Energy stocks have begun to perform better as investors recognize that the Artificial Intelligence (AI) boom and data centers will require massive amounts of energy in the coming years. Technology stocks continue to outperform in 2024 but more stocks have joined the party, and we believe that as momentum wanes for the technology sectors, the energy sector can push higher. In fact, it is the best performer thus far in March!
WHY IS THAT?
1. The narrative is improving. Demand for energy is increasing and there is growing recognition that renewables cannot carry the load alone. The determining factor on how quickly AI will develop may very well be limited by the availability of electricity for data centers.
2. It’s become more evident that natural gas MUST be part of the solution. It is the cleanest burning of the fossil fuels, it’s relatively cheap, abundant, and reliable. (More on natural gas to follow).
3. Traditional energy companies are no longer the bad guys. The energy transition is taking longer (and will take longer) than clean energy proponents realize. Consequently, the world will continue to rely on fossil fuels for decades to meet growing energy demand from population growth, economic growth, AI dedicated data centers, and from pulling undeveloped countries out of energy poverty.
Reality check: Energy companies are not just investing in fossil fuels. They are making significant progress in reducing their greenhouse gas emissions, (including methane), and investing in new clean energy technologies such as carbon sequestration, hydrogen, and renewables.
4. Higher oil prices. West Texas Intermediate (WTI) oil prices have again risen above $80 per barrel aided by higher than anticipated demand and lower oil supplies due to Houthi attacks of tankers in the Red Sea. OPEC+ is also doing their part by extending voluntary production cuts through the second quarter.
5. Natural gas is poised to move structurally higher. Domestic consumption of natural gas coupled with LNG (liquefied natural gas) and pipeline exports is poised to grow by as much as 20% or ~3% annually by the end of this decade. The growth in US consumption will be driven primarily by the power and industrial sectors.
6. Value proposition. The S&P 500 energy sector provides investors with a dividend yield of 3.1% versus just 1.4% for the S&P 500 and trades at a price to earnings ratio of ~12x versus ~21.5x for the broader S&P.
SAM’s Infrastructure Income strategy, heavily focused on midstream energy stocks, provides a dividend yield of ~5% and dividend growth potential of 5-7%. That combination of yield plus growth appears attractive to us given the historically high valuation of the S&P 500 and expectations of slowing price appreciation.
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S&P 500 Performance by Sector
Source: S&P Global as of 3/20/24
AI POWER CONSUMPTION POSITIVE FOR BOTH FOSSIL FUELS AND RENEWABLES
The expansion of Artificial Intelligence (AI) dedicated data centers is expected to meaningfully drive growth in power demand. In a recent report, “AI Power Surge—Quantifying Upside for Renewables & Natural Gas,” the Wells Fargo Equity Research team notes that power demand in the U.S. essentially hasn’t grown during the past 10+ years. However, that is changing with the rapid (albeit slowing) adoption of electric vehicles and reshoring manufacturing capacity that they estimate in their base case could add ~ 260 terawatt-hours (TWh) to power demand by 2030. AI data centers could add an additional 700 TWh of demand and in total, US power demand could grow 3% annually through 2030.
KEY TAKEAWAY:
AI power demand could result in incremental natural gas demand of 7 Bcf/d and require 27 gigawatts (GW) per year of solar power and 21 GWs of power from wind. For perspective, in 2023, natural gas accounted for 42% of electricity power and wind, and solar accounted for just 11% and 4%, respectively. Well’s Fargo assumes that incremental power demand from AI is met 40% with gas, 30% with solar, and 30% with wind.
The Boston Consulting Group forecasts that by 2030, data centers will account for 6.5-7.5% of total U.S. electricity consumption (in terawatt hours), up from 2.5% in 2022. (Source: Barron’s article “The Energy Industry Rushes to Embrace AI’s Electric Future,” published on 3/18/24.)
U.S. Electricity Demand
Source: Wells Fargo Securities, LLC estimates from “AI Power Surge—Quantifying Upside for Renewables & Natural Gas Demand” report published on 3/21/24
NATURAL GAS PRODUCERS AND MIDSTREAM COMPANIES POISED TO BENEFIT FROM AI
The Wells Fargo team noted that natural gas companies that can serve data center regions such as Northern Virginia are poised to benefit. For example, AI-related power demand is likely to push up Appalachian natural gas prices, drive higher Northeast natural gas production, require expansions of natural gas gathering and pipeline systems, and extend the useful life of these assets.
SAM’s portfolio strategies include companies that are poised to benefit such as natural gas producer EQT (NYSE-EQT Corp.) and midstream companies DT MidstreamInc. (NYSE-DTM), Energy Transfer LP (NYSE-ET), Kinder Morgan Inc (NYSE-KMI), MPLX LP (NYSE-MPLX) and Williams Cos Inc. (NYSE-WMB).
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Net Power Inc. (NYSE-NPWR) is also a potential beneficiary, albeit a riskier play. NPWR is in the process of commercializing a zero emissions utilities scale natural gas power plant. If successful, these 250 MW power plants can be located near data centers. Virginia is an ideal location because of its access to Marcellus natural gas production and favorable geology to sequester CO2. NPWR’s first plant is expected to be operational by the second half of 2027 to the first half of 2028. Stay tuned for another fireside chat with Net Power CEO Danny Rice and CFO Akash Patel scheduled for April 23rd. (More details to follow).
Forecast Natural Gas Consumption by Power Plants
Source: Wells Fargo Securities, LLC estimates from “AI Power Surge—Quantifying Upside for Renewables & Natural Gas Demand” report published on 3/21/24
WIND AND SOLAR COMPANIES ARE ALSO BENEFICIARIES OF AI
The Energy Information Administration (EIA) expects that developers and power plant owners will ad 62.8 GW of utility-scale electric generating capacity this year. This would be 55% higher than last year’s additions and the most since 2003. Solar will add 36.4 GW and account for most of the additions followed by battery storage 14.3 GW, wind (8.2 GW), natural gas (2.5 GW) and nuclear (1.1 GW). Note that over 90% of the new utility-scale power generation will produce zero emissions.
Wind and solar stocks have underperformed for more than a year as rising interest rates led to concerns about companies’ cost of capital and ability to finance growth. We believe these concerns were exaggerated—these stocks should get a boost as the Federal Reserve reverses course and begins to lower rates this year.
SAM’s portfolio strategies include wind and solar developers such as NextEra Energy Inc. (NYSE-NEE), NextEra Energy Partners LP (NYSE-NEP), Brookfield Renewable Corp. (NYSE-BEPC) and Clearway Energy Inc. (NYSE-CWEN).
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U.S. Planned Utility-Scale Electric-Generating Capacity Additions (2024) Gigawatts (GW)
Source: U.S. Energy Information Administration, Preliminary Monthly Electric Generator Inventory, December 2023
OBSERVATION:The world wants clean energy but there is growing recognition that it can’t abandon fossil fuels. Climate change activists may not fully appreciate that the world can still reduce emissions, grow its economies, pull undeveloped countries from energy poverty, while consuming more oil and natural gas. The tradeoff is that it will take longer to reach net zero emissions.
FEBRUARY REVIEW: MARKET REACHES ALL TIME HIGHS
The rundown:
· SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 4.3% compared to 5.3% for the S&P 500 and 2.2% for its customized benchmark as of 2/29/24.
· SAM’s Energy Transition Portfolio generated a return (net of fees) of 2.3% versus 1.3% for its customized benchmark as of 2/29/24.
· Midstream outperformed in February with a total return of 3.2%, as measured by the Alerian Midstream Energy Index (AMNAX).
· Utilities posted a gain and the clean energy sector underperformed, generating a total return of 1.5% and -0.1%, as measured by the Philadelphia Stock Exchange Utility Index (XUTY) and the S&P Global Clean Energy Index (SPGTCLTR), respectively.
· In February, all 11 sectors in the S&P 500 reported a positive performance, with Consumer Discretionary emerging as the best and Utilities, the worst. Energy delivered a 3.2% monthly total return. February month-end WTI crude oil and Henry Hub natural gas prices were solidly below the ~$80 per Bbl ($79.22) and ~$2.00 per MMBtu ($2.67) levels, respectively, which was up ~4% and down ~24% from last month.
2024 Year-To-Date Total Return
Source: Bloomberg, NASDAQ and S&P Global
RESULTS: SINCE INCEPTION & ONE YEAR
SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 67.4% and 8.5% for the periods since 11/10/20 inception and 1-year, respectively. This compares to a total return of 63.4% and 4.4%, respectively, for its customized benchmark and 51.4% and 30.5%, respectively, for the S&P 500 as of 2/29/24.
SAM’s Energy Transition Portfolio generated a return (net of fees) of -2.0% and -10.8% for the periods since 4/29/21 inception and 1-year, respectively. This compares to a total return of -0.5% and -7.6%, respectively, for its customized benchmark and 26.6% and 30.5%, respectively, for the S&P 500 as of 2/29/24.
Sam Partners’ Infrastructure Income and Energy Transition Strategiesseek to provide sustainable income and growth with capital preservation. This is accomplished by investing in a concentrated portfolio of high-quality midstream energy companies, utilities and clean energy companies that are well positioned to participate in the energy transition to a net zero carbon future. A diversified approach to investments across these sectors should optimize risk-adjusted returns, in our view. Our Infrastructure Income Strategy offers investors a current yield of ~5% and growth potential of ~5-7%; while the Energy Transition Strategy that is more heavily weighted with clean energy stocks and aligns with favorable ESG ratings, offers investors a current yield of greater than 4%. In a world searching for yield, we believe these Strategies offer a compelling value proposition.
IMPORTANT DISCLOSURES
Siegel Asset Management Partners is a registered investment adviser located in Plainview, New York. The views expressed are those of Siegel Asset Management Partners and are not intended as investment advice or recommendation. This material is presented solely for informational purposes, and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness, or reliability. All information is current as of the date of this material and is subject to change without notice. Third-party economic, market or security estimates or forecasts discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates or forecasts. Certain products and services may not be available in all jurisdictions or to all client types. Unless otherwise indicated, Siegel Asset Management Partners' returns reflect reinvestment of dividends and distributions. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
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