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Written by: Jacob Johnston | Advisor Asset Management
Semiconductors have garnered most of the attention in the artificial intelligence (AI) arms race. Semiconductor performance has been quite good with the Philadelphia Stock Exchange Semiconductor Index up 27% year to date (as of 8/21/24), well ahead of the S&P 500. What might be surprising is midstream energy performance has been even better. The S&P Oil & Gas Storage & Transportation Index is up 34% year to date, while MLPs (master limited partnerships) — as measured by the Alerian MLP Index — are up 16%. Interestingly, the broad Energy sector has been a relative underperformer and specifically the S&P Oil & Gas Exploration & Production Index is essentially flat, up only 1.6% year to date.
Source: AAM, FactSet data | Past performance is not indicative of future results.
The strength in the midstream space and the divergence among Energy subsectors is notable at a time when energy demand is forecasted to significantly increase in coming years due to transformations in technologies.
Demand
According to Goldman Sachs, it is estimated that, on average, a ChatGPT query needs nearly 10 times more electricity to process than a normal Google search. The International Energy Agency (IEA) estimates electricity consumption from data centers, artificial intelligence (AI) and the cryptocurrency sector could double by 2026. The IEA states in the 2024 Annual Electricity Analysis & Forecast, “After consuming an estimated 460 terawatt-hours (TWh) in 2022, data centers’ total electricity consumption could reach more than 1,000 TWh in 2026. This demand is roughly equivalent to the electricity consumption of Japan.”
Source: Strategas, IEA
Supply
According to the U.S. Energy Information Administration (EIA), 60% of electricity today is generated from fossil fuels, of which natural gas generates 43% — making it the largest resource for power generation by far. The demand from data centers, AI, and the cryptocurrency sector is growing far more quickly than the development of alternative sources of energy, meaning greater use of fossil fuels at least in the near term.
U.S. natural gas production and reserves are at record levels. 2023 U.S. natural gas production hit a record high to average 125.0 billion cubic feet per day (bcf/d). Data published in April 2024 proved reserves of U.S. natural gas had increased 10% from the previous year establishing a new record of 691 trillion cubic feet (tcf).
Source: EIA
Choke Point
We have sufficient production/reserves of oil and gas coupled with strengthening demand for electricity, with infrastructure being the key constraint in matching supply with demand over time.
Midstream energy companies connect the dots between the oil and gas producers to the power generators and are compensated based on volume. The increase in power demand could potentially lead to higher utilization rates and ultimately longer terminal values on existing infrastructure assets.
Source: EIA
More recently, midstream energy companies are going directly to electricity consumers. To prepare for the expected increase in power demand, data center operators have begun to develop on-site power plants. Energy companies are in discussions about building pipelines directly to the on-site power plants to have the gas and electricity available when they need it. This is one example of incremental growth opportunities within the sector above and beyond existing assets.
Storage & Transportation companies and Energy MLPs significantly outperforming Exploration & Production companies this year reflect this choke point and is a good example of how the midstream space is well positioned to benefit from rising volumes irrespective the price moves of the underlying commodities, in our view.
Opportunity
We believe these trends are secular in nature and expect midstream energy infrastructure companies focused on natural gas as long-term beneficiaries. However, just like the technologies driving the increase in electricity consumption, the energy infrastructure investible universe is rapidly evolving. There is an opportunity for a professionally selected portfolio that analyzes the various ways to gain exposure to this growing, sought-after sector, including equity securities of energy companies that are structured as MLPs, equity securities of other energy infrastructure companies, exchange-traded funds (ETFs) and closed-end management investment companies (CEFs) that invest significantly in MLPs and/or energy infrastructure companies.