Bad Infrastructure Grades Include Pipelines And Electricity Transmission Lines

It is very depressing to read the poor grades the ASCE gives to America's infrastructure.  The organization's Infrastructure Report Card for 2013 shows that most of this country's public facilities earn D's.  That is embarrassing.  It's also a serious disconnect from the World Bank's LPI, which rates America's transportation infrastructure as having the 9th best infrastructure worldwide in 2012.

The LPI ranking is a more comprehensive score that includes human competencies in processing and tracking movements.  The ASCE's report card addresses only the physical quality of infrastructure, but this does not explain its mismatch with the World Bank's data.  Adjusting the LPI rankings so that the "Infrastructure" column achieves primacy elevates the US to the fourth-highest overall score just for that category.  That is an even more severe divergence from the ASCE's opinions.  This disconnect's underlying cause becomes apparent once we delve into the World Bank's "Domestic LPI" data.  Clicking the "Infrastructure" link there shows that the LPI scores are based on self-reported assessments from respondents.  Compare this with the ASCE's more scientific assessment of physical deficiencies.  The ASCE's report card assesses investment need while the World Bank's surveys assess operating capacity.  The Alfidi Capital conclusion is that the US economy can continue to perform at the high proficiency that the LPI scores indicate, right up to the point everything falls apart if the US does not correct the glaring deficiencies the ASCE noted.

The ASCE report card thankfully addresses energy infrastructure.  Pipelines and electricity transmission lines are significant infrastructure categories, and many of these assets are privately owned.  USDOE's EIA tracks the natural gas pipeline grid but regulatory oversight for new investment is distributed among several federal agencies.  USDOT maintains the National Pipeline Mapping System for the most complete picture of the network's physical layout.  FERC has the most regulatory control over the pipeline operating companies when they address markets.  The AOPL's industry facts and policy issues do not address the overall physical condition of the nation's network.  Assessing the sectors' investment needs means examining the annual reports of the major pipeline operators.

FERC completed a comprehensive study of the electricity transmission grid in 2002.  The most important takeaway from any study of the nation's electric grid is that there is little connectivity between the east and west halves of the country.  The next most important takeaway is that there is little connectivity to the most promising undeveloped sites for wind farms in the north-central US.  The Edison Electric Institute tracks investments in the electric transmission grid.  The US Bureau of Land Management has a plan to accelerate permitting on land designated as corridors for transmission lines.  The need for additional investment is as obvious as the need for multi-jurisdictional regulatory coordination.

The US clearly needs to upgrade its physical infrastructure.  The ASCE's estimated bill for $3.6T could probably have been paid with the cost of our wars in Iraq and Afghanistan plus the Wall Street TARP bailout.  America instead chose to delay urgent investments in its public commons.  This huge bill for infrastructure must now compete with middle class entitlements that the Bowles-Simpson NCFRR report determined to be unsustainable.  America is in for a hard core wake-up.  The bill for infrastructure is due now.  

The Haiku of Finance for 01/31/14

Keystone pipe report
No carbon climate impact
Go ahead to build

The Limerick of Finance for 05/12/13

Gas exports have come into play
Energy sector joining the fray
Terminals to approve
Pipeline routes to improve
Producers will have a field day

The Haiku of Finance for 03/26/13

Show me a pipeline
Energy or biotech
It must make money

Thoughts On Master Limited Partnership ETFs

The prospect of hyperinflation demands due consideration of hard asset alternatives in a portfolio.  I've been exploring master limited partnerships (MLPs) to see if they fit my investing style.

I spend my daylight hours hearing roadshow pitches from oil and gas prospectors who explore producing wells one property at a time.  These wells are difficult enough for a small company with limited finances.  Pooling single wells into MLPs aggregates their production and enables partners to allocate capital where it can add the most to production.  Pipeline MLPs are intriguing for a related reason.  Their cash flow is the result of amalgamated production in large regions, regardless of how poorly a single well may be performing at any time.

Applying some Boglehead theory to MLPs leads to the conclusion that MLPs arbitrage away risks specific to single wells and pipelines.  It follows that an ETF of MLPs would arbitrage away risks of local geography and single MLP structures, leaving an investor with broad exposure to a flow of hard assets.

I will posit that the cash flow generated by an MLP ETF is a rough substitute for the cash flow generated by fixed income investments.  One crucial difference can make all the difference in a hyperinflationary environment.  Inflation gradually destroys the principal value of a fixed income security and reduces the real value of its coupon payments.  Even TIPS may not be immune to this destruction if their principal resets are not frequent enough to keep pace with inflation, or if the resets are based on artificially suppressed CPI calculations.  A hard asset ETF such as an MLP ETF may not suffer such a deficiency.  Its cash flows are derived from the nominal value of payments made for resource flows, so its value should theoretically hold during hyperinflation if it is rapidly marked to market.

The only MLP ETF I am currently considering for this role in my portfolio is the Alerian MLP ETF (AMLP).  I have not purchased it yet for several reasons.  First, it trades at a multiple of 22 times earnings, pretty pricey given the economy's long term average P/E of 14.  Second, its expense ratio is frighteningly high at 0.85%.  Finally, it has only been around for two years, and has not paid enough coupons for me to find its value using something like my REIT ETF valuation methodology.  I believe that methodology is applicable to an MLP ETF because REITs must pass through their cash flows as dividends to shareholders, just like MLPs.

I like that AMLP is optionable, so that if I did own it I could write short puts under it while inflation drives it up.  Other MLP substitutes like ETNs don't have that flexibility.  Come to think of it, I may decide to buy into it despite my reservations above if inflation really does get going.  Bargain or not, hard assets that generate cash flows bring the best of many worlds when hyperinflation starts destroying the value of everything else.

Full disclosure:  No position in AMLP at this time; this disposition could change with the onset of high inflation in the U.S.

Keystone XL Pipeline Could've Been A Contender

I may have been too generous a few days ago when I saluted a U.S. proposal to streamline business regulation.  What the government giveth, the government taketh away.  Federal support for the Keystone XL oil pipeline has suddenly ended, for the time being  I guess the reform proposal forgot to take away the State Department's veto power over commerce decisions.  This major infrastructure project would have provided jobs for unemployed Americans and secure energy for businesses.  The lesson for its backers is that it probably wasn't as environmentally friendly or cost-prohibitive as a failed solar panel maker like Solyndra, which of course got plenty of help from the U.S. government.  

Even our natural allies scratch their heads at this kind of decision making.  China now has a golden opportunity to obtain Canadian oil in furtherance of its strategic goals.  Chinese purchases of Canadian oil via pipeline would constitute a strategic breakout by giving an Asian nation its first-ever foothold in North America (well, at least since Russia owned Alaska in the 19th Century).  It sure would be nice if the State Department had taken that into account before it recommended against the Keystone XL pipeline.  TransCanada did the smart thing by trying to re-route the pipeline, so now it must wait until after the 2012 election cycle for the project to be approved when no one's paying attention.  

Algae.Tec (ALGXY) Growing Algae For Energy

Algae.Tec (ALGXY) has designed a prototype bioreactor that uses carbon dioxide and sunlight to drive algae growth.  The algae is supposed to be harvested for conversion into fuel.  Let's walk through their technology to see if their business model is viable.

One metric ton of algae has an energy content equal to seven barrels of oil, according to this company.  One Algae.Tec 40-foot container can produce 250 tons of algae per year (they claim).  The company's projections envision a configuration of 500 containers producing 125K metric tons algae per year.  That configuration will be difficult to reliably achieve due to the space required for sunlight collection.  Algae.Tec's parabolic solar collection system requires about 1/2 of a hectare to emplace the collectors.  Their business model envisions these container installations adjacent to existing fossil fuel power plants so the carbon dioxide captured from the plant's generation can feed the algae reaction inside the containers.  How many mixed-use power plants in the world have at least 250 hectares of empty real estate around their plants for the assembly of these containers and their solar collectors?  That, and the willingness of utilities to buy adjacent land for expansion, will determine whether Algae.Tec's plan is scalable.

Consider the potential financial returns.  Oil is now priced at about $100/bbl, so one Algae.Tec container can yield (7x250) no more than 1750 bbls/yr, worth $175K/yr in gross revenue.  That's the equivalent of a small oil well.  Algae.Tec claims an all-in cost of production at around $47/bbl (perhaps lower), so one container will yield ($53x1750) about $92,750/yr in net income at current oil prices.  It's important to remember that the oil will probably have to be trucked to refineries because most coal/gas power plants don't have petroleum pipelines leading out from their facility.  Trucking small batches of algae oil to refineries will be costly, unless the company can further refine the algae oil on site directly into biodiesel.  If the final product from these cogeneration facilities is biodiesel, it can be sold directly to local gas station franchises.  The amount of algae each container will yield also depends on regular sunlight and carbon dioxide inputs.  Power plants in cold northern climates will not have year-round sunshine.  Algae.Tec's facilities will thus be most viable in places like the American Southwest.

My analysis does not include the value of other products like animal feed that can come from this process.  That can add to the net income of $92,750/container.  Algae.Tec is thinking big by planning 500-container installations that can produce a net income stream of over $46M/yr by my math, but space requirements are everything.  Their pilot plant in Australia needs to prove that the whole integrated concept can work before they pursue cogeneration and carbon capture agreements with utilities.

This stock is very thinly traded for something with a market cap over $100M, with daily volume in the mere hundreds.  The inventors of their core technology hold 78% of the stock.  That makes it difficult for individual investors to exit a long position.  It appears that their Pink Sheet listing is brand new.

Frankly, I find this stock intriguing.  Most of its initial installations will be small and geographically limited to sunny climates but the income per container is valuable to utilities that need affordable cogeneration options and carbon capture tax credits.  I'm skeptical that the 500-module configuration will work everywhere, but as long as Algae.Tec keeps its costs low and has accurately estimated its production then the concept can attract the interest of utilities.  This one actually has some promise.  Let's see if they deliver.

Full disclosure:  No position in ALGXY at this time.  

Williams Fights Energy Transfer Equity For Southern Union

Energy Transfer Equity's (ETE) bid for Southern Union (SUG) should have been a done deal when it was announced.  Some acquisition targets are just too juicy to ignore.  Now Williams (WMB) is jumping into the fray with an all-cash $39/share bid for SUG.  Merger fights make life interesting.  The benefit to SUG investors is the enhanced price discovery from competing bids.  The problem is that the boards of both ETE and SUG have already approved their merger, so now a costly proxy fight among SUG shareholders is likely. 

This action might make for a good merger arbitrage play as long as Williams doesn't withdraw its bid.  I might have more to say in a few days once I have a chance to compare all three companies' financial statements. 

Kinder Morgan And The Smart Transportation Of Ethanol

It's nice to see common sense in the energy industry, where there is often very little margin for error (just ask BP and Transocean).  Kinder Morgan Energy Partners (KMP) does ethanol transport the right way.  Railcars take it to ports, with a small amount of proprietary pipeline for the last hurdle.  Minimizing the distance ethanol must travel by pipeline is crucial given its propensity for water solubility and pipeline corrosion.  Kinder Morgan has had a handle on those problems for some time now. 
Ethanol is part of America's energy future provided its feedstocks are grown organically.  That's the only way it can have a positive EROEI.  The entire energy sector is well aware of the challenges posed by transporting ethanol, but it's good to see at least one company showing leadership in developing a transport approach that makes sense. 

Full disclosure:  no positions in BP, RIG, or KMP.