Happy Holidays and all the best for the new year! We appreciate all your support and help in making 2023 another successful year for Siegel Asset Management (SAM) Partners.
We maintain strong conviction that traditional energy companies can prosper in the years ahead and believe in the long-term potential of clean energy stocks. There is growing recognition that the energy transition will take longer than conventional wisdom had envisioned, and that consumption of fossil fuels will last well into the second half of this century. At the same time, renewable energy, such as wind, solar, and hydrogen will represent a larger portion of the growing energy mix.
There has been a paradigm shift among energy companies that has not been fully appreciated by investors, in our view. Namely, these companies have eschewed reliance on external capital to fund their businesses and now generate meaningful free cash flow with which to return cash to shareholders. Balance sheets have never been stronger and consequently, financial risk has been substantially diminished.
SAM Partners’ focus is primarily on midstream energy companies that provide investors with attractive dividend yields coupled with modest growth in income that could in combination generate low double-digit returns. The kicker could come with an uptick in valuation.
YTD Total return vs. 10-year treasury (as of 12/19/23)
Source: S&P Global, NASDAQ and Bloomberg
MAGNIFICENT SEVEN RULED: TOUGH YEAR FOR CLEAN ENERGY, TRADITIONAL ENERGY, AND UTILITIES
The Market Commentary we published a year ago, “Energy’s Winning Streak to Extend into 2023” missed the mark by a wide margin. This is a humbling business.
We got some things right but missed the Magnificent Seven tsunami.
We correctly anticipated that oil and gas prices would trend lower but still be high enough to generate attractive returns for producers. Indeed, that was the case and oil and gas production in the U.S. hit record levels. We projected: “The Fed tightening cycle is likely to end with the Fed Funds rate peaking around 5% and inflation should continue to moderate.” This is slightly below the current Fed Funds target range of 5.25 to 5.5% and it’s looking like rates have peaked this cycle. The remaining uncertainties include: (1) timing of when the Fed will begin cutting rates, (2) by how many times and how much and (3) whether there will be a soft landing.
Utilities and Energy were the worst performing S&P 500 sectors in 2023.
Higher interest rates through October and cost of capital concerns weighed heavily on utilities and clean energy stocks. The Magnificent Seven rebounded sharply from a disappointing 2022 and were seen as a safe haven against a looming recession that never showed up owing to their strong cash position and free cash flow generation. These stocks got turbocharged in May as the artificial intelligence thematic took off and they never looked back.
Energy stocks never managed to sustain a rally.
WTI crude oil prices dipped as low as ~$67 per Bbl in March and as high as $94 per Bbl in September—as of this writing, it has settled back to ~$72 per Bbl. In general, companies such as midstream energy with high and growing dividends had to compete against short-term Treasuries that provided investors with risk free rates of return of more than 5%.
SAM PARTNERS YTD OVERVIEW
SAM’s Infrastructure Income strategy did well relative to its customized benchmark in 2023 and generated a return (net of fees) of 7.6% compared to 1.1% for its customized benchmark as of November 30. This compares to the S&P 500’s YTD return of 20.8% as of November 30, 2023.
SAM’s Energy Transition Portfolio generated a YTD return (net) of -12.0% vs. -10.4% for its customized benchmark. Our portfolio fell victim to investments in clean energy and utilities (the latter of which was the worst performing sector in the S&P 500). This compares to the S&P 500’s YTD return of 20.8% as of November 30, 2023.
SAM Partners’ objective is to provide investors with above-average income and attractive
risk-adjusted returns.
A GLANCE BACK AT 2023
1. S&P 500 rallied. As of December 19th, the S&P 500 was up 24.9% and, including dividends, generated a total return of 26.2% YTD. The S&P 500 has recovered the loss in 2022 and is essentially back to its level as of 12/31/21. The total return over the past three years was 10.5% annualized (assuming reinvested dividends).
2. Energy retreats after 2022 best S&P 500 sector performance. As of December 19th, the energy sector was down -3.2% YTD and, including dividends, generated a total return of +0.4% (as measured by the S&P 500 Energy Index). This compares to a total return of 65.7% in 2022. The total return over the past three years was 35.9% annualized (assuming reinvested dividends), still the best sector in the S&P 500 over that timeframe.
3. Commodity prices were down but at levels supportive of investments. Crude oil prices (WTI) and natural gas prices (Henry Hub) decreased approximately 10% and 31% YTD, respectively, as of December 19th. Notably, crude oil prices remained above $70 per Bbl, a level still supportive of drilling activity and adequate returns. Commodity prices were impacted by lower economic activity, warmer than normal weather dampening demand and robust supply.
4. OPEC + supports crude market. The cartel plus has maintained lower production quotas since November 2022 to support oil prices. At this past November meeting, they agreed to further cuts of 2.2 MMb/d. Saudi Arabia continues to carry the burden shutting in about 1.8 MMb/d since July, according to the International Energy Agency. The Saudi’s are producing just 9 MMb/d versus stated capacity of ~ 12 MMb/d. For comparison, the U.S. is producing over 13 MMb/d!
OPEC+ Implied Crude Oil Targets (Selected Producers)
Source: IEA
5. Inflation and interest rates peaked at multi-decade highs. In November, the consumer price index rose 3.1% year-over-year. Although inflation is still higher than it’s been in decades, it has moderated from its 9.1% peak in June 2022. After 11 straight interest rate increases, the Federal Reserve has maintained rates since July 2023. The last increase took the fed funds target rate to 5.25-5.5%. The 10-year treasury yield peaked at 5% in the middle of October and has since settled below 4% following the last FOMC meeting in December and dovish remarks by Fed Chairman Powell.
6. U.S. oil and gas production reach record highs and bring surprise to the upside. The U.S. is the world’s largest producer of oil and natural gas. Liquids production (crude oil plus natural gas liquids) is slated to grow by 1.6 MMb/d in 2023 (~ 8%) and natural gas by ~4% to average nearly 104 Bcf/d.
7. EV adoption loses steam. The major car manufacturers, such as GM and Ford, have slowed their capital expenditures devoted to electric vehicles due to slowing consumer demand growth.
8. U.S. avoids a recession in 2023. While many had feared a recession this year, it looks like the U.S. GDP grew by 2.5%.
A LOOK AHEAD AT 2024
1. Soft landing is possible. It’s way too early to claim victory, but it looks as if the Fed may have engineered a soft landing (i.e., a mild recession or avoided a recession entirely). The economy has held up better and inflation has retreated faster than most were anticipating. The Fed’s most recent “dot plot” has a median forecast of 1.4% GDP growth next year. Sounds good to us!
2. Commodity prices are likely to remain in trading range. We expect oil prices to trade in a wide range of $70 to $90 per Bbl (WTI) and natural gas similarly to trade in a wide range between $2.50 and $4.00 per MMBtu. Oil prices should remain high enough to generate attractive returns for producers while natural gas prices at the low end of the range will be a challenge. Hence, look for continued growth in the liquid’s rich basins such as the Permian, while dry gas basins such as the Haynesville and Marcellus will likely be flat at best.
3. OPEC plus maintains price support. The biggest risk to the energy outlook is Saudi Arabia’s resolve to keep barrels off the market to support prices even though it’s losing market share to growing U.S. production. It’s decision to open its spigots in November 2014 led to a painful price collapse. We Do NOT envision a replay.
4. Utilities and clean energy stocks do better. Lower interest rates should be a boost for these stocks. Clean energy shares that were most impacted by cost of capital concerns have substantial upside potential but are not without risk given hockey stick growth projections necessary to justify valuations.
5. Wind and solar generation to surpass coal in U.S. electric power generation. Solar generation is the fastest growing source of power in the U.S. The EIA expects wind and solar combined will surpass coal generation for the first time. Still, natural gas commands about 42% of power generation, while renewables (including hydropower) accounts for about 24%.
6. Expect more modest stock returns in 2024. It may be difficult for the S&P 500 to repeat the market gains of 2023 given elevated price-to-earnings valuations of ~20x based on Wall Street Consensus earnings estimates of $235. A reversion to the mean would imply ~10% stock gains and ~12% total returns including dividends.
7. Midstream energy returns should be very competitive. Against the backdrop of expected normalized stock market returns next year, midstream energy stocks should provide competitive returns given yield plus dividend growth approximating 12%. (Wells Fargo Research). In addition, we believe that there is room for a rerating that could push returns even higher.
COP28: TRANSITIONING AWAY FROM FOSSIL FUELS
The 28th annual Conference of the Parties (COP28) to the United Nations Framework Convention (UNFCC) on Climate Change was held in Dubai on November 30 to December 13. The summit, which was attended by almost 200 nations, was hailed as a success by many.
For the first-time, participants signed on to an agreement that cites fossil fuels, albeit, calling for “transitioning away from fossil fuels” rather than the “phasing out” of fossil fuels. The latter verbiage was vociferously opposed by fossil fuel producers led by Saudi Arabia. While noteworthy, “transitioning away” is less of a commitment than the “phasing out” language that staunch climate advocates wanted.
Javier Blass, a Bloomberg Opinion columnist, suggests that the wording is a concession to Saudi Arabia and other OPEC+ nations because it puts the onus on the demand side, rather than on the supply side. In other words, producers will need to continue to invest in fossil fuels to satisfy demand that continues to grow and to keep prices stable, notwithstanding efforts to transition away from fossil fuels.
KEY TAKEAWAYS FROM COP28
• Producer nations agreed to decarbonize their direct emissions and take steps toward reducing methane emissions. It should be noted that U.S. energy companies and major oil firms have already embarked on this path and have made substantial progress.
• Participants agreed to invest in low-emission technologies such as renewables, nuclear, hydrogen, carbon capture and sequestration.
• Parties acknowledged the need to triple renewable energy capacity by 2030. Utility-scale wind and solar developers should be major beneficiaries of this trend, in our view. These would include Brookfield Renewable Partners L.P. (BEP-NASDAQ), Clearway Energy, Inc. (CWEN-NASDAQ), NextEra Energy, Inc. (NEE-NYSE) and NextEra Energy Partners, LP (NEP-NYSE).
Global Electricity Generation by Source
• Participants recognized that transition fuels can play a role in decarbonization while also ensuring energy security. While not specifically mentioning natural gas, this essentially is an endorsement of the key role that natural gas can play in decarbonization by replacing dirtier fuels such as coal. Indeed, COP28 calls for accelerating efforts towards the phase-down of unabated coal power. Cheniere Energy, Inc. (LNG-NYSE) the leading producer and exporter of LNG in the U.S. and second largest producer globally, as well as EQT Corporation (EQT-NYSE), the largest U.S. producer of natural gas, and The Williams Companies, Inc. (WMB-NYSE), operator of the largest U.S. natural gas pipeline are ways to invest in the natural gas thematic.
See our Fireside Chats with:
o Anatol Feygin of Cheniere Energy, Inc.
o Toby Rice & David Khani of EQT Corp
o Chad J. Zamarin of The Williams Companies, Inc.
• More money added to the Climate Finance Fund. On Day 1, $260 million was immediately pledged by several countries for a loss and damage facility at the World Bank. Commitments total more than $700 million to date. The Climate finance fund aims to aid vulnerable countries deal with the negative impact of global warming.
CAVEAT: Should Donald Trump become President, we suspect that he would once again pull out of the Paris Agreement.
NOVEMBER REVIEW: MARKET REBOUNDS WITH INTEREST RATES STABILIZING
The rundown:
• SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 6.2% compared to 9.1% for the S&P 500 and 7.3% for its customized benchmark as of 11/30/23.
• SAM’s Energy Transition Portfolio generated a return (net of fees) of 4.6% versus 8.1% for its customized benchmark as of 11/30/23.
• Midstream delivered a solid performance in November with a total return of 7.3%, as measured by the Alerian Midstream Energy Index (AMNAX).
• Utilities underperformed and the clean energy sector outperformed, generating a total return of 5.1% and 9.4%, as measured by the Philadelphia Stock Exchange Utility Index (XUTY) and the S&P Global Clean Energy Index (SPGTCLTR), respectively.
• In November, 10 out of 11 sectors in the S&P 500 reported a positive performance with the exception of Energy (i.e., -1.0% monthly total return). Energy performance was negatively impacted by lower commodity prices. November month-end WTI crude oil and Henry Hub natural gas prices were solidly below the ~$80 per Bbl ($75.66) and ~$3.00 per MMBtu ($2.75) levels, respectively, which was down ~6% and down ~22% from last month.
2023 YTD Total Return (11/30/23)
Source: Bloomberg, NASDAQ and S&P Global
RESULTS: SINCE INCEPTION & ONE YEAR
SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 65.1% and 1.2% for the periods since 11/10/20 inception and 1-year, respectively. This compares to a total return of 59.9% and -3.8%, respectively, for its customized benchmark and 35.2% and 13.8%, respectively, for the S&P 500 as of 11/30/23.
SAM’s Energy Transition Portfolio generated a return (net of fees) of -1.5% and -18.1% for the periods since 4/29/21 inception and 1-year, respectively. This compares to a total return of -1.6% and -14.5%, respectively, for its customized benchmark and 13.0% and 13.8%, respectively, for the S&P 500 as of 11/30/23.
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 adheres to strict ESG criteria, 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.