We like to say, “the train has left the station” on the tracks to a decarbonized world - hence, the rapid growth in renewables, electric vehicles, and electrification. However, the ride is very expensive and in need of government support and subsidies. Some may not realize that traditional energy sources (oil, natural gas, and coal) are onboard for the ride and are unlikely to get off any time soon. In fact, natural gas is likely to make it to the final stop, especially if NET Power Inc. (NYSE: NPWR) is successful in its quest to provide clean energy powered by natural gas.
Several weeks ago, we hosted another fireside chat with Danny Rice and Akash Patel, CEO and CFO, respectively of Net Power. If anything, the pair sounded more confident and ebullient about the company’s prospects. A new catalyst in the story is the long-term opportunities to serve data centers’ almost insatiable appetite for power (please see our market commentary, “The Energy Sector is an Artificial Intelligence Beneficiary.”) Subsequent to our fireside chat, NPWR reported earnings. Danny started the call by saying, “Our total addressable market is expanding faster than we expected, and government policy is evolving in our favor.”
The following are highlights from our conversation. But first, a quick reminder of NET Power’s technology.
NET POWER – DELIVERING THE ENERGY TRIFECTA
NET Power is developing a utility-scale power plant that can generate electricity with practically zero carbon emissions and competitive costs by using responsibly sourced natural gas. The NET Power Cycle technology is potentially a game changer and checks all the boxes: it generates clean, low cost, and reliable energy or as CEO Danny Rice states, “the energy trifecta.”
Source: NET Power First Quarter 2024 Results presentation May 2024
Proprietary technology with a moat built around intellectual property patents. The NET Power Cycle technology uses natural gas and oxygen as inputs. An air separation unit separates oxygen from air and eliminates air pollutants such as sulfur oxides (SOX), nitrogen oxides (NOX), and particulates. The natural gas and oxygen combine creating CO2 and water vapor. Simplified, the CO2, in a super critical state, turns a turbine that creates electricity. The CO2 is repressurized and recirculated and a portion is exported for sequestration or commercial use such as enhanced oil recovery.
Source: NET Power Second Quarter 2023 Results presentation August 2023
HIGHLIGHTS
Development of its first utility scale project remains on track for start-up in 2H’27 – 1H’28. (We would be disappointed if it wasn’t completed by the end of 2027). Project Permian, a 300-megawatt plant will be in west Texas and will provide power to Occidental Petroleum’s (OXY-NYSE) first commercial-scale Direct Air Capture (DAC) Plant. DAC technologies extract CO2 directly from the atmosphere.
Three pillar business strategy has not changed. First, prove NET Power’s technology at the utility scale. The concept was proven in 2021 when power from its demonstration plant in LaPorte, TX was synced to the grid. Second, build a project backlog that is ready for execution by the time the first commercial plant is in operation. Third, prepare for manufacturing mode. Management plans to standardize the design, supply chain, and construction of the NET Power Plants. This should drive down capital costs from roughly $900 million for the first plant down toward a goal (stretch) of below $700 million.
FOUR MILESTONES FOR 2024
1. Begin validation of Baker Hughes’ equipment at NPWR’s LaPorte demonstration plant.
2. Complete Front-End Engineering and Design (FEED) for Project Permian. The FEED will form the basis for standardizing NPWR’s utility-scale plant design as well as firming up cost estimates.
3. Secure long-term Air Separation Unit (ASU) partnership.
4. Advance NPWR origination projects. (See below for details.)
First Origination Project (OP1) identified. On its first quarter earnings call, management revealed that it submitted an interconnect application with MISO (Midcontinent Independent System Operator), a regional transmission operator that manages the delivery of electricity across 15 U.S. states and Manitoba, Canada. The exact location for the application has not been revealed for competitive regions other than to state that it’s in the Northern MISO region. Additionally, NPWR with its partners intend to file Class VI CO2 sequestration permits this year. Permanent CO2 sequestration via Class VI permits qualifies for the $85 per ton 45Q tax credit. NPWR's plants could each sequester about 850 tons of CO2 per year and generate 45Q tax credits worth ~ $72 million. It’s important to also note that NPWR seeks to develop hubs or a cluster of plants in multiple locations that require baseload power. According to the company, MISO could accommodate 20 to 40 NET Power Plants.
Addressable Market Expanding Faster Than Expected. NET Power Cycle Technology can be used for baseload generation (i.e., 24/7), dispatchable generation to fill in for the intermittency of wind and solar, and for industrial uses. End use markets for NPWR plants include electric utilities, oil and gas companies, industrial companies, technology companies, and data centers, just to name a few. After several decades of no growth, power demand growth is expected to accelerate to an annual pace of 2 to 3% (see our last market commentary). NPWR notes that grid operators such as MISO, PJM, and ERCOT believe that they may not be able to meet peak summer power demand in the next few years. As power demand is forecast to grow, reliable baseload supply is likely to shrink over the next several decades as natural gas, coal, and nuclear plants reach the end of their useful lives. One source (Global Energy Monitor) suggests that this could equate to more than 800 GW of capacity.
Regional Transmission Organizations (RTOs) forecast significant shortfalls from baseload retirements and increased renewable penetration
Source: NET Power First Quarter 2024 Results presentation May 2024
Final EPA Rules on Power Plant Emissions is a Positive for NPWR. NET Power is well positioned to handle new EPA rules (see page 4) to limit emissions from fossil fuel power plants. The company estimates that its plants will capture at least 97% of its CO2 emissions.
NET Power Cycle Technology is Ideal for AI/Data Centers. Data centers require reliable power 24/7 and they want it to be clean (i.e., no emissions). NPWR fits the bill. In addition, it has a much smaller footprint than renewables and because of its modular design, it can be grouped to meet the demand of future data centers that may require up to 1 gigawatt (GW) or 1,000 MW of power.
Strong Balance Sheet at the End of the First Quarter. NPWR ended the quarter with ~ $625 million of cash and investments, and no debt. Interest income nearly offsets its corporate spending. The company purposely went public over-capitalized to ensure adequate funding for several years. It will contribute the first $200 million toward its Permian Project and with its partners [Baker Hughes Company (BKR-NYSE), Constellation Energy, and SK Group] will decide how to fund the balance.
ENERGY INVESTING IS GETTING ATTENTION!
The cover story for the May 20 issue of Barron's reads "Energy on Sale.” It was like an endorsement of SAM's two portfolio strategies, "Infrastructure Income" and "Energy Transition" that invest in midstream, utilities, and clean energy. Broadly, the energy sector has been underinvested in for quite a few years, and rightly so given very poor returns on capital deployed. But that is no longer the case as energy companies have refocused on capital discipline, generating strong returns, and returning cash to shareholders. As the headline implies (and as we've been writing), the valuation for energy is attractive. The article also highlights natural gas (as have we in "The Energy Sector is an Artificial Intelligence Beneficiary") as part of the solution to the coming surge in power demand.
We concur with the sentiment around several stocks mentioned in the article such as The AES Corporation (AES-NYSE), Constellation Energy Corporation (CEG-NYSE), NextEra Energy, Inc. (NEE-NYSE), and EQT Corporation (EQT-NYSE). To that list we would add DT Midstream, Inc. (DTM-NYSE), Energy Transfer LP (ET-NYSE), Kinder Morgan, Inc. (KMI-NYSE), MPLX LP (MPLX-NYSE), and The Williams Companies, Inc. (WMB-NYSE).
UTILITIES GET A JOLT FROM AI
The utilities sector has also gotten a jolt from AI and from the recognition that they will be vital to supplying the necessary incremental power. This thematic has more than offset the headwind from the likelihood that interest rates will stay higher for longer. Our favorite utility name is NextEra Energy, Inc. (NEE-NYSE) that owns Florida Power & Light Company, the largest electric utility in the US and via its ownership in Next Era Energy Resources, LLC (the world's largest originator of renewable energy from wind and solar).
Year-to-date, the utilities sector has outperformed overall energy and the broad market. Specifically, utilities are up 13.7% year-to-date as measured by XLU vs. 11.3% for the S&P 500 and 9.4% for the S&P 500 Energy as of 5/22/24.
Source: Bloomberg
EPA FINALIZES RULES ON POWER PLANT EMISSIONS
Last month, the United States Environmental Protection Agency (EPA) released final standards aimed at reducing emissions from fossil fuel-fired power plants. As illustrated in the chart on page 5, the power sector is the largest stationary source of greenhouse gases (GHGs), emitting 25% of total U.S. emissions in 2022. The regulations attempt to be a death knell for fossil fuel plants.
As a result of these changes, the agency forecasts reductions of 1.38 billion metric tons of carbon pollution overall through 2047 and up to $370 billion in climate and public health net benefits over the next two decades. Existing coal plants that plan to operate beyond 2039 must install carbon capture and sequestration technology (CCS) to capture 90% of their CO2 emissions by 2032. Coal plants planning to retire before 2032 are exempt from the emissions limits, while those retiring between 2032-2039 must reduce emissions by 40% through co-firing with natural gas.
Natural gas plants were dealt a little less harshly. Existing natural gas plants were spared for now but will face emissions limits in a future EPA rulemaking expected later this year. However, new base-load natural gas plants operating at more than 40% capacity must capture 90% of its emissions by 2032 and will also likely need to employ CCS technology. It seems like a big hurdle for potential operators to build new natural gas plants if the costs are unknown and likely to be prohibitively expensive.
A plethora of litigation is sure to follow. The EPA rulemaking seems very ill-timed given looming power generation shortfalls, concerns over reliability given the intermittency issues of renewables, and affordability. CCS technology is immature, has permitting issues and is likely to be expensive. Can you say inflationary?
Total U.S. Greenhouse Gas Emissions by Economic Sector in 2022
As disclosed in the EPA’s press release dated 4/25/24 , the suite of final rules includes:
“Strengthening Mercury and Air Toxics Standards: A final rule strengthening and updating the Mercury and Air Toxics Standards (MATS) for coal-fired power plants, tightening the emissions standard for toxic metals by 67 percent and finalizing a 70 percent reduction in the emissions standard for mercury from existing lignite-fired sources.” The agency expects a resulting decrease in emissions in 2028: 1,000 pounds of mercury, at least 7 tons of non-mercury HAP metals 770 tons of fine particulate matter (PM2.5), 280 tons of nitrogen oxides (NOx) and 65,000 tons of carbon dioxide (CO2). Additional expected benefits include $300 million in health benefits and $130 million in climate benefits over the 10-year period from 2028-2037.”
“Stronger Limits on Water Pollution from Power Plants: A final rule to reduce pollutants discharged through wastewater from coal-fired power plants by more than 660 million pounds per year, ensuring cleaner water for affected communities, including communities with environmental justice concerns that are disproportionately impacted.”
“Latest Action to Protect Communities from Coal Ash Contamination: A final rule that will require the safe management of coal ash that is placed in areas that were unregulated at the federal level until now, including at previously used disposal areas that may leak and contaminate groundwater.”
APRIL REVIEW: UTILITIES HOLD STEADY AS THE MARKET PULLS BACK IN APRIL
The rundown:
SAM’s Infrastructure Income Portfolio produced a return (net of fees) of -0.4% compared to -4.1% for the S&P 500 and -1.5% for its customized benchmark as of 4/30/24.
SAM’s Energy Transition Portfolio generated a return (net of fees) of -2.2% versus -2.7% for its customized benchmark as of 4/30/24.
Midstream was down in April with a total return of -1.4%, as measured by the Alerian Midstream Energy Index (AMNAX).
Utilities outperformed and the clean energy sector underperformed, generating a total return of 1.8% and -5.0%, as measured by the Philadelphia Stock Exchange Utility Index (XUTY) and the S&P Global Clean Energy Index (SPGTCLTR), respectively.
In April, 10 out of 11 sectors in the S&P 500 reported a negative performance with utilities as the best (and the only positive) performer and real estate as the worst. Energy delivered a -0.8% monthly total return. April month-end WTI crude oil and Henry Hub natural gas prices were solidly above the ~$80 per Bbl ($83.49) but below ~$3.00 per MMBtu ($1.68) levels, respectively, which was down ~1% and up ~9% 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 78.1% and 14.4% for the periods since 11/10/20 inception and 1-year, respectively. This compares to a total return of 71.1% and 6.3%, respectively, for its customized benchmark and 49.9% and 22.7%, respectively, for the S&P 500 as of 4/30/24.
SAM’s Energy Transition Portfolio generated a return (net of fees) of 3.6% and -4.4% for the periods since 4/29/21 inception and 1-year, respectively. This compares to a total return of 2.1% and -7.0%, respectively, for its customized benchmark and 25.3% and 22.7%, respectively, for the S&P 500 as of 4/30/24.
Sam Partners’ Infrastructure Income and Energy Transition Strategies seek 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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