morgan, and midstream capex fell by more than half. Many management teams responded with greater discipline on new spending, and cash returns on capex started to rise. In some cases the improvement was dramatic. Wells Fargo calculates that Williams Companies (WMB) generated a 20.0% ROIC over the past five years, almost double the 10.3% they earned during 2013-18 period.

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Targa Resources (TRGP) jumped from a miserable 6.2% to 20.1%. Former CEO Joe Bob Perkins used to call their capex opportunities “capital blessings”, to the frustration of sell-side analysts who didn’t feel very blessed. But the improved ROIC of recent years is behind the stock’s strong performance.

Industry capex remains well below the 2017-19 peak. The question for investors is whether a Trump victory will cause a resurgence in the optimism that led to higher spending and disappointing results.

One area where this is already happening is in more natural gas to support AI data centers. Wells Fargo estimates that WMB is investing $1.3B of capex into SESE at a 5x return, meaning when completed it’ll generate EBITDA of around $260MM annually, a 20% ROIC. Kinder Morgan (KMI) is investing $1.5BN into their SNG South System 4 expansion project at a 6X multiple (~18% ROIC). Both projects will help meet the increasing need for electricity from the AI boom.

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KMI missed expectations on earnings last week, but the stock nonetheless rose because of the SNG news. Investors looked ahead to the accretion from this and up to 5 Billion Cubic Feet per Day of growth opportunities. The irony is that KMI is among the worst allocators of capital in the sector. Wells Fargo calculates a five year trailing return of only 1.4%. The five years prior was 4.0%.

Several years ago we engaged KMI on this topic (see Kinder Morgan’s Slick Numeracy). Their chronic misallocation of capital dates back to when Kim Dang was CFO. She’s now the CEO, and when appointed last year promised to maintain “business as usual.” The stock’s positive response to AI power demand reflects a hope that Dang is a better judge of accretive projects than in the past.

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Over the past five years the market has favored companies with above average skill at deploying capital. KMI could benefit from the Targa Touch.

Proponents of windpower will be disappointed to have seen that wind output reached a 33-month low recently. Fortunately, natural gas made up the difference when hot weather boosted demand for air conditioning. Output from gas-fired power plants of 6.9 Terawatt Hours (TWhs) was, according to the Energy Information Administration “probably the most in history.”

The poor wind output is even more disappointing when you consider that we keep adding capacity. Last year wind generated 425 TWhs, down 2.1% from 2022. We have 147.5 Gigawatts of capacity which is theoretically capable of producing 1,292 TWhs annually (i.e. 147.5 X 365 X 24). So US wind operates at around 32% of capacity.

This is why it’s so misleading when progressives assert that renewables are cheap. They ignore the weather-dependent intermittency of solar and wind whose growth increases the need for excess capacity to compensate. It’s one reason why US electricity prices are rising even though the price of natural gas, which is the biggest source of power, remains low. Grids with more renewables need greater redundancy for when it’s not sunny or windy.

France gets about two thirds of its electricity from nuclear power. This is a constant reminder that carbon-free energy is available to other western governments able to design an approval process that allows predictable outcomes. Currently, constructing new nuclear exposes investors to the uncertainties of persistent legal challenges, making it hard to project IRR.

The CEO of France’s EDF recently complained about excessive subsidies for solar, which are distorting electricity markets by forcing EDF to buy solar power under the country’s complicated rules. They’re planning to add six new nuclear plants, although the recent French election has left political support unclear.

US energy policy is not perfect but has mostly avoided the distorting effects of blindly embracing renewables that is seen in many European countries.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

The International Energy Agency (IEA), which polishes its progressive credentials every time Executive director Fatih Birol speaks from his ivory tower, is forecasting fossil fuel use to peak within a decade. Down at ground level, evidence continues to mount that fossil fuel consumption will continue to grow, led by natural gas.

Williams Companies CEO Alan Armstrong sees natural gas as critical to providing the increased electricity needed for AI data centers. Although many big tech companies would prefer to rely on solar and wind, Armstrong is confident that the size of the increased demand as well as the requirement for 24X7 supply makes natural gas the obvious beneficiary.

Some planned data center operators have found utilities balking at supplying the needed electricity, and have approached Williams seeking direct supply of natural gas so they can bypass the grid.

The Pacific Northwest’s power grid has warned that within five years data centers in its region could consume 5X the power of Seattle.

Climate extremists may be surprised to learn that 60 percent of US emissions reductions have come on the back of converting coal to natural gas–fired power generation. This is the opportunity the pause in LNG permits is potentially denying other countries.

Armstrong even suggests it’s an issue of national security, since poor energy choices could leave the US struggling to keep up with others in the global AI race.

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Other energy companies agree with Armstrong. Antero Resources expects 14% pa growth in natural gas demand for US electricity generation. Kinder Morgan added a $3BN natural gas pipeline expansion which is expected in part to support increased power generation for data centers.

Texas is doubling the amount of loans it will provide for new natural gas power plants. The Lone Star state already relies on gas-fired power for nearly half of its electric needs.

The former Conservative government in the UK warned in March that, “Without gas backing up renewables, we face the genuine prospect of blackouts.”

The world is going to increase its use of all sources of energy. The US Energy Information Administration (EIA) publishes non-partisan forecasts, unlike the IEA. Calls from Conservative politicians to defund the IEA recognize that it’s strayed far from its original mission, to provide useful energy forecasts.

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Their acronyms may be confusingly similar, but their forecasts are not. The EIA sees global renewables supply growing enough to meet around half of the increase in total energy demand. Solar and wind will modestly gain market share, but because of rising living standards in emerging economies all sources will grow.

By contrast the IEA expects fossil fuel consumption to peak within the next decade. This seems especially unrealistic given upward revisions to data center power demand.

Pakistan has recently endured temperatures as high as 117 degrees F. Hundreds of people were treated for heatstroke, and dozens of deaths were attributed to it. One World Bank expert predicts temperatures will rise more in Pakistan than elsewhere in the world, possibly by as much as 9 degrees F by the 2090s. They’d like to buy more LNG which could reduce their coal consumption, but the Biden Administration’s permit pause is keeping global prices higher than they would otherwise be.

A friend in NJ told me the other day that he’d recently installed 30 solar panels on his roof and was saving around $300 per month in utility bills. He also relies on solar to recharge his Tesla. With the tax breaks he estimates the break-even is around eight years.

Another friend in California is similarly enamored of solar to recharge his EV and doesn’t miss going to the gas station. EVs are inconvenient for long journeys because of the time and effort required to recharge on the road, although my Californian friend thinks it’s silly to let such infrequent trips be a consideration.

I was surprised to learn that solar panels don’t work when conventional power from the grid is down. Avoiding the inconvenience of a power outage with your own personal solar farm would seem attractive, especially given our aging infrastructure.

Solar panels are programmed to turn off when the power’s down to prevent them from sending electricity back to the grid when workers may be repairing storm damage. If you have a battery, you can still use stored solar power when it’s cloudy and the grid is down.

For our part, we’re upgrading from an oil furnace to natural gas. This will reduce our emissions by a third. Think of it as the Conservative’s approach to fighting climate change.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Tellurian finally put its investors out of their misery, selling to Woodside for $1 per share. The 75% premium to the prior day’s close is only impressive because the stock has sunk so low to this point. Founder Charif Souki was never able to obtain financing for this LNG wannabe. In 2022 in one of his regular videos on Youtube he memorably issued a mea culpa (see What’s Next For Tellurian?) for insisting on retaining natural gas price exposure in the Sale Purchase Agreements (SPAs).

This made the business model riskier because the future cashflows from liquefaction were less certain. Potential investors balked; SPAs expired because Tellurian hadn’t started work on their Driftwood LNG terminal.

Souki is a visionary with an excessive risk appetite. At Cheniere he wanted to start a natural gas trading business, which would have introduced more earnings volatility to a company with visible, long term cashflows from liquefaction. He was eventually pushed out.

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At Tellurian the collapse in energy stocks during the pandemic resulted in a margin call on his personal, leveraged holdings in the company. Souki persuaded TELL’s board to compensate him for successfully getting the Driftwood LNG terminal started even though he hadn’t (watch Tellurian Pays For Performance in Advance).

Souki was pushed out in a repeat of his exit from Cheniere. Like Joe Biden, he stayed at it for too long.

TELL’s price drifted lower as the odds of Driftwood being completed receded. The LNG permit pause added further uncertainty.

A couple of years ago TELL was trading at $4.50. Its acquisition by Woodside more than 75% below that price reflects the low odds of Driftwood ever being financed. Woodside is betting that the LNG permit pause will be lifted, most likely by an incoming President Trump. Kamala Harris, younger and to the left of Biden, might even keep it in place if she’s elected.

The most likely outcome is that the Driftwood LNG export terminal, now in the hands of a company with the resources to finance it, will be completed. This will be a win for the climate by allowing LNG buyers to use less coal, and for our domestic energy sector.

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With all the chatter of the Trump Trade and the inflationary impact of a Republican-controlled White House and Congress, the bond market is remarkably non-plussed. For the past year, ten-year inflation expectations as derived from the TIPs market have stayed in a tight range between 2.15% and 2.5%.

The Personal Consumption Expenditures (PCE) deflator, the Fed’s preferred measure, runs around 0.25% to 0.5% lower than CPI. This is because it’s constructed using dynamic weights that reflect actual spending patterns rather than the fixed weights in the CPI.

So as a practical matter bond investors are endorsing the Fed’s desired inflation objective of 2%. Given that monetary policy allows for some asymmetry – an inflation overshoot is less problematic than an undershoot – you could even argue that bond investors think there’s little asymmetry in the outlook.

Stocks have rallied during the summer, due to indications from Fed chair Jay Powell that rate cuts are coming but also because the odds of a Trump election victory have increased. Trump’s odds of winning didn’t dip with Biden’s withdrawal over the weekend.

VP Kamala Harris is a great opportunity for Trump to run against a liberal Democrat from California. She may yet turn out to be a better campaigner than she was during the primary four years ago, when she withdrew at an early stage. Otherwise, Republicans look set to sweep both houses of Congress too.

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Container rates have been moving steadily higher this year, reaching levels last seen during the pandemic. There are signs that companies are building inventories of goods in the US, anticipating sharply higher tariffs after the election. Shipping rates from Shanghai to Los Angeles have more than quadrupled this year.

Ten year yields at 4.38%, approximately unchanged over the past month, don’t reflect the Trump Rally that is apparently driven in part by higher inflation expectations. Betting markets favor Trump over Harris by roughly a 2:1 margin. Democrats appear to be rejecting a competitive convention, thus foregoing the opportunity for a more centrist candidate to emerge.

Long term bond yields offer scant compensation for America’s fiscal outlook and there’s a good possibility of one party controlling both the White House and Congress. Therefore, shorting long term treasury notes expecting deficits and inflation to move higher looks like a good trade to this blogger.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

Press reports suggest President Biden will bow to the inevitable and withdraw from the election – the first time since Lyndon Johnson an eligible president has declined to run. Betting websites and financial markets have been pricing for a new Democrat candidate since the debate. Presidential candidate Kamala Harris is unlikely to fare much better, so whether Biden drops out as he should or defies almost the entire Democrat party, they’re in for a drubbing. It’s plausible that the Republicans could regain Congress, enabling policy shifts in several areas.  

Trump’s first term in office wasn’t good for energy investors. “Drill baby, drill” doesn’t align with capital discipline, and the pandemic completed the trifecta with over-spending and energy transition fears that had depressed returns. An observer blissfully unaware of America’s politics might infer that Democrats are good for traditional energy.  

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Although climate extremists helped induce caution among energy executives, the last four years of strong performance are more accurately viewed as the result of a switch to financial discipline and positive cashflow. The current administration’s policies have not been intentionally good for the energy sector, and recent strength in the American Energy Independence index (AEITR) is attributable to the recognition that Republicans are in the ascendancy.  

A lighter regulatory touch will boost energy sector profitability at the margin. More Federal land will be opened for drilling, although much of America’s E&P activity falls under state oversight. For example, the Marcellus shale extends into New York state, but the prohibition on fracking will remain regardless of who’s in the White House.  

The pause on new LNG export permits will be lifted, which will benefit just about everyone by eventually allowing cheaper, low emission US natural gas to displace polluting coal in developing countries. This will eventually push domestic gas prices higher but even over the next five years exports will go from 12% to maybe 22% of supply, so any effect will be small and slow to appear.  

Globally, Iran will probably face increased barriers to its oil exports. A cessation of hostilities in Ukraine will allow a resumption of Russian exports. US output may increase but shale faces the tyranny of decline curves much steeper than conventional drilling, which impedes sustained higher levels of output. Fears of lower prices from increased supply could be negated with surprisingly robust demand in emerging economies as they seek higher living standards.  

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So far the bond market hasn’t considered the outlook for inflation. Having grown up in fixed income I naturally retain the bias that bonds represent the cool-headed unemotional investors while equities are full of manic-depressives. Because markets are connected, the recent strength in energy must be attributable to a more positive regulatory environment and not the inflation protection that the sector offers.  

A Republican sweep in November will introduce asymmetric inflation risk. Neither party has shown much interest in fiscal discipline, concluding correctly that there are few votes to be gained in promising to tax more and spend less. As a debt-financed real estate developer, Trump probably appreciates the asset appreciation inflation brings as well as its erosion of the real value of debt.  

A recent interview with Business Week offered a summary of inflationary policies. These include tariffs and tax cuts including a renewal of the 2017 Tax Cuts and Jobs Act. Curbs on immigration will push wages higher. Fed chair Jay Powell can expect public pressure to cut rates as soon as the election is over, and when his term ends in May 2026 he’s unlikely to be replaced with a hawk.  

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Moderately higher inflation is the least painful solution to our fiscal outlook. Trump will like that foreign investors will figure prominently among those enduring an erosion of the real value of their holdings. He’ll blame the Fed for higher treasury bill yields (see Monetary Policy Is Increasing The Deficit).  

One thing about divided government is that gridlock constrains the ability of either party to press forward with its agenda. There’s nothing about Trumponomics that should provide comfort to the fixed income investor. The first 100 days of a Trump presidency with an aligned Congress could quickly adopt policies that are pro-growth with little regard for fiscal prudence.  

This blog offers no view on the rightness of such policies, although our personal investments are positioned for them. You take the world as you find it. Investments in real assets would seem to offer the best protection. Midstream energy infrastructure, with its barriers to entry and inflation-linked contracts, is in our opinion an inevitable beneficiary as the market outlook adjusts.  

For now inflation has receded as a concern. The disarray in the Democrat election campaign could enable policies that rekindle it. Owning US midstream energy infrastructure is, in our opinion, part of the solution.  

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

As we head into earnings season, Kinder Morgan will as usual kick off the reports from midstream energy infrastructure. The appeal of pipelines has always been their predictable earnings underpinned by long term contracts. Earnings surprises have been rare for several quarters, except for Cheniere which regularly beats to the upside.

Many investors continue to regard energy with trepidation. Uncertainty over the path of the energy transition is a major reason. A period of poor returns caused by too much capex exuberance during the shale revolution and culminating in the 2020 pandemic is another.

Ben Graham once said that in the short run the market’s a voting machine but in the long run it’s a weighing machine. Sentiment is ephemeral, and financial performance long ago overwhelmed the disfavor many felt towards midstream infrastructure.

The response to covid was excessive once the data showed that most people weren’t going to die. We needed to protect older people and those with co-morbidities. The sharp but short drop in markets reflected the realization that our economic response was more damaging than the virus itself.

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Hence the S&P500 recovered to its 2019 year-end level by June 2020. Midstream took until February 2021. But relative performance since pre-pandemic has favored the American Energy Independence Index (AEITR) over the market.

By March 2022 the AEITR had recovered so strongly that it was ahead of the S&P500 from their YE 2019 levels and it’s never looked back. Stocks have performed well over this period, and the S&P500 has been boosted by AI stocks, none of which are in the AEITR. Midstream has powered along anyway, with the added benefit of a low correlation with the market.

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During the 2022 inflation contracts that often incorporate PPI-linked price hikes drove a 21% return, 39% ahead of the S&P500. So, if you’re worried about a resurgence of inflation or a dip in AI stocks, midstream could offer useful diversification.

The inability of solar and wind to displace fossil fuels is apparent in the most recent BP Energy Outlook. Since 2000, primary energy derived from renewables has grown at a 2.5% annual rate, barely faster than natural gas, coal or hydro each at 2.3% pa. Given the low starting point of renewables and $TNs in subsidies, it shows how hard it is to displace reliable energy with something that’s intermittent, requires enormous space and consumes substantial minerals.

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This blog is in favor of sensible measures to reduce emissions. The most positive development has been the growth in natural gas. Increased output since 2000 of 57 Exajoules (EJs) is almost twice that added by renewables at 29 EJs, which have been able to meet only 15% of the increase in global energy consumption over this time. Fossil fuels have gone from providing 85% of global primary energy to 84%.

The biggest failure is the world’s inability to cut back on coal, which remains the energy of choice for developing countries. China receives misplaced praise for its investments in solar and wind but derives nearly 9X as much primary energy from coal as from renewables (89 EJs vs 10 EJs).

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Blog readers often send me interesting material. Mark Mills is a senior fellow at the Texas Public Policy Foundation and often writes about energy. Here’s a link to a concise, clear video explaining the impossibility of pursuing energy policies embraced by progressives. Thanks to Dave Bachmann from Westfield, NJ for sharing.

I also discovered Konstantin Kisin, a wonderfully articulate critic of wokeness and its chief concern, climate change. My thanks to Gene Muenchau of GHJ Financial Group in Oakdale, MN for bringing him to my attention. In his engaging style Kisin reminds that billions of people in emerging economies are going to prioritize energy to support the health of their children and higher living standards over reducing CO2 emissions. New York’s banning of natural gas in new buildings will create inconvenience without impact, because most of the world simply wants more energy.

Konstantin Kissin talks a lot of sense.

The widespread discrediting of wokeness, ESG and Diversity, Equity and Inclusion (DEI) are coinciding with more realism about the energy transition. The E in DEI promotes socialism by seeking equal outcomes instead of equal opportunities. The I is intended to exclude white males so as a practical matter is racist. This is not how America became the great country it is.

The rejection of progressive left-wing philosophies that demand guilt instead of fostering pride over humanity’s achievements and opportunities is a recognition of their negativity and inutility.

This overall shift away from the group-think of university faculties is refreshing because it is overdue. Along with the disastrous investment returns on renewable energy, it is making reliable energy and its supporting infrastructure ever more appealing to thoughtful investors.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

BP’s 2024 Annual Outlook continues to navigate carefully the political minefield that faces any big energy company in making projections about energy consumption. They’ve simplified their scenarios – in 2022 Accelerated, Net Zero and New Momentum all sounded faintly hopeful and for the first two totally unrealistic. New Momentum was the scenario intended to present the way things are currently moving, but nonetheless sounded optimistic.

BP points out that these are projections not forecasts – the subtle difference intending to persuade progressives that they are bought into the energy transition even while they’re not making money from it. BP’s market cap of £75BN ($96BN) is the lowest in two years and back to where it was 25 years ago. They’ve lagged their peers by 50-75% over the past five years. The green strategy they adopted four years ago hasn’t excited their investors.

BP’s Annual Outlook now has two scenarios: Current Trajectory and Net Zero. They’re self-explanatory – one projects what’s likely to happen on current policies and the other overlays policies consistent with the UN IPCC’s Zero by 50 goal.

They are miles apart.

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There are some interesting differences between the current path presented today versus what BP thought in 2022. US natural gas production by 2035 is now forecast to be 10% bigger than back then, at 1,168 Billion Cubic Meters (BCM), or about 113 Billion Cubic Feet per Day (BCF/D).

Global natural gas production is expected to grow, albeit less quickly, meaning the US share will grow to 25%.

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Growing Asian demand for natural gas and the disruptions to Russian exports to Europe have caused LNG demand to grow at 8X the rate of natural gas overall.

Climate change forecasts are dominated by the interplay of emerging country GDP growth versus increased energy efficiency and decarbonization. The world has never experienced a decline in energy consumption as far back as meaningful records exist. BP’s Current Trajectory scenario now sees global energy consumption peaking around 2040.

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Two years ago none of their scenarios contemplated reduced energy consumption. Even in Net Zero it was roughly flat.

Energy consumption grew at 1% pa over the past four years, slower than over the prior decade. But the pandemic was a big factor, and absent another global disruption it’s hard to envisage demand growth disappearing within the next decade or so.

Coal is one sector where optimism about its demise continues to look premature. 84% of global production is in emerging economies, and because coal reserves are so widely distributed it is mostly consumed where it’s mined. Coal-to-gas switching for power generation remains the most effective way to reduce emissions. The US is helping by growing its LNG exports, despite the Administration’s efforts to impose constraints on new permits.

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Nonetheless, the world is using more coal than ever. BP still projects consumption to decline, albeit from a higher level than a couple of years ago. Its use in developed countries is going to shrink by half over the next decade, which seems plausible. Developing countries are projected to peak within a couple of years. Two years ago BP thought the peak was happening right then. This most damaging fossil fuel consistently pushes back forecasts of its demise.

If coal use does drop it’ll be because increased natural gas production has been able to fill the gap.

Renewables growth is projected to be slower in developed countries than BP thought two years ago. Higher interest rates and the dismal investment returns on solar and wind are hurting. Across emerging economies, 2025 renewables output is now expected to be double what BP expected only two years ago, a remarkable shift. Projections for China have been revised lower, meaning their share across all developing countries will drop from around a half to 15% by 2035.

China’s energy policies still prioritize energy security over emissions reduction, a long term preparation for conflict over Taiwan. Nobody should confuse their solar and wind investments as anything but a push for energy independence, insulation from the western sanctions that will inevitably follow any conflict with their island neighbor.

The bottom line is that traditional energy is going to dominate for the foreseeable future. Fossil fuels represent 84% of primary energy as calculated by BP, and they expect this share to be 77% by 2035. A couple of years ago their projection was 70%. Natural gas is the only fossil fuel projected to grow. It will eventually be the world’s favorite source of energy.

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On my trip to Minneapolis last week, I had the opportunity to see long-time investor Scott Mundal. Scott grew up on a farm in South Dakota, and now runs his own investment business in Morris, MN. His life is a wonderful American success story illustrating what hard work and ability can achieve. We had a most enjoyable dinner.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

The White House pause on LNG permits has impacted negotiations. Poten and Partners, a research firm, estimates that Sale Purchase Agreement (SPA) volumes are –15% in 1H24 versus a year ago. It’s hard to get buyers to commit to buying LNG from a new export terminal without certainty about when it’ll be constructed.

Fortunately, last week a Federal judge lifted the pause. Appropriately, it was U.S. District Judge James Cain in Lake Charles, Louisiana, the site of Energy Transfer’s proposed LNG terminal whose planning has been impacted by the pause.  Cain said the pause was, “completely without reason or logic” and described it as, “arbitrary, capricious, and unconstitutional.”

The LNG export opportunity persists because US prices are cheap while production remains robust. Output is running at 107 Billion Cubic Feet per Day (BCF/D), but demand has grown from 95 BCF/D a year ago to 102 BCF/D now. Power consumption is the biggest driver, up from 40 BCF/D to 45 BCF/D.

AI data centers are going to consume increasing amounts of power, which will support natural gas demand. We may already be seeing this. Texas recently announced plans to double their low-interest loan program that supports the construction of natural gas power plants, from $5BN to $10BN.

Governor Abbot thinks they may need as much as 130 Gigawatts (GW) of power capacity by 2030 from all sources, versus the 85 GW they have now. Even after doubling the loan program it’s likely to be several times over-subscribed.

Texas is a good example of how growing power demand will flow through to natural gas. Texas has had good success with windpower which provided 28% of its electricity last year. Natural gas was 40%. Regardless of goals to increase the share of power provided by renewables, natural gas remains a convenient, reliable and clean resource.

Fracking has unleashed cheap, secure energy for the US. Germany is de-industrializing because of high power prices. Britain’s new Labor government is committed to becoming a “clean energy superpower” and is centralizing the approval of new wind farms to speed up construction. The US is reducing emissions with natural gas and attracting FDI because it’s cheap. No other country has adopted such a pragmatic yet self-interested energy policy, albeit one that’s the result of policies from both parties.

US natural gas prices have surprised many analysts by staying low, with the Henry Hub benchmark at around $2.50 per Million BTUs (MMBTUs). It’s cheaper elsewhere, with the basis reflecting transportation costs to the Henry Hub distribution point in Louisiana. Gas from western Canada is priced $1.80 per MMBTUs below the benchmark. Associated gas is often produced with crude oil and is unwanted but must be dealt with. Flaring has come down sharply, from 1.3% of production five years ago to 0.5% now. It’s become harder for E&P companies to obtain a flaring permit by arguing that needed infrastructure is unavailable.

The Energy Information Agency is forecasting $2.90 per MMBTUs for 2H24, up from $2.10 in 1H24.

As we head into earnings season the phrase “upside risk” is showing up in JPMorgan’s outlook. It sounds like a high class problem unless you’re a short seller. For several quarters pipeline companies have delivered results that were largely in-line with some modest surprises, except for Cheniere who consistently beats forecasts. We’ll be interested to hear from Energy Transfer (ET) whether the court-ordered lifting of the LNG pause has helped them progress with their Lake Charles project.

Williams Companies (WMB) won their legal dispute with ET over WMB’s ability to build a gas pipeline that crossed over an existing one owned by ET. It was either unsafe or anti-competitive, depending on which side was talking. With a judge having concluded the latter, WMB is suing ET for damages. Sometimes it seems that ET is involved in half the energy sector’s disputes.

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I visited Minneapolis and had the opportunity to visit long-time blog readers and pipeline investors GHJ Financial Group in Oakdale, MN with Andrew Freiberg, our regional wholesaler from Pacer Financial. It’s always a great pleasure to meet people who have been following us for a long time online. We had a most enjoyable chat, and I shall look forward to stopping by again in the future. The background for the photo was selected to show Big Ben.

In discussing EVs, I learned that charging stations are increasingly being targeted by criminal gangs. There are lots of stories of vandalism and theft of the copper that’s used. But EV owners are wealthier than average and can represent a target themselves while they’re waiting…and waiting for their cars to recharge.

The outlook for reliable energy has never looked brighter.

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

Energy Mutual Fund

Energy ETF

Real Assets Fund

93% of car trips are less than 25 miles, according to data from the Bureau of Transportation Statistics. The problem with EVs in America is with the other 7%. That’s where the range anxiety and charging infrastructure become an issue.  

According to a recent survey from McKinsey, the US has among the least satisfied EV owners, with 46% intending to switch back to an Internal Combustion Engine (ICE) with their next purchase. Only Australia, another big country with high average mileage, reports more dissatisfied EV owners at 49%.  

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It’s a failure of the EV industry that almost half their customers are unhappy with their purchase. Along with poor charging options, cost is another factor. US sales rely heavily on altruistic choices by customers who are virtue-signaling. Research has shown that blue-leaning regions are far more likely to buy EVs than red. It’s why California dominates EV registrations. This is a problem for future sales, similar to subscription churn. If half of your subscribers don’t renew, it’s hard to grow your customer base.  

Hybrid plug-in electric vehicles (HPEVs) are thought to be a good compromise. You can always rely on filling up with gas, but by keeping the battery charged you can minimize use of the conventional engine. The problem is that HPEV owners tend to not bother recharging, because (shockingly) it’s so convenient to stop by a gas station. So owners often fail to achieve the EPA mileage estimates that are advertised. 

We’re running out of buyers who are willing to pay more for faster acceleration or to show they care about climate change. Like solar and wind power, reducing greenhouse gas emissions costs more than business as usual.  

Except with EVs it could be different. Almost half of US households own two or more cars. The EV industry is selling expensive vehicles intended to replace one of the two ICEs a household owns.  

There’s a market for very cheap EVs, perhaps souped-up golf carts, for the 93% of journeys that are local and don’t rely on charging infrastructure. As a policy matter, this could induce consumers to add a car that covers most of their driving needs while keeping the ICE for longer trips. The EV would be a compliment to the ICE, rather than trying to be a substitute.  

These cheap EVs would need to be bigger than a golf cart – half of US auto sales are light trucks and minivans. But cheap EVs would compensate for the range anxiety. Even if we carpet the country with charging stations and speed them up, Americans are just not going to spend twenty minutes recharging.  

BYB’s Seagull sells in China for around $12K. They’d sell millions at that price in the US. They could, except for the tariffs imposed on them, because the White House has a flexible concern about climate change. Red state energy workers aren’t much use to this White House. Blue state auto workers may be. So the latter are protected with tariffs, at the expense of higher US GHG emissions.  

Joe Biden told everyone the energy transition will be painless. So far it’s not.  

More coherent energy policies are looking more likely since the debate. Guy Caruso served as administrator of the U.S. Energy Information Administration (EIA) from July 2002 to September 2008. In a recent WSJ op-ed he argued that US LNG exports provide energy security to our allies and lower GHG emissions by displacing coal. We’re betting that the LNG permit pause will be lifted by next year, part of a more pragmatic policy approach to climate change. 

If President Biden could struggle out of bed in time for an abbreviated day to consider the issue carefully (see Biden Tells Governors He Needs More Sleep and Less Work at Night) he would never have imposed the pause.  

Midstream continues to perform well, with the American Energy Independence Index +18.6% for the first half of the year. Wells Fargo points out that the sector’s correlation with the S&P500 has been falling and is only 0.33 in 2024 versus 0.51 over the past five years. 

Part of the reason is in the inflation protection that pipelines offer. Because tariffs are so often regulated with an inflation price escalator built in, cash flows responded positively when inflation surged in 2022. Investors have started to take note, which has underpinned performance.  

Midstream has also closed most of its valuation gap with utilities, with EV/EBITDA of 9.3X compared to utilities of 9.6X. But leverage is lower (Debt:EBITDA 3.4X vs 5.2X) and dividend yields higher (5% vs 3.8%).  

In our opinion, there remains plenty of upside. 

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

Energy Mutual Fund

Energy ETF

Real Assets Fund