SL Advisors Talks Markets Archives - Page 5 of 25

Energy Transition Profits Are Elusive

August 25, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Energy Transition Profits Are Elusive

00:00 / 00:05:24

Rivian’s R1T truck has a special storage compartment for golf clubs. Nothing else so eloquently describes the conundrum facing the auto industry. America is not an obvious market for EVs. It’s a vast place, so we drive greater distances. Gasoline is cheaper than in other developed countries. And we like big cars – two thirds of US sales are light trucks and SUVs.

Progressively tighter standards on CO2 emissions are pushing auto makers to develop EVs in order to be able to keep selling cars. Given US consumer tastes, those cars need to be big. But the golf storage capabilities of the R1T surely address a very narrow sliver of the market. I can attest that the parking lots of country clubs are devoid of light trucks. And the guys at Home Depot loading their trucks with lumber to build a deck are not contemplating how that new wedge will get them reliably up and down from off the green.

Moreover, golf clubs are generally politically conservative. Climate change is not a common topic on the tee box or in the bar afterwards.

The golfing light truck owner more worried about global warming than his short game is a niche market.

Nonetheless I know two, and like all my friends who own EVs they love them. But each also has a traditional car to complement their $60K Tesla or $100K Rivian. EV owners always have another car.

Seven years ago Ford fired then-CEO Mark Fields because the board felt he wasn’t moving the company aggressively enough into EVs. New management addressed the problem, and so now Ford is losing $BNs on EVs. They recently dropped plans to produce an EV SUV. The writedown could be as big as $1.9BN, and they expect to lose $5.5BN this year on EVs. While bigger gasoline-powered cars are more profitable to manufacture, the reverse is true with EVs. Batteries don’t scale easily. Ford has decided to slow their EV push.

A survey several years ago showed that car journeys are overwhelmingly short, with fewer than 5% over 30 miles. I’ve never run a car business, but it looks to me as if the auto industry is squandering substantial sums trying to build a car that covers 100% of trips, instead of producing one that does almost all of them. Range anxiety kicks in at much more than 30 miles, so although the survey doesn’t offer that detail, an EV can probably suffice for 97-98% of an owner’s trips.

Since all the EV owners I know have a second car, instead of aspiring to build an EV that renders the long distance back-up unnecessary, why don’t manufacturers offer very cheap EVs for local trips? Consumers could keep the gas-powered car in the garage, brought out infrequently for that 200 mile journey to see grandma. Offer souped-up golf carts. Or take advantage of China’s substantial support of its domestic battery manufacturing to import their cheap EVs instead of imposing 100% tariffs.

Developing countries are demanding $TNs in transfers to help them transition to low-emission energy systems. In a neat twist, by importing Chinese EVs they would be subsidizing our energy transition rather than the other way around. Transportation sector emissions would fall. The addressable market would extend beyond the virtue-signaling residents of blue counties, and golfing light truck owners.

Public policy doesn’t treat climate change as the existential threat policymakers claim it is. Otherwise, we would freely import Chinese EVs and solar panels. The Sierra Club would be calling for a Federal regulatory structure for nuclear power that enables a vast buildout. We’d be pushing our cheap natural gas on developing countries to displace coal.

The White House hails tighter emissions standards that will, “…create good-paying, union jobs leading the clean vehicle future.”

That’s fine but admit that the energy transition is outrageously expensive and competes with other priorities.

Ford, like the rest of the auto industry, is finding energy transition profits elusive. Tesla is the notable exception. Windpower is generating billions in losses (see Windpower Faces A Tempest) . The S&P Clean Energy Index has performed miserably over the past five years, returning 6.9% pa compared with 16.4% pa for the American Energy Independence Index.

If you want to make a small fortune investing in the energy transition, start with a big one.

Midstream energy infrastructure companies can take the tax credit opportunities created by the Inflation Reduction Act while also generating reliable cashflows from their existing business. They can selectively invest in carbon capture or hydrogen hubs where Federal largesse is sufficient to tip the economics into profitability. But there’s no existential threat to their traditional business, because energy transitions have historically taken decades. This one will too.

Many investors like us are concluding that pipeline companies are among the best ways to participate in the energy transition.

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

Energy Mutual Fund Energy ETF Real Assets Fund

Energy By The Numbers

August 21, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Energy By The Numbers

00:00 / 00:05:24

I traveled from San Diego to Portland, OR last week and enjoyed a delicious wine pairing dinner in nearby Oswego with a group of investors. Oregon is wine country, and its residents are knowledgeable about varietals and vintages. I met some people who cultivate vines as a hobby and enjoy producing enough to fill a few five gallon jugs.

Over six courses and wines we discussed investments. Although we hold US and Canadian midstream companies, energy is a global business and many of the upside opportunities come from demand growth in emerging economies.

The Energy Institute Statistical Review of World Energy, formerly published by BP, is a rich source of data on global energy production, consumption and trade. It can be helpful to understand the broad trends at work in considering the future. An enduring theme concerns the energy transition, which pits the desire of rich, mainly OECD countries to reduce emissions against the drive for higher living standards common across emerging countries.

Per capita energy consumption and GDP are highly correlated. Billions of people want to live like Americans, and who can blame them? The Energy Institute (EI) estimates that 750 million people don’t have access to electricity to light their homes, refrigerate their food or run air conditioning. 2.6 billion people rely on wood, charcoal, coal or animal waste for heating and cooking. They want better.

In June Pakistan experienced a heatwave that sent thousands of people to hospital and killed hundreds.

Naturally it was blamed on climate change, as is every extreme weather event nowadays. Poorer countries are more vulnerable to a warmer climate, and yet the rational policy choice for Pakistanis is to buy more air conditioning, meaning more energy consumption. Only 6% of their electricity comes from solar and wind. That’s the problem.

Comparing the US and China neatly captures the changes between rich and developing countries. China’s primary energy consumption passed the US in 2009, eight years after they joined the World Trade Organization, and has never looked back. China’s population is 4X the US. That reaching this milestone took so long is a testament to the penalty decades of communism imposed on its people until its leaders embraced their unique form of capitalism without democracy.

China’s per capita energy consumption remains less than half the US, which is among the world’s highest. Canada, which considers itself a leader on climate change, undercuts this claim since the typical Canadian uses 30% more energy than her American neighbor to the south. It’s because Canada is cold, with a relatively dispersed population which means more long journeys, and some energy-intensive industries such as pulp and paper along with oil and gas production.

It’s notable that China’s per capita energy consumption is now the same as the EU, with each series moving in opposite directions. The calculation is simply energy used divided by population. As OECD countries outsource manufacturing to developing ones it can flatter their emissions. But Germany is also de-industrializing as companies flee restrictive energy policies with some of the world’s highest prices.

In the trade-off between emissions reduction and GDP growth, China and the EU have opposing priorities.

China’s total Greenhouse Gas Emissions (GHGs) passed the US in 2004. Former White House Climate Czar John Kerry used to praise China’s efforts on climate change because of their enormous investments in solar and wind. These intermittent sources provide almost twice as much primary energy as in the US. But everything about China’s energy sector is huge. They burn 56% of the world’s coal, more than 11X the US.

China’s energy policies are better viewed from the standpoint of energy security rather than the energy transition. They are reducing their dependence on foreign-sourced crude oil, because when the inevitable conflict over Taiwan happens their imports will be vulnerable to western sanctions.

An area that gets too little attention is the enormous growth in US production of Natural Gas Liquids (NGLs). Think ethane (used to manufacture plastics) or propane (used for crop drying and in your outdoor gas grill, and for restaurants in places like Naples, FL that are unserved by natural gas).

US NGL output has grown at 9.5% pa over the past decade. We now produce almost half (47%) the NGLs in the world, up from 29% a decade ago. We export around 1.7 Million Barrels per Day of propane. Japan and China are the two biggest markets, together taking around 40% of exports.

None of this would have happened without fracking and the shale revolution. This in turn was made possible by privately owned mineral rights, a uniquely American concept that allows landowner and driller to negotiate, regulated and taxed by the state. It’s brought us to energy independence.

Another reason why this is a great country.

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

Energy Mutual Fund Energy ETF Real Assets Fund

Long Term Energy Investors Are Happy

August 18, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Long Term Energy Investors Are Happy

00:00 / 00:05:35

2Q midstream earnings have come in mostly at or ahead of expectations. Oneok had a strong quarter and are expected to raise full year EBITDA guidance in November. Targa Resources also beat analyst estimates and raised full year guidance. Cheniere beat expectations and once again raised full year guidance, something that is becoming a regular occurrence for them.

Evidence of the AI-driven boost to natural gas demand was evident in several reports. JPMorgan now expects data center power needs to increase natural gas demand by 4.6 Billion Cubic Feet per Day (BCF/D) by 2030.

Wells Fargo has looked closely at Enlink and believes that new pipeline capacity for Natural Gas Liquids (NGLs) coming online will allow them to negotiate substantially lower prices for shipping NGLs that their Marketing unit owns. Wells estimates that they could negotiate tariffs 50% lower than at present, adding $112MM of EBITDA (i.e. +17%) by 2028.

I spent some time last week at the annual LPL Focus Conference in San Diego. Two years ago it was held in Denver, and many attendees complained about the walk from the hotel to the convention center which passed by numerous homeless drug addicts and struck many as unsafe. There were apparently some instances of assault and robbery. Next year the conference will once again be in San Diego, and I suspect Denver will no longer be on the circuit.

The area around the San Diego marina where the conference was held is very nice, with a pleasant jogging trail. My Uber driver was a happy Tesla owner and reminded me that by 2035 no regular cars will be available for sale in California. She charges it on a regular 220V circuit every night which takes 10-12 hours. Her house is too old to accommodate higher voltage and the nearest public charging station is, oddly, 30 miles from home. This means after driving the car all day it’s unavailable to go out in the evening. Tesla drivers all seem to explain away the inconveniences they endure.

It’s always a great pleasure to catch up with long-time clients and friends. LPL is a fast-growing firm, and attendance was reported at 9,000. The conference featured several motivational presentations along with senior executives reminding advisors how important they are to the firm’s success.

Advisors on the LPL platform routinely report that they’re happy with the support and the comparative freedom they enjoy to run their businesses as they see fit. You could feel the positive energy, capped with a rousing performance by Lionel Ritchie at the Rady Shell, an outdoor theatre on the San Diego marina. The enthusiastic crowd cheered whenever the singer said the LPL name.

Advisors attending the conference left no doubt convinced that they’re partnered with the best firm in the business and believing they can continue to add clients.

Investor Ida Zhu runs a thriving business in Seattle. As an immigrant myself I always find their stories fascinating, typically full of hard work and ambition. Ida’s was no exception.

Clients of Aaron Irving from Carlsbad, NM have similarly benefitted from his early insights about the pipeline sector. Aaron lives in the Delaware Basin, part of the Permian Shale play, so knows first hand from local friends and clients how the energy business is doing.

Pipeline investors are pleased. Performance has been good for several years. The industry has adopted a parsimonious approach to capex, which is boosting cashflow. Few seem worried about the election. One might think an investor base that is heavily Republican would be dismayed by the improving polling of Kamala Harris. Some attribute it to the honeymoon – the relief that Joe Biden finally acknowledged what everyone else knew.

Others don’t think the party in power will make much difference to returns from energy, which tends to follow a cycle much longer than the four year electoral one. As we’ve noted before, returns under Biden have far exceeded those under Trump. The former is good for cashflow and the latter will make production easier. For many reasons, energy investors are more concerned with the continuation of financial discipline that has prevailed for the past five years than who’s in the White House.

This optimistic outlook is supported by the fundamentals. Data center power demand growth is no longer a forecast, but is making an impact now. Given the lead time needed to add generating capacity, typically 3-5 years according to Goldman Sachs, electricity prices are set to keep rising. Last year they rose 6.2%, outpacing inflation.

The push towards renewables is exacerbating things because solar and windpower lead to more excess capacity. Since these weather-dependent sources typically run 20-35% of the time, more dispatchable power is needed as backup. It lowers the utilization of the whole system. The oft-repeated claim that solar and wind are the cheapest form of energy is at odds with the reality of rising prices as their deployment continues.

Data center demand is also slowing the retirement of coal-burning power plants. This all supports the case for more natural gas. Cost, reliability and coal displacement are among the reasons for JPMorgan’s forecast of 4.6 BCF/D demand growth over the next six years. The outlook for infrastructure supporting reliable energy remains good.

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

Energy Mutual Fund Energy ETF Real Assets Fund

The Coming Fight Over Powering AI

August 14, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

The Coming Fight Over Powering AI

00:00 / 00:05:39

US natural gas and its related infrastructure isn’t the only beneficiary of the AI-driven boom in power demand. Utility stocks have been rising, as investors assess growing power demand will boost earnings. The S&P Utilities Index is several per cent ahead of the S&P500 this year.

Operators of data centers well understand the challenges they face in obtaining reliable electricity. This is coming at a bad time for grid operators, who are already struggling to incorporate renewable sources into their power mix. Weather-dependent solar and wind operate 20-35% of the time. This requires increased redundancy across a grid as they add more dispatchable power (mainly natural gas) to compensate for when it’s not sunny or windy.

Some data centers are lining up their own sources of electricity. One example is a campus owned by Amazon Web Services (AWS) in Pennsylvania that will buy power from Talen Energy’s Susquehanna nuclear facility. But the AWS data center will retain access to the grid, run by PJM, the regional transmission organization.

Electricity markets are complicated. Exelon and American Electric Power (AEP), who operate within PJM’s region, have filed a formal protest with the Federal Energy Regulatory Commission (FERC). They are challenging Susquehanna’s application for a non-conforming Interconnection Service Agreement (ISA).

It’s not possible to assess the merits of this protest from public documents. But the filing does offer insight into issues that are likely to become common areas of dispute among industrial customers, power providers and regulators.

The infrastructure that delivers electricity (ie power lines, transmission stations etc) represents a significant fixed cost that is shared across customers approximately according to how much electricity they use. Residential solar panels are already challenging this model – California no longer credits homes that send excess power back to the grid at the same price they pay, because the economics no longer work.

The Exelon/AEP protest suggests that Susquehanna is trying to connect to the grid without fully paying for its costs. It asks why the nuclear facility will synchronize its power with the grid while still claiming to be separate from it. Data centers need extremely stable power with minimal harmonic distortions, so perhaps there are technical reasons Susquehanna needs to be “synchronized” with the grid.

The protest goes on to note that another unit at the facility had an unplanned outage last year, but apparently “no load was dropped” suggesting that grid power made up the shortfall.

Exelon/AEP are telling FERC that Susquehanna wants to “…operate as a free rider, making use of, and receiving the benefits of, a transmission system paid for by transmission ratepayers while not sharing in the costs.”

Susquehanna retorts that the protest is stifling innovation. As the competition for reliable power intensifies, such disputes will become more common.

Meanwhile, PJM recently held an auction to provide their Regional Transmission Organization Reliability Requirement for the 2025-26 delivery year. Think of this as surge capacity to be available during a heatwave or when a substantial portion of its generating capacity is down. Unsurprisingly, solar and wind represented just 2% of the responses to the auction, since they produce power when they can, not necessarily when it’s needed. Natural gas was 48%.

PJM is estimating they’ll need 2% more surge capacity than in the prior year. The auction cleared at $269.92 per Megawatt-Day, more than 9X the prior year’s 28.92 figure. Moreover, their reserve margin shrank from 20.4% to 18.5%.

This is not good news for PJM customers. PJM attributed the price jump in part to the loss of 6.6 Gigawatts of generation capacity (mostly coal) that is retiring. Because it’s not being replaced at the same rate, there’s less power available.

The North American Electric Reliability Corporation has warned grids across the country that the energy transition as it’s currently being implemented is reducing reliability and increasing the risk of power cuts.

Solar and wind are especially useless at providing surge capacity because their operators can’t be certain how much they can produce. Natural gas was almost half because it’s “dispatchable”, meaning it can be delivered when needed. It’s another example of the inferior quality of solar and wind compared with traditional energy.

JPMorgan suggested that another reason for the price jump is that power providers are holding back, skipping the auction while they negotiate long term contracts with data centers.

The hunger for power to support AI is on a collision course with plans to decarbonize our electricity. Old forecasts of modest 1% annual demand growth driven by EVs is now turbo-charged to 5% or more. Globally, added renewables are unable to even meet the increase in primary energy consumption across developing countries. In the US the Exelon/AEP dispute with Susquehanna is only the first of many.

Energy investors will be learning more than they expected about the commercial intricacies of America’s electricity supply.

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

Energy Mutual Fund Energy ETF Real Assets Fund

Sierra Club Shoots Itself In The Foot

August 11, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Sierra Club Shoots Itself In The Foot

00:00 / 00:05:14

Once again a liberal activist judge has succumbed to a far-left climate extremist group. On Tuesday DC Circuit Chief Judge Srinivasan, along with Circuit Judges Childs and Garcia sent parts of a previously granted permit from the Federal Energy Regulatory Commission (FERC) back for review.

NextDecade’s (NEXT) Rio Grande LNG export terminal was one of the victims, although FERC was the respondent in the case. Today, obtaining any number of permits from a regulator is only the beginning of the approval process. Those permits then have to withstand legal challenges from judicial terrorists whose objective is to block infrastructure projects by increasing their cost and uncertainty of completion.

We’re invested in NextDecade because we believe providing cheap US natural gas to developing countries around the world, allowing them to grow their energy consumption with less reliance on coal, will continue to be profitable. The Sierra Club and their weird partners wrongly believe that India and other Asian countries will use more solar and wind if they can’t buy US Liquefied Natural Gas (LNG). This is not supported by the facts.

Coal is the single biggest source of primary energy for the Asia Pacific region. 83% of the world’s coal is consumed there, of which China is 56%. It provides 47% of that region’s primary energy and 54% of China’s. Coal generates on average 2X the greenhouse gas emissions as natural gas per unit of power generation and also generates harmful local pollution.

If you care about climate change, you want to reduce global coal consumption.

The Sierra Club is not pursuing policies to reduce emissions. As well as opposing natural gas to displace coal they are against nuclear. They’re obstructive to the real work and are nothing more than a bunch of virtue signaling loony leftists. They are weird.

It’s unclear how this will play out. On the same day as the court ruling which affects Trains 1-3, NEXT filed an 8-K with the SEC disclosing an agreement with Bechtel to build Train 4. The company hasn’t yet responded to the court ruling other than to say construction continues on the first phase.

NEXT has some big customers lined up to buy its LNG, including Shell and Exxon Mobil. TotalEnergies is a strategic partner, with a stake in NEXT and an agreement to buy its LNG. The ruling requires FERC to issue a revised Environmental Impact Statement (EIS), in part because the environmental justice rights of some nearby residents are at risk of being compromised. Specifically, the court found that they, “…may experience significant visual impacts, as well as significant cumulative visual impacts.”

The Rio Grande LNG terminal is being built alongside the ship channel in Brownsville, TX, so it’s this view that will be impacted. I don’t know what else you’d expect to see along the Brownsville Ship Channel other than energy infrastructure. It seems to me like buying a house near an airport and then complaining about the noise.

There’s no indication from FERC how quickly they will respond to the ruling and how long a new EIS will take.

Large holders of NEXT include York Capital Management, Blackrock and even Marc Lasry (co-founder of Avenue Capital, a distressed debt firm). Lasry is a well-known Democrat party fundraiser and has often drawn criticism from the weirdos at the Sierra Club for his investments. It’s an example of how fringe they are.

On Friday Ukrainian troops captured a key gas transit point supplying Europe as part of their incursion into Russian territory. Ukraine released a video of their troops at Gazprom’s Sudzha gas measuring station. US LNG provided vital supplies to Europe following Russia’s invasion of Ukraine. They still rely somewhat on Russia, some of which passes through Sudzha. European energy officials will have been made acutely aware of how tenuous that remaining supply is. America can be a reliable source.

Between the LNG buyers and investors there are some deep pockets who want to see the Rio Grande project through. We think that’s the most likely outcome, although the election adds some uncertainty.

New energy projects are less likely, which raises the value of existing energy infrastructure. Democrats have unwittingly been good for energy investors by discouraging investment in new supply. A President Harris probably wouldn’t be a supporter of new LNG, although she might note that swing state Pennsylvania will likely provide its throughput.

Under Kamala Harris, pipeline companies would have even less reason to boost capex, which will in turn drive up free cashflow.

Alan Armstrong, Williams CEO, has commented that they see less competition than in the past for new business. Energy Transfer and Cheniere each raised full year EBITDA guidance again when they reported earnings last week. Sierra Club policies will further strengthen their dominant market positions.

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

Energy Mutual Fund Energy ETF Real Assets Fund

Carry Traders Get Carried Out

August 7, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Carry Traders Get Carried Out

00:00 / 00:04:51

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.

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.

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

Is Natural Gas Turning?

August 4, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Is Natural Gas Turning?

00:00 / 00:05:16

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.

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.

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

Cash Returns Drive Performance

July 31, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Cash Returns Drive Performance

00:00 / 00:05:27

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.

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.

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.

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

Gas Is A Growth Business

July 28, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Gas Is A Growth Business

00:00 / 00:04:47

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.

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.

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 Drifts Into Stronger Hands

July 24, 2024/0 Comments/in Midstream Energy Infrastructure SL Advisors Talks Markets/by Simon Lack

SL Advisors Talks Markets

Tellurian Drifts Into Stronger Hands

00:00 / 00:04:42

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.

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.

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.

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