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Co-authored with Philip Mause
One of High Dividend Opportunities’ senior analysts worked on energy issues in Washington, D.C., for many years. He remembers attending a meeting at which one participant enthusiastically embraced electricity as the clean energy cure to all of our problems – “It is absolutely clean. You plug something into the wall and there is no smoke, no radiation, nothing at all – clean as a whistle!!!”
Of course, electricity is relatively clean at the point of end use but that is because the dirty work is done miles away in generating facilities. At the time of the comment (some 40 years ago) coal was the largest source of electric generation and it was not very clean. Thus, switching energy consumption from another source to electricity does not necessarily benefit the environment or stabilize the climate. Everything depends upon how the additional electricity is to be generated.
Since the turn of the century, the most striking change in the generation of electricity has been the transition from coal to natural gas. The table below provides (for 2000 and 2022) the total electricity generation in the United States in billions of kilowatt hours and the amounts generated by various sources. The data comes from the Energy Information Administration.
Total Coal Natural Gas Hydro Nuclear Oil Wind Solar 2000 3,802 1,906 601 275 753 111 3 0.4 2022 4,243 829 1,689 262 772 23 435 146
As noted in the above table, hydro-based energy stays about the same but it jumps around a bit from year to year based on snow and rainfall. Nuclear has been stable with little new construction and the closure of some plants offset by higher capacity factors in plants that continue in operation. Oil-based energy has declined a great deal over the years but is still used in Puerto Rico and Hawaii to a considerable extent. Wind and Solar are growing rapidly but, over this time period, they did not grow nearly fast enough to entirely displace coal. Natural gas has become the generating “fuel of last resort” and has grown rapidly to become more than twice as large as the next largest generating fuel.
At this point, it should be noted that total “kilowatt hour” (or kWh) production does not really give one a complete picture of the problem. There are two other very important considerations.
First of all, some sources of electricity generation are transitory – that is, they can not be called upon with perfect flexibility. Solar and Wind fall into this category. They can be made much more flexible with the addition of enormous storage capacity so that kWh generated at a time of low demand can be stored and utilized when demand is higher. But this storage comes at an economic cost. A second problem is siting. The U.S. does not have a “national” grid, and regional and local grids are in need of upgrading. Plants have to be sited in locations where access to a grid is available and from which the power can be shipped to demand centers without confronting troublesome “bottlenecks” in these systems.
The Impact of Electric Vehicles
Adding a massive source of demand in the form of electric vehicles will create challenges for an already challenged system. The U.S. consumes roughly 8.5 million barrels of motor gasoline per day. Using a conversion factor of 8 kWh for one gallon of gasoline (based on efficiency estimates and experience), it would require roughly 1 trillion kWh to displace all of the motor gasoline (but none of the diesel fuel) in the U.S. This calculation does not include any growth during a period in which the U.S. population and vehicle miles traveled will probably be growing. Under these conservative assumptions, the conversion to electric vehicles would involve an increase of nearly 25% in the consumption of electricity.
WSJ – April 12, 2023
In projecting where we are headed, we should also bear in mind that there has been a long-term trend in developed countries for a higher and higher percentage of all energy consumed to be in the form of electricity. We are already seeing efforts to ban natural gas heating and cooking; the replacement technologies (heat pumps and electric cooking devices) will also add to electricity consumption.
If over the next 22 years, we have the same background growth we have just had (441 billion kWh), AND we displace motor gasoline with electric vehicles (1 trillion kWh), AND we eliminate coal (829 billion kWh), – we will need 2,270 billion kWh of new generation (assuming – unrealistically – absolutely no retirement of existing facilities other than coal facilities). This will have to be strategically located and will have to be available on demand.
It is very unlikely that we will see much growth from Hydro over this time period (most of the really good hydro sites have been utilized). If Nuclear is going to contribute to a solution, we have to start designing, permitting, siting, and financing these plants at 8:00 am tomorrow morning because they take a very, very long time to complete. In order to satisfy this need, Wind and solar kWh send-out would need to nearly quadruple over this time period and enormous amounts of storage would also have to be built. Using current growth per year, solar and wind could grow by 1,700 billion kWh in 22 years, leaving a shortfall of 570 billion kWh. Even if solar and wind were able to accelerate and hit the 2,270 billion kWh target in 22 years, it would not put a dent in the current level 0f demand for natural gas as a generating fuel.
All of these problems are complicated by the need to site, get approval for, and overcome “Not in my Backyard” objections not only to generating facilities themselves but also to the massive transmission facilities that will have to be built to transport the electricity from the point of generation to the point of consumption.
The Natural Gas Solution
Natural gas has had and will continue to have some clear advantages as a solution to the electric generation problem. The NG pipeline system is pervasive and provides many locations from which NG can be withdrawn into a generating facility. Modern NG combined cycle facilities are very efficient and – although not easy to site – are easier to build and site than most other alternatives. NG facilities do not have the “transitory” issue that wind and solar present and generally do not require as large a footprint. Fracking can produce massive quantities of NG and there is always potential to import from Canada.
The position of NG in terms of global warming is complex. At the generation site, it emits considerably less carbon dioxide per kWh generated than oil or coal. On the other hand, methane leaks have the effect of emitting a very very damaging greenhouse gas into the atmosphere. The U.S. industry has taken measures to control and minimize the leaks and this must be a top priority for the industry going forward.
The reality is that as the generating source of last resort, it is almost inevitable that NG consumption for the generation of electricity will increase in the coming years. A long-term solution will have to involve research and development leading to new technologies for base load capacity which may include better nuclear or geothermal plants. But for a considerable length of time, the industry is very likely to depend heavily on NG electric generation.
Before getting into specifics, it should be noted that an entirely separate source of NG demand now comes from exports (mainly in form of NLG). Whereas 22 years ago the U.S. was a large Net Importer of NG, we are now a very large exporter with nearly 20% of domestic dry gas production going to exports (most recently, largely to Europe). For strategic reasons, we will want to be considered a reliable source of supply for Europe. Even if the Russia/Ukraine war comes to an end and the world gets back to a kind of pre-war “normal”, Europe will never want to be as dependent on Russian NG as it was in January 2021. The reality is that we will probably be able to export whatever NG we do not use domestically for the foreseeable future.
NG-oriented energy companies offer a great way to invest in this long-term trend. Because NG-producing companies can see their profits fluctuate significantly based on the commodity price, we prefer to invest in the related infrastructure companies (or midstream companies). These midstream companies transport (through their pipelines) and store NG. Their profits depend more on the volumes transported or stored, rather than the price of the commodity itself. Furthermore, it is getting very difficult to build new pipelines because of difficult regulatory approval, and therefore competition will remain low in the future for the existing pipelines. The companies that own the current pipeline and storage facilities will be the biggest beneficiaries.
NG has been an unexpected beneficiary of the green revolution. We believe that each portfolio should have exposure to NG midstream companies, as in the long run, the returns should be enormous. Furthermore, as income investors, the vast majority of these midstream companies offer big yields, often +8% of recurrent and stable income. Note that it can be tricky to identify those midstream companies that have the majority of their revenues from NG because many also transport oil, NGLs, and other products. We don’t want to be invested in midstream companies that are mainly involved in crude oil, as the demand for this commodity is projected to peak in 2025 and start to decline.
Two great Natural Gas midstream companies:
Antero Midstream (AM) provides infrastructure oriented to NG and generates a very nice yield of 8.7%. Enterprise Products Partners (EPD), yield 7.3%, is a solid owner of key infrastructure necessary for the NG industry.
At ‘High Dividend Opportunities’, we have a good exposure to NG midstream companies that help boost the overall yield of our ‘model portfolio’, which currently carries a yield of +9%. Investing in natural gas is great for both income investors and growth investors, as demand for NG is set to boom as part of a multi-year trend.
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