- As winter looms in the Northern Hemisphere, the global energy crisis is likely to worsen. Although inflation and gas prices are high in the U.S., energy investor Adam Rozencwajg says the mood in Europe is “somber” and the fuel shortages are “worrisome.”
- Petroleum supplies are shrinking everywhere: “Most of the world, other than the U.S. and the OECD countries, operate hand-to-mouth and they don’t keep inventories of crude oil,” Adam explains on an episode of Top Traders Unplugged.
- Nuclear power is likely part of the answer to future energy needs, but it’s not without challenges, such as perceived challenges related to safety as well as where and how to store nuclear waste.
Only two and a half years ago, in the second quarter of 2020, we saw the lowest energy costs in human history. In the last five months, energy prices skyrocketed to the highest rates ever, for some products.
As a natural resource investor for the last 15 years, Adam Rozencwajg has seen more than a few cycles. As one-half of Goehring & Rozencwajg, a boutique research firm focused exclusively on “contrarian natural resource investments,” he argues that betting against the fossil fuel industry is folly, at least for now.
Adam says today’s bearish market, which swung between historic highs and lows within just 36 months is “a sign there’s something wrong,” although “we’re still in a fairly strong cycle.”
We welcomed Adam back to Top Traders Unplugged for an in-depth discussion of the forces that have (and continue to) shape the global energy crisis.
Here are just a few of the takeaways from our conversation, including shifts in supply/demand, the major players on the world stage, the role of the Strategic Petroleum Reserve (SPR) and whether nuclear power might emerge as a long-term solution.
Winter is coming
The United States is (so far) largely “insulated” from the energy crisis, says Adam. Although gasoline prices average nearly $4 per gallon and inflation is at a 40-year high, the mood “doesn’t feel quite as somber as it does in Europe,” where the crisis is “very, very real and very, very foreboding.”
He doesn’t want to downplay the struggles of American families, but he thinks that as winter approaches in the Northern Hemisphere, the crisis will proliferate across the globe: “There’s a potential for a real choke point in the months ahead,” he warns.
How did we get here? The war between Russia and Ukraine certainly worsened market instability; it continues to cause “huge dislocations and shocks,” Adam explains. But ultimately, “a huge reduction in capital spending in the oil and gas industry over the last decade” is to blame.
That’s not changing anytime soon, especially because powerful governments are “antagonistic and negatively predisposed towards the energy sectors, more than they ever have been,” he says.
Supply, demand and the market rollercoaster
We can’t talk about the petroleum industry without understanding the dynamics of supply and demand.
Crude oil markets generally produce about 100 million barrels a day, and that supply and demand grow by about 1 million barrels per day, per year. When the market is unbalanced, supply might be (for example) 500,000 barrels per day above demand, or vice versa. That would be a large deficit or surplus, but “we’ve seen numbers much bigger” — for instance, when COVID caused a huge, sudden demand disruption.
The price of oil is set by 0.1% of the entire market, which equates to a few hundred thousand barrels a day. To put that into perspective, at their peak, the shales grew annually between 1.5 and 2 million barrels daily.
For the last 10 or 15 years, all of the supply growth in the world came from shales and other non-OPEC production declined. Periodically, the OPEC bloc was forced to respond.
At times, OPEC “kept the market in balance,” but other responses were disastrous — like the 2014 “Thanksgiving Day Massacre,” when OPEC announced that it would keep its production target unchanged and oil prices plummeted by more than 10%.
In 2020, OPEC’s wavering during the COVID crisis led to a dip into negative prices.
Shales won’t save us
Since the pandemic, “everyone’s been looking to the shales,” which are producing — but not much.
The marginal growth is driven by what the industry calls “drilled but uncompleted wells,” he explains. Because 50% of the total cost lies in completing a well, some companies held off on finishing drilling projects they launched during the pandemic until the market stabilized.
Today, the rig count is up 45% from its all-time low in 2020, but they’re still well below 2019 levels. Indications suggest that the shale industry knows it only has five to seven years of high-quality drilling inventory left, which might be why companies keep drilling at sub-2019 rates: They have more time to figure out their next steps.
All signs point to shrinking petroleum
By and large, the rest of the non-OPEC world is out of petroleum. Canada and Brazil might produce some oil, but declines in other places balance out to net zero.
OPEC member Venezuela has the largest oil reserves in the world. But after the dictatorial government nationalized its drilling operations in the late ‘90s, the country’s energy industry was “totally cannibalized,” its machinery stripped and scrapped in the wake of a collapsed economy. The U.S. restricts Venezuela’s ability to invest, and coupled with the political strife, it could be many years before it taps those reserves.
That leaves the 12 remaining member countries of OPEC.
“At this point, there’s a fairly broad consensus that the only countries with any spare capacity to speak of are Saudi Arabia, the UAE and Iran,” but how much those three have is subject to debate, Adam says.
Although the Saudi kingdom does have an “unbelievable geological endowment,” many experts suggest its reserves are dwindling — a theory reinforced in June 2022 when reporters overheard French president Emmanuel Macron tell Joe Biden on a hot mic that the UAE and Saudi Arabia are close to their production capacity.
Strategic (but finite) reserves
The Strategic Petroleum Reserve is an emergency stockpile of oil maintained by the U.S. Department of Energy (DOE). With capacity for 714 million barrels, it’s the largest publicly known emergency supply in the world — although China “probably” has a large reserve as well, says Adam.
Since 2015, the U.S. government has sold oil from the reserve to fund the federal budget deficit. After a six-month surge designed to drive domestic gas prices down (at the rate of 1 million barrels a day), the inventory stands at roughly 420 million barrels.
“We’ve released [barrels] from the reserve at an unprecedented rate,” Adam explains. “Most of the world, other than the U.S. and the OECD countries, operate hand-to-mouth and they don’t keep inventories of crude oil.”
Dipping into the SPR was meant to put a cap on oil prices by flooding commercial inventories. And although one could argue that it helped pull back prices by $10 or $15 per barrel, it didn’t do enough — and unfortunately, those reserves are finite.
Adam emphasizes the S in the SPR, noting that it was put in place “after OPEC used oil as a weapon in the 1970s.”
It happened twice, he adds: “When the U.S. supported Israel in the early ‘70s … and when the U.S. was perceived to have allowed the overthrow of the Shah in the Iranian revolution. In both cases, in order to punish the West, Saudi Arabia withheld oil from the market, and it created huge problems” — including an energy crisis that led to severe gasoline shortages and blocks-long lines at pumps.
The end of energy abundance
Although gas is still readily available in the U.S., we’ve come to the end of the era in which energy is abundant — and the world could look very different even sooner than we think. It is worth watching “The History of Energy” to understand just how much humans have relied on an abundance of energy to make all the progress we’ve achieved.
Adam knows the global energy outlook sounds pessimistic, but he does think solutions exist.
Nuclear power is the most promising. It’s extremely energy efficient and can address our carbon needs, as opposed to windmills and solar panels, which “require so much energy to actually make energy that we can’t sustain our standard of living.”
Case(s) in point: Germany has doubled its electricity-generating base with renewable energy. South Africa has increased it 2.5x – and both experience massive blackouts regularly.
“We have to start being realistic about energy efficiency,” Adam adds.
We’re in the thick of an energy crisis, “yet people are saying we have to get away from oil and gas and invest more in renewables. But will only make this problem worse,” he argues. “This is not a carbon issue. This isn’t a global warming issue. For the time being, we need efficient sources of energy to get us over this hump. We can debate the rest later.”
The future: Going nuclear?
People want a “greener” world. The way we get there seems to be the key point of difference.
We put too much CO2 into the atmosphere and as a result, temperatures are increasing. Adam suggests there are things we can do to improve energy efficiency and reduce carbon. Most countries haven’t given this much consideration, but that’s changing.
The European Union ratified a “green taxonomy” making nuclear a major part of its efforts to combat climate change. Now, France, UK, Netherlands and even Japan embark on new nuclear buildouts and extend existing infrastructure.
It’s complicated, but nuclear power is part of the answer to our future energy needs.
With reserves dwindling and production approaching net zero, “You either have to lower your standard of living dramatically — which I am completely opposed to; it’s unethical and ridiculous and anyway, society doesn’t move in that direction — or you need to keep emitting CO2, or you need to embrace nuclear,” says Adam. “Those are your three options. There’s nothing else, and the quicker people realize that, the better.”
Problems are few, but perception is everything
Nuclear energy infrastructure requires a long lead time to build and deploy, so we can’t depend on it to thwart the problems caused by Russia’s incursion into Ukraine. Aside from that, Adam says there are three issues with nuclear power we have to face — two of which are matters of perception.
1. It’s expensive.
Building nuclear infrastructure has gotten “astronomically” more expensive and many Western companies have dismantled their nuclear engineering businesses over the last 10 years, “probably because of economies of scale; we haven’t built very many of them,” Adam notes.
2. Safety challenges.
Safety is a concern, but it’s less of a problem than people might think. “Over time … the number of deaths in the nuclear power business is [virtually] nothing per megawatt hour. [Many] more people die in coal mining accidents every year.”
3. The waste issue.
Another perceived problem is nuclear waste — both from a proliferation/security perspective keeping waste safe from those who might want to steal it to make bombs — and from a storage perspective. Adam points out that both France and the U.S. have devised solutions to both.
He’s particularly excited about new, fourth-generation, small modular reactors that address all of those issues, like those designed by Washington state-based TerraPower, which is financed by Bill Gates. They address cost head-on, cost significantly less than current-generation reactors, and are much safer than anything in use right now. Some of the technologies TerraPower is working on now would reduce the amount of nuclear waste “by an order of magnitude or more,” he adds.
Innovation in the nuclear energy space has been quiet since the Fukushima disaster of 2011. “It’s been dark days,” Adam says. But great things are happening — although right now, solely in private companies. No opportunities for nuclear energy investment exist at the moment — but in the era of dwindling oil resources, perhaps that will change soon.
“I’m actually very optimistic, believe it or not,” says Adam of our ability to meet the challenges of climate change head on.
Although energy abundance is in the rear view, our current energy crisis is part of a cycle like any other. History tells us the market will eventually expand just as it now contracts.
Short-term plays are risky, but big-picture opportunities for investors are still possible.
“For those that want to trade this market, I’m not the right person to talk to,” he says. “But for people who want to play out over a cycle and make a long-term investment decision, I think the fundamentals are very much intact.”
This is based on an episode of Top Traders Unplugged, a weekly conversation series with the most interesting and experienced investors, economists, traders and thought leaders in the world. Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.