Adam Rozencwajg - Global Macro Series - May 11th, 2022

[00:00:07] Adam

When we speak to investors and colleagues and things like that, most people think that the fact that oil and gas fell in the last decade has been a huge headwind for wind and solar. They say, “Finally, now that energy prices are going up, wind and solar will be so much more competitive that it’ll actually increase adoption.” Instead, we’re starting to see write-offs of wind and solar assets because people are realizing on the manufacturer side, they just can’t produce these assets anymore now that we have an energy crisis.

[00:00:38] Intro

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Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:28] Niels

A new world order is emerging, and in our Global Macro Series, I along with my co-host, Cem Karsan, want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game-changing issues, and hopefully dig out nuances in their work through meaningful conversations.

Our guest today is one of the most sought out people when it comes to understanding the global natural resource shift we’re witnessing right now. So please enjoy our conversation with Managing Partner at Goehring and Rozencwajg, Adam Rozencwajg.

Adam, welcome and thank you so much for joining Cem and I today, for what I’m sure will be an incredibly eye-opening and insightful conversation as part of our Global Macro Series. How are you doing?

[00:02:26] Adam

Very well, thank you. Thank you so much for having me. I’m really looking forward to it

[00:02:29] Niels

Absolutely. It’s our pleasure. I thought I would start our conversation a little bit different today in kind of a pop quiz-style fashion, but with only one question, where I’m sure your answer will set up for lots of interesting avenues to explore. The question is this, from a scale of 1 to 2030, how confident are you about the ESG policies of today?

[00:02:54] Adam

Oh, my goodness. What a loaded question. Look, I think that the ESG movement over the last 10 years has had a huge distortive effect on capital in the US, and really in Europe. To the extent that it’s a big deal here in the US, it’s even more so across Europe, with a lot of funds having explicit mandates and things of that nature. I’m sure we’ll talk all about it today. But what that has really done is that has curtailed and constrained capital into a lot of the more traditional energy industries, notably, oil, gas, and coal, and that’s really having a huge supply impact now. So you’re starting to see capital budgets that are down, in some cases, 70% from their pre-COVID levels. They’re starting to make a rebound now, but it’s not nearly as fast as what anyone thinks.

I think a big part of that is the fact that the ESG pressures are still very much in place. So when oil was $20 and ultimately went negative in April 2020, but let’s call it $20 on a month-end basis, most investors that you spoke to and analysts said once it hits $30 or $40 or $50… Remember the talk that the shale companies, oil is in a bear market because the shale companies all make so much money at $40. Well, that came and went and $50 came and went and here we are at $100. A lot of these companies aren’t really responding with higher drilling budgets. That’s because there’s still this huge ESG pressure.

None of that would matter if the ESG mandates worked. What I mean by that is if wind and solar and electric vehicles were able to provide this huge amount of baseload uninterruptible power at very efficient rates, and we could have abundant cheap energy from renewables, then you could constrain the traditional energy industries of capital. But that’s not the case. We could talk about why that’s not the case. We are in a situation where we’re in a full-blown energy crisis and the companies still really don’t have the latitude to be able to invest in their assets.

[00:05:00] Niels

Absolutely. This was just definitely a small teaser question to get you warmed up here. We’re going to dive into many things ESG related and a lot of other interesting things, I hope. But before we do that, since it’s your first time on our podcast, perhaps I could just ask you to set the stage a little bit to maybe provide a few highlights from your own background and then we’ll take up all the different topics afterwards, if you wouldn’t mind.

[00:05:27] Adam

Sure. I make up one half of Goehring and Rozencwajg Associates. We are a natural resource investment firm, so we focus exclusively on the world of natural resources. I’ve been doing this basically all my career. My business partner and colleague Leigh, who you might see in the background here, we all work together in a big open office, has been doing this since the early 1990s. He started managing the Prudential and then later the Prudential Jennison natural resources funds from 1991 to 2005, developed a fantastic track record, best in the industry in the resource space, and then in 2005, went to a hedge fund based here in New York called Chilton Investment Company and ran the Chilton Global Resources Fund for about 10 years. I joined him in 2007 and I’ve been working for him and now with him ever since. In 2015, at the end of 2015, we were at that point, three, four years into a fairly substantial bear market in resources.

We’re value investors, we’re contrarian investors, and we were looking at the fundamentals and we were saying, “Look, I understand why the market is in a bear market today, but we think that the bear market is nearing an end and we want to make sure we have maximum exposure to that.” So we decided to leave Chilton at the end of 2015. We returned our clients’ money and we started Goehring and Rozencwajg in 2016 at what we felt was the bottom of the resource markets.

We can talk about our investment style and things like that. We’re value and contrarian and when you’re those two things, you can certainly be early. We’re often early. So we’re probably a little early there too. Although, I think in retrospect, with COVID aside, most commodities basically did bottom at the end of ’15, beginning of ’16. Oil was $27, February of 2016. Copper made its lows at the end of ’15, gold as well. There’s been a huge amount of volatility and pullbacks and what have you. It hasn’t felt like a bull market. But in retrospect, when the history is written, that’ll have been the start of the bull market.

So now we manage about $350 million. We’re growing very quickly. We’re certainly not as big as we used to be but that’s largely because capital flows into the space are still little to none. In fact, if you look from 2021 to today when oil stocks have doubled and tripled, the amount of money that’s gone into oil ETFs (oil stock ETFs) has basically been nothing. In fact, in some months, it’s actually been negative. So we just haven’t seen the capital be put to work, and that’s where the opportunity is today because the fundamentals are good. There’s still no money in the space.

[00:07:59] Niels

Yeah, absolutely. Actually, I want to pick up on what you just said about you’d like to be early, because that’s one of the things that I’ve noticed also by following your work. I remember you saying, at some point, that what you and Leigh aim to do really is to write about things that maybe others won’t be writing about until a year from now. So from my point of view, I would love to go back maybe four or five years and just ask you, if you can, give us a little glimpse into what you were writing about back then and tie that in, and then we’ll bring it up more to where we are today perhaps.

[00:08:37] Adam

Yeah, absolutely. If you go back let’s say four or five years, one of the things that we were talking about that we were very early in talking about, probably four or five years ago, which now has become a lot more of the mainstream view, is the idea (and this might surprise you, because we’ve been talking a lot about energy, but we’ll talk about copper) that copper is this really green metal, and that if you want to have any type of renewable rollout, it’s going to take a huge amount of copper. At the time, copper was in a very severe bear market. It bottomed at $1.50 a pound. Money was staying away from the space and it was viewed, I would say, by ESG investors as a very dirty extractive industry.

I don’t think there’s a huge differentiation placed across mining and the idea that it would be instrumental in wind and solar and electric vehicle rollout was not on anyone’s radar screen. I should point out, we didn’t make our investments in the copper space based on that. We really made our investments in the copper space based on the idea that there have been no major discoveries across the last 10 years. Copper deposits take a long time to bring online so you go from discovery, to proving up resource and reserve, to building the mine, to bringing it online. So you have a pretty good line of sight. If you haven’t made the discoveries 10 years ago, you’re not going to be bringing on the new supply now. So this big supply problem, the existing mines were beginning to age.

Then we started to look at all these different tranches of demand, including the fact that more of the world was electrifying in general, including the fact that the way people were modeling China was completely off-base. People were looking at China and saying China consumes 50% of the world’s copper, it’s not 50% of the world’s GDP so it must be overconsuming. That was not the right way to look at it. You have to look at the installed copper base in a country and you say when a country gets to a per capita GDP of $10,000 per capita, then all of a sudden, you’re going to need this amount of copper in the system for things like electricity distribution and for things of that nature.

So when you started to do those numbers, China was actually going to get to like 70% of world copper without necessarily overconsuming. So we looked at all these different sources of demand and then we said what would really take things off the charts would be to the extent that we are going down this renewable path if we’re wrong about the ultimate energy efficiencies of renewables or if we make a policy mistake. If we’re right about the underlying fundamentals of renewables but we decide to push forward with it anyway, which is basically what happened, that would have a huge tailwind to copper demand. So we were talking about copper as a green metal. In fact, I think we called it the ultimate green metal back in 2016, maybe early 2017. That was really ahead of the curve.

More recently, in 2019, right before COVID, we developed a huge amount… We were talking before we started recording about machine learning and neural networks and things of that nature. We set out to answer a question that’s very pertinent today and was very pertinent then as well, which is, what has driven productivity changes in the shales and what does that tell us about the future? Because you have to understand that depending on where your listeners are listening from, it will be more or less known to them, the only major source of oil supply growth, in the non-OPEC world over the last decade, has been the United States. Everywhere else has been flat. Canada and Brazil are growing a little bit, but that’s offsetting declines in other places. Of that, it’s all come from the shales.

So understanding the trends in the shales is really critically important. But no one has really done the work. Productivity had grown from 14 to 17, no one understood why. The industry was telling people that they were just getting better at drilling wells and we tried to really understand what was behind that. What we concluded was, the industry wasn’t any better at drilling wells, they were better at picking where to drill. They were drilling their best wells first, they were high grading. If that’s the case, they were going to start to run out of high-quality drilling locations sometime in the near future. If that’s the case, then production would stop to grow in a lot of these basins.

So we did that in 2019 and we said there’s going to be a very, very strong tightening in the oil markets going forward because you’re going to have to deal with the headwind of falling productivity, whereas before, you’ve had rising productivity by being able to focus in on these areas. Sure enough, that happened. Now, it happened in a bit of a circuitous roundabout way because COVID meant that we dropped 70% of the rigs, we shut in production and made the data almost impossible to analyze.

But what we’ve seen coming out of COVID is that the wells that have been drilled are flat to declining in productivity. We haven’t been able to get that sort of leverage of laying down your worst rigs and high grading even more, which is what we’ve seen in past drilling cycles. So when the industry did retrace so dramatically in 2020, we said now we’re entering into a full-blown energy crisis. So we were the first people in June of 2020 with oil at $30 a barrel, just having been negative only 90 days prior, we said there’s a coming energy crisis. That’s been exactly, obviously, bearing out now today.

[00:13:58] Niels

Speaking about this historical perspective, Adam, you published a video, I think a few months ago. By the way, it’s a very educational historic account of the energy sector and I really enjoyed it. I’ll definitely link to that in the show notes of today’s conversation. But you say that, based on your analysis, if we continue down this path of renewables, it’ll end up in a lose-lose situation with no winners. Can you explain that view a little bit?

[00:14:31] Adam

Sure. I’m not sure there’s no winners. I’m sure there’s window manufacturers that would probably do very well and carbon blade producers. But yeah, look, for a long time, we’ve been focused on this concept, which we’ve now claimed that going forward could be the next thing that everyone talks about, whether it is or not remains to be seen, but it’s this concept known as energy return on energy invested. Believe it or not, there’s quite a bit of literature and quite a few books out on energy history, which you would think is terribly dull, but I find it absolutely fascinating. So there’s some really good books written on the topic, and I think in our quarterly letters, we mention a few.

But if you go back, you can really study human history and evolution through the lens of being able to harness energy. It’s quite an interesting roadmap and study. So the term energy return on energy invested, we didn’t invent that. It’s in the literature of energy economics. There’s been quite a bit of work done on it. But it’s basically the concept that for any energy system, it produces usable energy, but it also consumes energy to make that energy. That’s true when you’re looking at hydrocarbons. You have to consume energy in drilling wells. There’s this concept of the boundary. Where do you want to draw the boundary? So obviously, the actual energy cost to drill the well needs to be included.

You should probably put some fraction of what it costs to build the drilling rig, divide it by how many wells that rig can ultimately drill. You need to take some amortization of the trucks that need to roll to get there and things like that. So the concept can get very tricky very quickly, but I think the intuition is quite straightforward, the idea that it requires energy to make energy, and you can try to measure how efficient different energy sources are at making energy. For most of human history there’s reliable data going all the way back to 1 AD. I would presume that pre-1 AD to 1 AD are awfully similar, but let’s start there, so 2,022 years of energy history.

For the most part, we as a people consumed energy in the form of food for both ourselves, animal feed for animals, which would then plow the fields and things of that nature, and wood. Wood was used both as a heat source, it was used as a construction material. That was really basically the majority of what we used. There’s a little bit of metal that was consumed. However, it was incredibly difficult to produce because in order to mine the metal and then to smelt it, you were doing it all using wood and charcoal and things of that nature. So it was very, very, very costly and very, very rare, which is why you can look back at major battles won and lost by the availability of steel and things like that. Very difficult to do.

You can look at how much energy was consumed per person and you can look at the average population size and you can look at all these different things. They were all basically flat for about 16 centuries. Growth in both real GDP, population, energy consumption, it ran about 0.02% per year over that time, so basically zero. The reason for that was that if you look at that type of an energy economy made from feed, food, and wood, your total energy return on energy invested was anywhere between 5 and 10 to 1. So for one unit in, you got 5 to 10 units out, probably 10 units at the actual energy source level and then when you look to what they call societally, increasing the boundary, you’re probably close to 5 to 1.

With those energy economic numbers, you were able to basically create enough energy to feed yourself and your family and your animals and provide shelter with almost no surplus energy leftover. Here’s the interesting part. If you have no surplus energy leftover, if all of your energy is being used to just exist and then to create more energy the next year to be able to do it all over again, you don’t have any ability to really grow surplus capital either. This is something that I think is kind of an important intuition, the idea that most things in the economy, in fact, I would argue everything in the economy, is conversion of energy from one form into the other. Clearly, that’s true in manufacturing, but I would argue even in the service industry.

To me, a quintessential service industry is like a Goldman Sachs investment banker, and nobody consumes more energy than a Goldman Sachs investment banker. So I’m not sure why moving from a widget factory to services is somehow not energy intensive. Everything is converting, moving ourselves around and converting energy from one form to another. You can debate that with me, but I think that there’s ample evidence over time that that’s the case. So if you have no surplus energy after you spend energy on creating more energy, you spend energy on your subsistence lifestyle, then you’re not going to be able to grow the economy. Sure enough, that was true for 17 centuries. And then almost exactly coincident around 1650, the UK basically ran out of trees.

They chopped down their entire forest and they were forced to move to burning coal. They said, “We’ve noticed that this thing burns too and so let’s try to use it.” What they noticed immediately is that the amount of energy that it released per unit of energy in was 30 to 1, much, much, much higher than the 5 to 10 to 1 of wood. So now, you consumed the same amount of energy for your subsistence life, but instead of consuming one fifth of the energy to create the energy, you only consumed 1 to 30. So instead of 20% going towards energy, 3% went towards energy, and that difference was free. That became your surplus capital.

Almost overnight, growth rates exploded in population, in real GDP, in energy consumption. Really interesting things like the maximum size of a city went from a million people, started to grow. From 81 to 1650, there was 1 million person city at a time on Earth. You couldn’t get bigger than that because by the time he brought in all the food and all the wood from the hinterlands into the city if it was bigger than a million people, you basically had consumed all the energy that you were going to have harvested there. So you’re better off starting a new city, somewhere else that was closer to its sources of energy. With coal, that was no longer a limitation.

So cities started to proliferate, they started to grow, you started to have two cities with a million people. Now eventually, today, I think there’s 420 cities of over a million people, and Tokyo, the world’s biggest city is 25 million people or whatever it is. So obviously, a huge seismic change in the 16th and 17th century- 17th century, 1650. It’s really kind of interesting. You started to almost immediately see that surplus capital compound on itself, including the idea of looking at steam engines and pumps. One of the early pumps driven by steam power was used to, maybe no surprise here, de-water the coal mines to be able to get thicker seams that were a little bit deeper and to be able to provide even more energy and on and on and on.

I’m sorry, I misspoke a little bit. That original 30 to 1 efficiency, that’s sort of where we are today on coal. When we actually moved to coal in the 17th century, we probably moved 5, 10 to 1 to about 15 to 1, and that difference spurred all the capital. Fast forward, things got more and more and more evolved, and in the late 19th century, we really harnessed the ability to consume fossil fuels in hydrocarbon form, meaning oil, and then eventually, natural gas. Today, those technologies, traditional fossil fuel hydrocarbons, all have an ERoEI of about 30 to 1, and that is where we’ve opened up effectively the modern world that we know today.

Energy consumption went off the charts. Everything went up. Growth rates went up by a factor of 20 as we harnessed these more efficient energy sources because now, we use next to nothing in terms of our energy base to produce more energy compared to when we were using it all with wood and food and feed.

So where does that leave things going forward? The downside to fossil fuels is clearly that they emit carbon. I don’t think that that’s something to be taken lightly. We’re not climate change deniers. I would say that I think a lot of people have a lot of hubris and confidence and a lot of very complicated systems when it comes to how carbon interacts with the atmosphere. But I do think that emitting carbon into the atmosphere is warming the planet and we should probably find ways to curtail that.

The question is how we do that. The solutions that we propose, what do they look like from an ERoEI basis? Because there’s really serious ramifications. For 17 centuries, we didn’t grow. For 17 centuries, the average life expectancy was 40 years. Now, I should point out, it wasn’t 40 years old because that’s how long the median person lived. It’s 40 years old because your infant mortality rate was 20%. So these are major, major, major differences from the modern world that I don’t think anyone is really prepared to go back to. So we have to, I think, at least address the elephant in the room. As I’m sure you can imagine what I’m going to say, renewable energy has a very bad ERoEI. You can read in the literature.

What’s interesting is when we first did this math, we obviously relied on a lot of academic sources and things like that, I said, “Oh, my goodness, as soon as we say this stuff, people are just going to come out and just attack us and whatever, and say how we’re wrong about this and wrong about that.” For the most part, they haven’t and I don’t think it’s because the letter of our work has gotten a lot of attention and I just think that it’s been mostly because the numbers are really quite hard as far as I can see. So where there is some ambiguity, and I’ll address this really upfront, is the idea that if you look at a single windmill, ideally located, that’s very different than a grid powered by wind. It’s different for two reasons.

First of all, the utilization rate of that asset in an ideal location is very different from the average. There’s a huge discrepancy, obviously, much more than a coal plant. Where you put a coal plant doesn’t really matter, you can get a lot of consistency from plant to plant. But where you put a windmill, if you put it in a good area, it could have an efficiency as high as 35 or 40% meaning it’s dispatching power 30% of the time. The worst is sub 10%, which I don’t think people realize. That asset that sits there is only dispatching electricity. On average, the whole fleet is like 15 to 20%. The best ones are higher and the worst ones are lower.

The second thing related to the first is, are you assuming this one windmill in isolation or are you dealing with the fact that wind and solar are intermittent, meaning the sun doesn’t shine and the wind doesn’t blow and no electricity is being generated? As we all know, we’re not used to living in power grid like that. We’re used to power on demand. You turn the light switch on, it doesn’t matter. You don’t look outside and say, “Is it windy out? Can I turn the power on?” So how do you manage that? Well, you’re going to have to manage it in three different ways really. One is to build out (this is crazy, but true), the cheapest way to deal with short-term variability is just to build out huge redundancies in the system, to build out two windmills instead of one and put them far away.

I think that should begin to show you how expensive and how energy-intensive it is to deal with intermittency. The cheapest, reliable option to deal with the fact that minute-to-minute weather patterns change is just to build an entire second windmill. Each one of these things is like 100 meters tall, 300 feet tall. But that, of course, won’t help you get through day and night, particularly for solar, but also for wind. Wind patterns change in the day and night. So you’re obviously going to have to have some degree of battery backup as well. Batteries, particularly lithium ion batteries, are very, very, very energy intensive to mine all the materials, and then to actually manufacture the battery itself.

If you look at all the energy that gets consumed in a Tesla or any electric vehicle over its life, about half of that energy will go to actually propelling the car forward and almost half that energy is embedded in the battery itself. It’s a very energy-intensive process. Even the Wall Street Journal wrote about this that it takes, I don’t know, 100,000 kilometers before you break even on your energy savings compared to internal combustion engine, because upfront, the day it comes off the lot, you’ve consumed a huge amount of energy already and then you amortize that over time. So you’re going have to have batteries to get you through day and night. And then the larger issue is also these seasonal patterns of winter and summer and things of that nature.

To be honest, no one has really addressed that. There’s no batteries that are long duration enough to be able to handle seasonal variations and seasonal variability. So when you add all the redundancies of having to build two windmills, having to back that up with lithium ion batteries, and then I haven’t even addressed the seasonality because nobody really has a good solution for that, your energy return on energy invested for both wind and solar dropped to about, in the case of wind, it’s between 5 and 10, to 1, and in the case of solar, it’s between 1 to 1 and 5 to 1, really quite awful.

I would argue that we’ve seen, over time, for 16 centuries, that type of an ERoEI leaves no surplus energy available for growth of any kind. And on day one, it would mean we’d have to divert a huge amount of energy to making more energy. So we would take a one-time hit to our quality of life, and then our ability to grow from there would be very, very limited. I think that is problematic to the point of it being a non-starter. So we need to find something that is going to be able to have a high ERoEI, be efficient, and ideally not generate any carbon.

[00:29:01] Niels

Absolutely. Lots of things to unpack there. Cem, where do you want to go with this?

[00:29:05] Cem

Well, I’ll just pull on that thread a little bit more. There’s a belief that wind and solar follow Moore’s law, you’ve talked about this a little bit, that eventually, these costs will come down due to technological advancement, etc. Why is that not the case with solar and wind? Can you dive a little deeper there and explain why we’re not going to eventually get to a cheaper place?

[00:29:28] Adam

Yeah, sure. So it’s a huge misconception, and actually, a lot of very prominent energy thinkers and academics have talked about how the market and investors have just run rampant with this idea that we’re going to have a Moore’s law in wind and solar. It’s just really not the case. What is the case is that the cost of wind and solar have fallen dramatically over the last decade. What you’ll see a lot of is a chart that is referred to as the learning curve. When people say it’s not quite a Moore’s law, they say, “Fine, it’s not a Moore’s law. It’s the learning curve.” And what it shows on the x-axis is the total installed capacity of the technology, either wind or solar, and then on the y-axis, it has the levelized cost of electricity, meaning on a fully baked basis, what can you dispatch power on?

Now, none of those are the true levelized cost of electricity because none of them incorporate redundancy or batteries, but we’ll leave that aside. The underlying cost of the wind and solar just at the unit basis, on what they call levelized cost of electricity, has fallen 75 to 80% in the last 10 years. If you extrapolate that trend going forward, it will fall more, and they say that’s the Moore’s law. So there’s obviously some very right off the bat problems with this, namely, you start to run into issues of physics and chemistry that become problematic.

With Moore’s law, you’re starting to run into those now, but it did follow a trend where you’re able to double the density of processing power in 18 months or whatever. You are starting to run into physical limitations on Moore’s Law and the chip business now too, but you’re going to run into them on the macro side of things, these big, big machines much, much more quickly. I’ll give you a just a silly example of that. If you look at a lithium ion battery (a lithium ion battery, they also claim is following Moore’s law. It also is not, by the way) fell from $1,000 a kilowatt hour to $150 a kilowatt hour in 10 years. $100 a kilowatt hour is kind of the magic number where it could begin to become competitive.

So the argument goes, “Look, we’re 90% of the way there. We’ve gotten from 1000 to 150. Now, we just need to go to 150 to 100.” But what people don’t realize is that most of these lithium ion batteries have like $100 worth of raw materials in them. So you have to manufacture it, I guess, on a volunteer basis after that in order to get at that cost. The same thing is true of wind and solar. Some people show this, that you violate laws of thermodynamics by extrapolating these transactions, which is not physically possible. However, if you want to try to get a little bit more pointed and talk about why the costs have fallen, and why actually not only do I think that Moore’s law won’t hold in the sense that it won’t continue on this exponential getting cheaper every year but it’ll actually might get more expensive, is the idea that we looked at, over the last 10 years, what has driven the cost reduction.

It’s sort of a funny thing to say, but very few people have actually looked at that. So we looked at how much it costs to actually build the thing, how much it costs per ton of steel that goes into it, per ton of cement. We built it up from the bottoms up. We added a manufacturer’s margin and things of that nature. The other thing that people don’t realize is that in the levelized cost of electricity, there’s a cost of capital component in there. You do this stream of electricity that is going to be generated over the life of the asset divided by its capital cost, but you discount that stream of electricity in order to get a net present value, if you will, and that’s what goes into that number.

So we built formulas to try to reverse engineer and calculate what these levelized cost of electricity, how you get to them, and what drove that reduction over the last decade. If you think about it, the last 10 years have been very, very unique for two reasons. The first reason is we’ve had the lowest cost of capital in 4000 years of interest rates. The second is that every form of energy from peak to trough fell by about 90%. Gas in the US peaked out at 15 bucks. In 2007, fell to $1.80. Oil peaked at $140, went negative, let’s say, 2015, on a weekly or monthly basis. Coal fell 90%. Uranium went from $150 to $19. Everything fell 90% peak to trough.

Well, it turns out that in order to make a windmill or solar panel, you need a lot of two things. You need a lot of capital and you need a lot of energy. You look at the amount of energy, for instance, that goes into manufacturing the (I don’t have the numbers in front of me. I should), but there are 20 tons of steel (I don’t know if that’s right or not) that goes into the tower of the windmill, the carbon fiber that goes into the cells, the energy that’s required to mine the copper that goes in to the transformers and all the gathering system, the cement that gets laid in the foundations, the fact that you need so many of them. I think this is sort of an interesting fact.

If you look at one well in the Permian, one lateral shale well in the Permian, and you look at the total energy to drill and complete that well, that will generate the same amount of usable energy as not one, but 10 windmills each standing 100 meters 300 feet or 20 story building tall. Just look at all the material that goes into that. It’s just a huge amount of energy cost that goes into it. So you spend a lot of money and you spend a lot of energy, and both of those things have been the cheapest in real terms in human history. Interest rate is the cheapest in nominal terms as well. Energy, a huge peak to trough reduction. I don’t think it should be surprising then that the cost of wind and solar fell. Things would have to be terrible if they hadn’t fallen. It’s sort of shocking they didn’t fall more.

I’ll just stop there for a second, because I really can’t emphasize enough how out of the mainstream that view is. When we speak to investors and colleagues and things like that, most people think that the fact that oil and gas fell in the last decade has been a huge headwind to wind and solar. They say, “Finally, now that energy prices are going up, wind and solar will be so much more competitive that it’ll actually increase adoption.” Instead, we’re starting to see write-offs of wind and solar assets because people are realizing on the manufacturing side, they just can’t produce these assets anymore now that we have an energy crisis. So I think it’s a really, really misunderstood sector and segment.

We have enjoyed cheap money and cheap energy, both of which are on the verge or have turned now. Certainly, energy prices are moving higher and the cost of capital seems to as well. The idea that we will be able to manufacture things that are super energy-intensive and super capital-intensive and see their costs go down, it’s just not going to be the case. So yes, costs have fallen. There is an analogy to Moore’s law, in the sense that in Moore’s Law, costs fall, and here, costs have fallen, but the underlying drivers couldn’t be more different.

[00:36:45] Cem

I find that fascinating. We talk about this a decent amount across other products as well. But the idea that central bank activism over the last 40 years has driven a technological revolution in a lot of industries and really pushed a growth over investment. Duration trade has done incredibly well for 40 years as a result. People have been able to bet on 40-year outcomes and not worry about cash flow. So the value of cash has been very low.

Now that we see that reversing, this is what happens with boom and busts broadly and why liquidity is so important. You see all that malinvestment begin to rise to the surface. I’m curious if you see a significant amount in the next, say, five years of creative destruction happening in the solar and wind space given that it’s been primarily government-backed in a lot of ways and also backed by just free money.

[00:37:45] Adam

I think it’s a really interesting question. I think that the concept of free money leading to malinvestment, I wouldn’t say it’s widely understood because people seem to keep doing it. But certainly amongst a certain set, like yourselves and your viewers and listeners, I think that that concept is understood. If you take interest rates, particularly if you suppress them, if you put the thumb on the scales, you keep the price of money artificially low or just low in absolute terms, then, like you said, your duration blows out and your penalty for malinvestment is de minimis, and so you end up favoring or not being penalized for lack of cash flows and things like that.

So cheap money leads to distortions of investment. That’s the takeaway. I think it’s less well understood that cheap energy will lead to distortions of energy, but I think that’s equally as true. In fact, it’s basically the same principle. There’s really not much of a difference. All you’re saying is that, if the cost of energy is very, very low, in this case, I won’t say it was artificially low, but it was uniquely low largely because of the successes of the shale revolution and the fact that we brought on two of, basically, the most important oil and gas fields in the 20th century were brought online simultaneously in the US in a matter of five years. I’m talking about the Permian on the oil side, and the Marcellus on the gas side.

So you had this period, this wonderful period of cheap, abundant energy, and that led to malinvestment of energy. We invested in things that are extremely energy-intensive, that don’t necessarily have a high return on energy, if you will. There’s a few other examples of technologies that have proliferated in the past 10 years that are very energy hungry. They’re a little bit more controversial and so we can leave them for another day maybe. But I think of cryptocurrencies, even our favorite pastime and hobby aspirationally. If you used to be very, very fabulously wealthy, you aspired to having thoroughbred racehorses and maybe sailing yachts and things like that.

Now, if you’re fabulously wealthy, you go into space, which I presume is much more energy-intensive than either of the latter. So our activities are all energy-intensive across the board. It’s because we’ve had a malinvestment of energy because energy has been cheap. So where do I see creative disruption or things going forward?

I think, ultimately, what’s going to have to happen here is capital has to come back to the oil and gas business because it’s been too long now. We’ve seen attrition, we’ve seen depletion. We haven’t developed the next Marcellus and Permian. I think they largely don’t exist in the sense that we’ve looked, certainly in the US. There’s no two new shale basins waiting in the wings to replace the Permian in the Marcellus. International shales, interesting question. We don’t think that geologically, we actually think most of the great shales in the world happen to be located in the US.

There’s a few examples. Russia has good shale potential but there’s next to no chance that the Russian shales get developed at this point given how much Western technology is going to be needed. So I think money needs to come back into the space. Either the money that’s there has to be much more productive, which there’s no indication, in fact, we’re going the opposite way, or we need more dollars. So I think that’s going to be the major investment creative destruction, if you will. It’s not maybe what we’re used to, but it’s going to be this idea of money having to flow back into things that were thought to be relics of the past.

As far as technologies go, maybe this is a good time to talk about it. In a framework or rubric of looking at what we need going forward, we need energy that’s extremely energy efficient, high ERoEI, and should ideally not generate any carbon. There’s one thing that fits that bill, and that’s uranium and nuclear power. For one unit of energy, I told you hydrocarbon is about 30 units of energy out. With nuclear power, it’s 100 units out. For the investors on the call, if you think about the efficient frontier and you have a trade-off between risk and return, this is like off the frontier. Everything else is typically a trade-off between carbon and efficiency and one unit to trade for the other. And this is just off the charts. This is the quadrant you want to be in. So we’re starting to see now, I think, a very frank discussion about nuclear power.

We’re starting to see a more honest assessment of the risks of nuclear power, which are very, very low. On any metric you look at, nuclear is extremely safe. Europe has added it to its green taxonomy. France has an ambitious new program, the UK does as well. Germany is obviously having just decommissioned its last nuclear power plants. I think they have a couple still, but is more reluctant. But even in Germany, there’s a little bit of a new discussion, at least. China certainly has a massive new build reactor program going, and India looks to be the next to go.

So I think, actually, after having been very pessimistic and very cynical for a long period of time, I’m actually becoming very, very optimistic, because if the endgame of all of this is that we finally embrace nuclear power, we could end up with this step change in energy efficiency that is almost as important as it was in 1650 going from wood to coal. If that’s the case, we could just be on the verge of a period of great prosperity. It doesn’t feel that way these days, but it’s possible. So I think that that is where you can start to see a lot of really interesting change happen.

[00:43:25] Cem

There’s so many directions to go here. Niels, go ahead. Sorry.

[00:43:29] Niels

Yeah, you’re absolutely right. There is so many things to talk about. Anecdotally, Adam, just to share, I live in Switzerland where there’s no windmills, I can assure you, because the wind doesn’t blow much down here. But I’m Danish by background and we have a lot of windmills and a lot of technology. There’s a couple of really interesting things. Before I go there, I just want to say that the whole nuclear debate in Europe is, of course, incredibly interesting. Having grown up in the late ’60s and ’70s, I do remember the campaigns against nuclear.

Certainly in Denmark, it was pretty visible. Even as a young kid, I remember it. Of course, we decided not to have nuclear. And then of course, the Swedes decided to build a nuclear 15 kilometers away from the capital of Denmark, which is completely crazy.

Anyways, I want to shift gears a little bit because I see another trend and I see this happening in Denmark specifically. By the way, the new windmills that the Danish and other producers are producing now, we’re not talking about 300 feet. We’re talking about 800 foot tall windmills. So there’s a new, interesting twist to all of this, and that is we’re now seeing a fight not between the greens and the blacks, so to speak, in terms of fossil fuel. It’s between the greens and the greens because it’s the climate guys and the nature guys, because nobody wants these windmills in their backyard.

In fact, in Denmark, all of last year, only three land-based windmills were set up, which is nothing really. If you look at the plans that the Danes, suddenly, we want to be independent of Russia and gas in no time, like in eight months. It’s not going to happen. But we’re going to have to build a lot of windmills, they say, onshore as well as offshore. So I’m curious, in your research, in your work, whether you’re starting also to notice these discussions between the two types of greens. What do you think that might do to the whole debate about renewable energy?

[00:45:51] Adam

Yeah. We are starting to see that. Frankly, I think it’s great because when you have somebody that appears to be arguing in favor of oil and gas and you have someone that appears to be arguing in favor of environmentalism, part of the argument from the environmentalist is, “Well look, when you factor in the externality of killing everyone on earth, then all of a sudden, our technologies are even more economic than yours.” It seems like quite a high cost and what have you. It makes it very difficult to actually debate whether or not any of these technologies work. I would argue that wind and solar and electric vehicles clearly don’t work.

If you have environmentalist on environmentalist debate, I think, in some regards, it is more healthy because I think you end up with less of what I would call almost a religious dogmatic argument here that just becomes, “Do you want everyone to die so that you’re rich or do you want to save the world?” What kind of a conversation is that? I’m sorry, your windmills aren’t going to work because, like you said, they’re 800 feet tall. You need to have two times redundancy and then you need to have child-mined cobalt from the Congo aggregated and brines from South America with lithium produced, brought together and manufactured in an extremely energy-intensive, by the way, dried by natural gas fired heaters to create batteries that last for 10 years and then end up in a toxic landfill.

It’s not a question of saving the world or not. Your technologies don’t work. So I think at least if you have environmental on environmental debate, I frankly might not agree with either side in some of these debates, but at least I think it focuses the issue and requires a little bit more reason and rationality.

I’ll give you a great example. We’re running out of battery metals- well, not that we’re running out. It’s just if you look at the demand projections, we don’t have enough. Nickel tends to be a key choke point. So if you look, you have cobalt, lithium, nickel. Those are major. There’s others in there as well but those are the three that a lot of people talk about. Cobalt, to some degree, people have tried engineering cobalt out of batteries to greater or lesser success or failure.

Cobalt tends to stabilize the battery and prevent it from catching on fire. Lithium ion batteries are horribly flammable. The last company that tried to remove cobalt was Samsung and that’s when all their phones started to explode in people’s pockets. So people haven’t figured it out, but there’s at least talk of getting it. Nickel is in almost every battery formulation. It seems very unlikely that we’re going to engineer nickel out of the batteries. There’s not a lot battery-grade nickel available. You can get nickel in two forms. I don’t want to get too in the weeds, but what is a nickel sulphide and the other is a nickel laterite. In a nickel laterite, you have to process it to make battery-grade nickel and the processing is one of the most CO2 intensive processes in the world today. Fine. No one debated that.

There has now been talk in order to meet Volkswagen’s demand for lithium ion batteries of developing a major new nickel project. It is a nickel laterite so it will be very co2 intensive to upgrade that nickel, and it’s in Indonesia under very dense jungle rainforest cover that will need to be clear cut. So you have a situation now where if you look at the amount of CO2 that will be released, because one of the cheapest, most effective ways of sequestering CO2 is through photosynthesis in forests. You’re going to clear cut this forest, produce a nickel laterite, process the nickel laterite, very CO2 intensive, to make it into a battery, to put it in an electric vehicle, to get a very efficient diesel car off the road.

First of all, forget the money that you spent that you could spend reforesting other parts of the world. You’ll have emitted more CO2 in that whole process. You’d be better off just leaving the whole thing alone. That’s starting to get attention and so there’s environmental groups that are starting to talk about that on both sides of things. So I think that that’s kind of interesting. We’ve been talking about stuff like this for a long time but no one’s interested in hearing from us because we’re perceived to be not environmentally friendly, which even though we have a huge investment in nuclear and I think we’re very environmentally friendly. So maybe environmental and environmental debate can help reframe some of these issues and get people thinking about things honestly.

[00:50:23] Niels

Yeah, absolutely. I want to send it back to you, Cem. But I do want to ask one question before I do so because you mentioned things like, where can we find oil and gas? Where is it likely to be? Not that I want to make this a Danish-centric conversation, but the Danes have, again, become a little bit in the middle of this because of the Arctic and because of Greenland and other places up there. I’ve seen some studies or research talking about a US geological survey that estimates the Arctic resources are something like 90 billion barrels of oil and 1,670 trillion cubic feet of gas, half of that belonged to Russia, as far as I can tell. What do you make of this? Is there any viable truth to this? Could we even get to it if it was there?

[00:51:20] Adam

Oh, those are some interesting questions. I think, certainly, a lot of activity in the Arctic is becoming more feasible as temperatures do rise. There’s shipping now in lanes that were not feasible 10 and 15 years ago. So I do think, yeah, the geological prospect is there. No one has done any work in the Arctic for quite some time. So it’s very, very early. It’s certainly not something that can be turned on quickly, and frankly, a lot more work needs to be done just on the resource to understand the geology better.

But yeah, there’s some very, very large numbers coming out of the Arctic regions. I think offshore areas, both in the Gulf of Mexico and abroad offshore, also are holding a lot of promise that are probably less harsh weather and things of that nature than going into the Arctic. But ultimately, where the next generation of hydrocarbon basin is going to come from is an open question. There’s not a clear path for it, although I do tend to think that it involves a lot more investment in the offshore side of things.

[00:52:26] Cem

My father is actually a PhD structural engineer for an offshore oil platform so I grew up in this space. One of the things I find interesting is some 30, 40 years ago, we were already talking about nuclear and how nuclear should be more prevalent and used more. It does seem almost too good to be true. Why have we not? Obviously, we all know what happened, all the nuclear disasters that we’ve seen historically, but we’re talking about going to Mars. There’s incredible advancements in technology in the last 20, 30 years. Are there other things that we’re missing in terms of cost to nuclear, environmental costs, things that maybe we’re not talking about enough just to look at the whole picture?

[00:53:16] Adam

I think when critics talk about nuclear, there’s the idea of nuclear waste, which I think is manageable and addressable in the sense that some of the new designs of these, what they call, small modular reactors end up with dramatically less waste. But even if we had to store nuclear waste, it’s so small. It definitely needs to be handled properly and in a secure fashion. But quite frankly, it’s not dangerous in and of itself. I have to be careful. It is radioactive, but right now, nuclear waste is kept on-site in a lot of nuclear power plants because there’s not a good place for long-term storage.

So it’s not the fact that it is horribly radioactive in and of itself. It’s really a security issue. France does it very, very effectively. The US has a very, very strong option in the Yucca Mountain which is a topic unto itself and I don’t want to get too bogged down. It’s been very controversial going back and forth. The other thing, though, that I think needs to be addressed when it comes to nuclear power has to do with the cost and the cost overruns and our collective ability to build nuclear reactors today. There’s these new fourth generation nuclear reactors. One was built in South Carolina. Eventually, it was abandoned and scrapped because it was like three times over cost and years and years delayed.

China rolled out its AP1000, which is the equivalent of that design. It suffered some cost overruns, but it’s doing much, much, much better in terms of being able to bring those online on time on budget. Part of the reason for the cost overruns in the last 10 years, of course, has to do with the fact that following Fukushima, everyone changed their security and safety standards and everything was checked and rechecked. I think that’s appropriate. But what it ended up doing was it ended up basically meaning that all the money that was already put to work on assets that were being built had to be torn up.

There’s great examples of a billion dollars’ worth of concrete had been poured on a foundation, and then all of a sudden, the standards became more exacting and you looked and it wasn’t level to whatever of an inch that it needed to be. You had to tear the whole thing up and start over. So that, particularly midstream, becomes almost impossible to get over. If you look in the West, our ability to build large scale nuclear reactors, I think there’s a question mark around that. Now, as far as economies are scaling Moore’s law, I think if we did have a nuclear renaissance, we should be able to get better at building them and get some of that learned experience back.

You look at the nuclear reactors that were built in the 1960s and 1970s, they’re all operating safely and efficiently today. Many of them are having their permits extended. So we know how to do it and we knew how to do it decades ago. There’s no reason we shouldn’t be able to do it today. But as of right now, there have been cost overruns, certainly, on new build reactors in the West. One of the things that people are trying to do to address that is the idea of what they call small modular reactors.

There are two that are very, very high profile. One is backed by Bill Gates’ Breakthrough Energy Ventures, and the other I think is about to list via SPAC. Those promises to deliver smaller reactors, modular, meaning that it’s going to be a uniform design and you can manufacture it in a central location and send it all around the country and eventually the world. And then there’s some safety designs inherent in some of these new designs that are supposed to be a lot safer and a lot more manageable. It’s supposed to get around two things. One is the idea of the NIMBY, not in my backyard. These things are supposed to be smaller, which should have less opposition. I’m not so convinced that that’s true. I don’t think when someone builds a nuclear reactor, if you tell them it’s smaller, I think that people will still be pretty upset. But anyway, we’ll have to wait and see.

And then the idea of it being modular to help drive down costs. Now one thing I would say, and I haven’t studied the issue as closely as I would like because both these companies are still private, but when it comes to energy and the history of energy, it’s very unusual, in fact, I want to say it’s never been the case, where small has been better and more efficient than large. Energy tends to benefit from scale, from amortizing fixed costs over a larger output. So you tend to see big power plants and big oil rigs and things of that nature. So this would be a departure from that. But maybe it’s the case. We’ll have to wait and see. So those are things that are trying to address the cost issue. China, like I said, right now is probably the leader in being able to manufacture what I would call more conventional nuclear reactors in their AP1000. The West, it’s sort of unclear if we still have that skill set.

[00:57:55] Cem

The title of this pod is Top Traders Unplugged, so let’s dive in and get a little deeper. Are there any names in the nuclear space, uranium broadly, that you like to the extent you’re able to talk about it, or specific areas that you’d have people look at?

[00:58:16] Adam

It’s so tricky. Leigh and I were talking about this this morning. Uranium producers are tough in the sense that it’s not a big universe. There’s two producing companies. Cameco, with their assets up in Canada, and Kazatomprom with their assets in Kazakhstan, and then a smattering of smaller development stories. I got to tell you, uranium prices bottomed at $19 a pound. Most of the development stories need $75 a pound in order to get funding and move forward and generate any type of return. They’ll tell you less.

When you look at really, ultimately, I think where uranium needs to go for the banks to be able to step in and finance these things and for there to be a return, I think it’s really $75 across the board for most of them. I’m sure I’ll get some angry emails and phone calls afterwards.

So where are we today? The spot prices are in the mid-$50s. It’s moved up, like I said, from $19. You’re getting closer to some of those being viable, interesting projects, but it’s tough. So if you’re speculative, you can definitely play in that space and try to catch that move if uranium ultimately goes to between $75 and $100, maybe even a little bit higher, on a sustainable basis. Those companies should all do really, really well.

I won’t mention names there because we have one that we’ve disclosed that we own and that’s NexGen. I think it’s probably the highest quality development story that’s out there. There’s a smattering of others, and you could definitely get beta playing those on a move higher on uranium prices. But ultimately, there’s a little bit of speculation there because none of them really work at today’s spot price. Cameco and Kazatomprom on the other hand, they both run and I think if uranium prices do move higher, there’s certainly upside potential in both those names. Of the two, from a really interesting perspective, I think it’s probably Kazatomprom just because given all the issues with Russia and Ukraine right now, that stock has sold off dramatically and represents a deep discount to Cameco today. But those are the names that we own.

We own both of those, the sort of large bellwether, really the only two producing uranium companies in the world. So kind of crazy. Just to tell you how bad this bear market was in uranium, if you look at what they call the cost curve in a commodity, which is to say every mine in operation and its cash cost of operation, typically if you get the price of copper down, let’s say, to within the 90th percentile of that cash cost curve, that tends to be a good fundamental bottom for copper prices. When 10% of the mines operating today can’t do it profitably, that’s a pretty good indication of a near bottom. In uranium, you took it down so that you had a duopoly with two producing companies in the world, and they couldn’t produce in their flagship mines.

I don’t know how you can get the price so low that a duopoly can’t make it work. So it’s a unique market structure and it makes it tricky. We own both those names. We own NexGen, like I said. We own some uranium or what’s used to be the Uranium Participation unit, now it’s the Sprott Physical Uranium Trust. It’s a vehicle that basically issue shares to the public closed end fund and then it goes out and buys physical uranium. That’s going to be basically a tracker. Again, they might argue that they have certain features that makes it have growth prospects, but it’s basically a vehicle to track the uranium price. So not the best hyper-differentiated views there. I think you stick with the bellwethers when it comes to Uranium.

One of the areas that I think is really, really interesting, which we talked a little bit about, is US natural gas stocks. I think those could really be violent movers higher this year. The reason for that is with all this energy crisis going on around the world, and for your US listeners that might not be aware, on a global basis, gas prices are like $30 in MCF. They got as high as $50 in MCF. On an energy equivalent basis, that’s the equivalent of $300 per barrel oil. With the rest of the world at $30, in the US, everyone’s talking about how expensive natural gas is. It got to $7, so this huge difference. The reason is, the US is basically an island. We produce gas and we can export a little bit of it through LNG. I shouldn’t say a little.

We’re now the world’s largest LNG exporter after having imported, being the world’s third largest importer 10 years ago. Now, we’re the world’s largest exporter. But we still have more gas than we know what to do with. So the market has still basically been in a surplus market, and that’s why there’s this distinction between the US price and the world price. But what happens if the US gas shales sputter a little bit? What happens if they’re not able to fill the next slug of LNG export capacity that comes online? Well, then you’re going to lock the US price into the world price. So you could have a move from $7 to $30 very, very, very quickly.

The gas stocks today, by the way, are pricing in like $4. If you look at range resources, which is a big position of ours, they’re one of the best remaining locations in the Marcellus and the southwest corner, the Marcellus Shale. If you use last year’s PV10, which is effectively in their 10k, they have to publish the value of their reserves using 380 gas, the stock still is upside today. if you put in today’s price, the stock is like a double or triple from here potentially. So these names have a lot of value even at today’s prices, and let alone where gas could go, I think some of these names could be very, very, very strong performers.

[01:03:58] Niels

We obviously, unfortunately, don’t have unlimited time with you, Adam, but I do want to maybe go in two different directions before we end. One thing and it kind of relates to what you talked about with natural gas. A lot of people think of the US as being energy independent. I’m certainly no energy expert at all but what I do understand is that yes, the US has a lot of oil but it’s the wrong kind of oil and so actually you import quite a lot or the US imports a lot of oil every day because there refineries requires a different kind of oil to what you have in the ground.

My question to you because obviously we’re doing this conversation in the middle of the Ukraine crisis and the Russian sanctions, etc. I think both Cem and I have the belief, in line with Peter Zeihan’s work, that we probably are in a process of deglobalization, etc. So how are you guys thinking about this idea of just oil. In a world of deglobalization, if you have the wrong kind of oil, you’re still kind of, I guess, vulnerable to some extent. How are you guys thinking about this whole issue of deglobalization and getting the oil to the right people?

[01:05:16] Adam

I think it’s a great question. I think ultimately, it’s not in any of our models or numbers today, and we’ll have to see how things progress. I really have no great insight into that. I think that the current energy crisis, the groundwork was laid long before Russia invaded Ukraine. I think it has to do with the fact that, basically, we could talk about our neural networks and our machine learning and our productivity models. Basically, we diverted $1.5 trillion from efficient hydrocarbon development into fairly inefficient wind and solar development. We need to spend that money again. We need to write off what effectively won’t work from an energy-intensive perspective of wind and solar, and then reinvest that money into oil and gas. So Ukraine brings all these issues forward.

Deglobalization makes things worse. I will talk about how I think that plays in. But ultimately, I think it’s important to realize that this crisis was in place before the Ukraine and no matter what happens, will be in place until we spend that money to bring on that productive capacity again.

Now, as far as deglobalization goes and things of that nature, I do think it’s going to have an impact. I think people have become used to the idea that maybe we were running too lean of a supply chain for finished goods during COVID. I think that became the mantra of, yes, you want to have high return on capital by bringing your supply chain way down. And people said, “Well, wait a second, maybe we should add the security of that supply chain in case there’s disruptions and whatever.”

I don’t think people have made the leap to say actually, they probably need to secure the supply chain upstream as well, both to just be able to provide the extra material to build out the supply chain, that’s going to require a lot of energy and materials, but then also, we probably want to have some redundancy in the raw material supply chain itself to be able to have inefficiencies like you’re talking about, the wrong kind of crude going to the wrong refinery. The analogy I’ll make there is that we operated that kind of a world for a period of time during the Cold War. There wasn’t complete free fungibility and things of that nature.

When the Soviet Union collapsed in the early 1990s, there was a huge bear market as all that material flooded into the world commodity markets. So from the early ’90s really to 2000, you could argue that there was a huge amount of excess Soviet material, whether it’s uranium, whether it’s steel capacity, aluminum smelting capacity, what have you, that sort of made its way into the world market. And then it was eventually absorbed by the late 1990s, and China rose as a source of demand and things tightened and it became a bull market. So presumably, if that led to a huge amount of excess supply, then going in the other direction will have the opposite effect. Like I said, those numbers aren’t really… we’re not factoring that in yet, but I think that that could definitely be a tailwind to resources going forward.

I’ll tell you something else. The idea of pulling demand forward and inventory hoarding because of rising commodity prices is something that no one’s factoring in either. In the 1970s, a huge source of demand came from the fact that with inflation and with rapidly rising prices, there’s an incentive to hold inventory to buy things today, and whether that’s at the raw material side. So you actually create demand because of the inflationary expectations. I think in a lot of different ways, we’re entering a period and a playbook that really no one has dusted off in 40 years. I think we’ve been in a de-inflationary, disinflationary period for 40 years.

We’ve had a hyper financialization of the world and we’ve had a basic neglect for raw materials. I think that entire playbook needs to be reconsidered. So what are the ultimate ramifications to that? There could be huge tailwinds. I think this this decade, as my partner Leigh likes to say, when we look back in 10 years and we say, what was this decade all about, I think this will have been the decade of shortages.

[01:09:09] Niels

Yeah. I couldn’t agree more. We haven’t even spoken about gold, the fact that countries like Egypt are buying lots of gold suddenly, that countries like Australia suddenly want to audit their gold. The fact that Germany, of course, 10 years ago asked for all their gold back. We haven’t talked about commodities like neon, where Ukraine has 90% of all neon supply comes from Ukraine. Before we kind of end up, I do want to ask you a little bit about the link between energy prices and GDP or growth, etc.

My understanding is, and correct me if I’m wrong here, that there is a certain level of- whether it’s oil or whether it’s energy as a whole I’m not entirely sure. But when it hits something like to 7% of world GDP, that’s when you start seeing an impact on demand, on growth. And that, as far as I understand, is around $180. At $130, we’re at about 5% of GDP, so to speak. Does that tie in with some of your analysis that we’re not quite at a stage where this will be a real limited factor? On the other hand, we got to $147 in 2008 on oil so it’s not unimaginable that we’re going to get to $180 in the next 12 months.

[01:10:37] Adam

For sure. I think there’s a couple of things. Yes, there’s a lot of debate and a lot of ways to measure it and what have you. I also think that one way that people often don’t do is they look at global numbers. But I think really, you have a marginal barrel that could get squeezed out and I think that’s in the West. I think it’s a lot easier, for instance, for us to reduce our energy demand in the West, if we all had to, than it is when that unit of energy is going to urbanize someone from an agrarian lifestyle into an urban lifestyle in India, for instance. So I think if you look at the numbers just in the US, what’s 10% of GDP, that’s very different.

Energy expenditures as a percent of GDP is different in the United States than it would be somewhere else, even at constant prices. I like to look at western US energy consumption as a percent of GDP. Primary energy at about 10% historically has served as a little bit of a drag or a fairly dramatic drag on economic growth. So based on our numbers, yeah, probably at $150 oil, you’re through that level and I think thingwill probably slow following that. Now, that’s not a hard and fast rule and it’s not as though you enter into a recession immediately nor is it the fact that oil prices don’t move higher from there. So I think if you took oil to $180 a barrel on a spike, I think that’s entirely possible.

I don’t know that the world economy really works with oil and other forms of energy moving up commensurately at that level of real dollars per unit of productive energy. Ironically, I think it’s tied to the ERoEI. Too much of your economic system is being directed towards simply making energy, which in and of itself is the driver of growth of the economic system. So it’s like it’s the fuel of the system and if too much of that economic system gets pushed towards making its own fuel, it stalls. I think the word stall is really appropriate. I think it stalls, literally stalls.

[01:12:50] Niels

Yeah, absolutely. Before we leave you, Adam, there are many places we could have gone today and we will definitely have to get you back later in the year to touch on some of those topics. But I do want to give you a chance to maybe talk about things that you thought we missed and we should have brought up if there’s a particular burning topic that you think yeah, I definitely want to get that out to the audience.

[01:13:16] Adam

No, I think we really covered a lot. One thing that I would like to mention, we do have investment products, but whether it’s ours or anybody else’s, I’m agnostic. We get a lot of calls saying, “Have we missed this move?” And we try to measure that. A lot of these stocks and a lot of these sectors have moved up a lot off their bottoms. However, believe it or not, this is one of those crazy things where if something’s $100 and it drops 90% to $10, and then it doubles to $20, it’s still off 80%. So I think that the key point here is when I look at energy weighting in the S&P 500, when I look at the price of commodities relative to the price of stocks, when I look at materials in the S&P 500, these are still at basically all-time lows.

Just to give you a context of the S&P, I’m sorry, I’ll be American-centric here. But to be in the context of the S&P 500, it has averaged about 10% over the long term. In a real bull market, a top was made in 1980. It reached 30% of the S&P, pretty shocking. It got to 1.8% of the S&P in 2020 from 30. So that’s down whatever 97%. Even from 10 to 1.9, it’s down 80% from its average. Today, it’s 3.9%. So you’d have to more than double the weighting in the S&P 500 from today just to reach average, and you’d have to basically go up eight fold or seven fold, I guess, in order to reach the old peak.

Now, I’m not saying it should go to the old peak. I think that would be irrationally exuberant if it made it’s all time high in terms of waiting. However, when you ask, is it over? It’s far from over. So right now, for instance, this is the 26th of April. Today, we’re seeing pullbacks in the last couple of days in the raw material sectors and in the stocks or whatever. I think that for people that really have a long-term view, these need to be looked at as potential opportunities to buy if you’re inclined, because I don’t think we’re anywhere near the top right now.

[01:15:26] Niels

Yeah. I think that’s a good point you made. I’m glad we just managed to get that in. Adam, this has been a tremendous conversation with so much knowledge shared from your experience. So thank you so much for doing that with us today. By the way, make sure you follow and subscribe to Adam’s work. You can of course, find the links in the show notes for today’s episode. As you can tell from today’s conversation, we’re living in a true global macro driven-world, and it is perhaps more important than ever before to stay informed. From Cem and me, thanks so much for listening, and we look forward to being back with you as we continue our Global Macro Series. In the meantime, take care of yourself and take care of each other.

[01:16:07] Ending

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