EV targets depend on critical minerals

https://www.cbc.ca/news/canada/calgary/minerals-mining-metals-ottawa-nickel-electric-vehicles-1.6415887

Eugene van den Berg, May, 2022

Access to and the ability to mine Critical Minerals on a sustainable basis will be the next quest in energy transition. The requirements to meet the ideology to rapidly shift to EV are staggering. That does not mean I am anti-Renewable Energy and Electric Vehicles (EV). It comes down to scarce resources and access to them measuring against steep transition expectation curves.

Here are other important things to consider concerning the required charging infrastructure and the headaches that represent.

The World Bank’s Impractical Electric Car Clap-Trap

What drives energy and oil markets in 2022 and beyond?

Many factors are at work at the same time from different economic perspectives shaping the outlook for oil and energy markets in 2022. The world is more uncertain, climate change transitioning serving up its own realistic challenges, geopolitical tensions, as seen many years past, are at the order of the day, and the low investment in oil and gas, since 2015, is ushering in a period of high and rising oil prices. It is the overriding key factor driving the price, of not only oil, but key commodities too.

Commodities require vast amounts of cheap and reliable oil and energy resources to process and distribute it. Economics 101 teaches us that where demand exceeds the sustainable supply, the price will rise.

This is exactly what set in during April 2020 when a new commodity super cycle came into existence. The demand for Renewable Energy (RE) components drive the demand for critical minerals. Even such critical minerals need oil to process and transport them. To add insult to injury, there are not enough critical minerals easily and readily accessible to support an aggressive sustainable transition to RE.

Energy shortages fuel rising costs in all areas of the global economy. All peoples of the world will feel the bite attached to what is now quickly becoming concerns over energy and food insecurity. The world has lost sight of reality when aggressive climate change policies ramped up to support an ideology in which the effects are not fully being understood nor quantified.

An obsession with ideology, which is driven by consensus science, is leading to creating more uncertainty and more complex problems to solve as we move towards achieving the Cop26 and 2050 net-zero goals.

At the time of writing,  US Dollar strength (Dollar Strength) was not evident. Since writing in 2021, about the current commodity super cycle (that formed in April 2020), the million-dollar question remained then what Dollar Strength could do. We have seen both commodities (CRB Index, S&P GSCI Index) and crude oil pulling back. Mainly driven by Dollar Strength amid the sharp rise in US interest rates combined with the US Dollar as safe-haven status. With that, almost all short-dated yields in the USA are now above the long-term US government 10-year yield.

source: Trading Economics

source: Trading Economics

What we observe is contributing to the oil-financial market and the oil-physical market moving sharply out of alignment. The fundamentals, as I discuss and point out to them below, remain valid. The reality is the world is short oil and many other key energy commodities. Goldman Sachs, and specifically Jeff Currie, leading Commodity Economist, points out the imbalances that are prevailing in energy markets with the expectation that it will take a long time for supply and demand to be fully back in equilibrium.

Seeking Alpha writes: “Commodities took a dip in June, despite strong performance in the first half of 2022. We believe the outlook for shortened supply is unchanged and may keep commodities in a long-term bull market.”

Eugene van den Berg, May 2022 (updated July 2022)

EvB Market analysis_a

Transitory Inflation? Think again.

This Is Now The Worst Drawdown on Record for Global Fixed Income

https://www.bloomberg.com/news/articles/2022-03-23/global-bond-losses-deepen-to-11-from-2021-high-most-on-record

Eugene van den Berg, March 2022

Bloomberg writes:

“Global bond markets have suffered unprecedented losses since last year.”

It was evident then already, by mid-2021 that all the central bank talk, about inflation being transitory, was merely tactics to suppress rising bond yields.

Bond markets are predictors of what to expect going forward.

In early 2021 bond yields started to rise fueled by inflation concerns. Those concerns were valid because:

  • Commodity prices started rising during 2020. A new commodity supercycle started to form in April 2020;
  • Commodities’ rise is fueled by demand for core commodities used in renewable energy. This demand in return is fueled by policies backing the “green new deal” and climate change hysteria:
  • Demand for commodities drives the thirst for oil and gas. Commodities cannot be processed without the use of oil;
  • Increased demand for oil causes the oil price to rise. Oil and gas are major input costs in all goods and services being consumed, this transportation costs rises

Inflation is also fueled by massive govt spending on Covid-19 support programs. On top of that, the world is in a huge debt position considering all debt, both government and private sector debt, that exceeds ~500% of global GDP. Global government debt alone accounts for ~226% of global GDP.

Adding fuel to fire stemming from Quantitative Easying (QE) impacting money supply.

Looking back now, who in their right minds could give thought, weighing everything together, that inflation in 2021 was transitory? The central bank elites with impressive PhDs got it wrong. Are we on our way to stagflation? The probability for that is increasing.

O, and it’s ridiculous to refer to the inflation landscape as “Putin-flation”. It is not. World events of late merely added to an already unfolding inflation story.

The world WILL wheep – “Peak Oil-Hysteria” the new Peak-Oil

Manhattan Contrarian Announces The Arrival Of “Peak Oil-Hysteria” — Manhattan Contrarian

https://www.manhattancontrarian.com/blog/2021-11-3-manhattan-contrarian-announces-the-arrival-of-peak-oil-hysteria

Eugene van den Berg, Nov 2021

WSJ writes:

I think it’s been a big mistake, quite frankly,” Mr. Biden said Tuesday on the sidelines of the summit. “The rest of the world is going to look to China and say, what value add are they providing? They’ve lost an ability to influence people around the world and all the people here.”He said he felt the same way about Russia. “Literally, the tundra is burning,” Mr. Biden said of Russian President Vladimir Putin. “He has serious climate problems and he is mum on his willingness to do anything.

The truth and reality is, China gets it. Without fossil fuels, it’s much harder, costly, and more challenging to transition to net-zero.

China seems to have adopted a two-pronged strategy around duality. Keep on relying on fossil fuels whilst developing Renewable Energy. It’s a phased approach.

China is rated high on the “food chain” concerning electric vehicle (EV) developments. Yet, it still has to set a legislative date when the country will ban the sale of Internal Combustion Engines (ICE) in the future.

Excluding the impact that China may have on global oil demand, the graphic below depicts what the reduction in the demand for oil may look like considering EV legislated cut over future dates. The analysis includes the bold ambitions of Ford and General Motors announced earlier in 2021.

The demand for oil will not disappear instantly. Mankind is the “Siamese Twin” of energy. Without energy, poverty eradication efforts will fail. Without oil, the quality of life will be substantially lower.

A very big part of what is being missed, in all climate change adaption and transition policy and discussion, is the undeniable fact that what we are looking to transition to, being RE, has many obstacles still to be solved around storage, reliability, and replacing baseload. Solving those are more important compared to the effort being invested in sizing up Green House Gas emissions reduction targets.

On top of that, electric grids require massive expansion and capital to expand capacity to feed and support the increase in demand stemming from charging needs. That’s not the issue but rather a consequence.

What’s different with this energy transition compared to when society transitioned from horse and carriage to the ICE, was that what we transitioned to was cheap and in unlimited supply.

In comparison, RE energy is free from the sun and wind. However when the sun shines and when the wind blows. The current global energy crisis, yes it’s driven mainly by low investment in fossil fuels since 2015, and compounded by lower wind occurrence to drive reliance on RE wind.

CNN’s Fareed Zakaria sums it nicely. We need an energy transition strategy. Even if the world can reduce GHG emissions the reality is the world still depends on ~84% of its energy needs forthcoming from fossil fuels.

The question is how much RE is required to fully replace fossil fuels? RE investment and expansion still have a long way to go.

We are undeniably in a compounding energy crisis. It’s merely the beginning gauging the recent rise in electricity production costs in the US and Europe.

Put the climate hysteria to the side and develop policies and strategy that embraces duality as the world transitions to RE.

It’s all about scaling, nothing less nothing more

https://www.wsj.com/articles/how-to-gameplan-your-office-days-an-overachievers-guide-to-hybrid-work-11629711000?mod=e2fb&fbclid=IwAR3M9yRFD1jWSAGoDnJY5UwrxLNEQ35n_kkFOyO0uqAoeeA-m7BmqRRgYfI

Eugene van den Berg, Nov 2021

The days of those pestering “keeners” are numbered. Thank God for that.

I laughed out loud reading the beginning part of this article.

The WSJ writes:

 It’s not going to be who comes on-site every day but the person who can work and lead effectively across different places and spaces effectively.

We live in a world driven by information and globalization. In one business day, the world changes a lot.

Just think about how technology has changed since the early 2000s. Many businesses we took for granted no longer exist. Good examples are DVD stores, CD Music-, Record and Video/DVD shops that first downsized during the late 2000s and then disappeared in the 2010s. Think about the early years of Netflix and Netflix today.

Shopping is likely next as more people grow to adapt to online shopping. The Covid19 pandemic ushered in a more significant permanent shift to online.

In the same fashion, just as businesses adapt to changes, employees, managers, and leaders too will adapt.

Those that can scale, without strings attached, combined with strong collaboration and communication skills, are the new leaders, notwithstanding your technical background.

Finance can be the champion of this. Finance already plays a central role within the organization by being truly service-centric to help other departments gain improved visibility on data and numbers.

Start talking about Hyperinflation

Twitter CEO Jack Dorsey’s dire warning: ‘Hyperinflation’ will soon ‘change everything’ | Fox Business

https://www.foxbusiness.com/economy/twitter-ceo-jack-dorsey-hyperinflation-warning

Eugene Van Den Berg, Oct 2021

Is the risk for Hyperinflation real? Or, is it merely a feeling combined with a “word” that comes to mind? I’ll give you that much, I grew up with- and have seen high levels of inflation, but not Hyperinflation. For some, the rise of inflation to above ~4% in Canada and the USA compared to inflation targets set by the Bank of Canada and the Federal Reserve, at around ~2%, is very overwhelming. Especially folks that have been born after the middle 1990s. The rise in inflation over the past few months translates into a ~100% increase in a very short space of time. It is indeed overwhelming.

To talk about Hyperinflation, we need to start observing economies moving towards month-over-month inflation of ~50% (some background on Hyperinflation). Given the rise in inflation since May of 2021, it’s not likely to happen anytime soon. Could we get there gradually? Perhaps, but not likely given the reasons cited that is driven by technology to keep rising costs down, and creative destruction. I’ll add a few extra points to that, to consider: The changing world from being a totally industrialized economy transforming into a services economy and the gig-economy, jobs that were in demand some 30 to 40-years ago are making way for technology-services and technology-serving related jobs.

Recently I needed to assist my younger son to make flight changes. We held on the phone line for a long long time to be connected with a booking agent. We decided to drive to the airport to go to the airline’s ticket booth. We arrived only to learn, that to effect flight changes, one has no other option other than to call; or if the ticket was booked with the ability to make changes, then make those changes online. It got me thinking, technology and the internet removed a services channel and replaced it with a different type of services channel. That is the kind of development that keeps costs down.

Let’s review Money supply as measured by M3 and M2. Other measures include M0. M2 is still used by central banks and economists but the emphasis on measuring money supply from different levels was modified over the years evolving from M0, M1 to M2, M3 and now MZ.

Investopedia defines the various Money Supply measures as:

“M0: Physical paper and coin currency in circulation, plus bank reserves held by the central bank also known as the monetary base M1: All of M0, plus traveler’s checks and demand deposits. M2: All of M1, money market shares, and savings deposits. M3 is a measure of the money supply that includes M2 as well as large-time deposits, institutional money market funds, short-term repurchase agreements (repo), and larger liquid assets. M3 is traditionally used by economists to estimate the entire money supply within an economy, and used by governments to direct policy and control inflation over medium and long-term periods. As a measure of money supply, M3 has largely been replaced by Money Zero Maturity (MZM). MZM, which represents all money that is readily available, is a measure of the liquid money supply within an economy. It includes money as cash in hand or money in a checking account, for example.

M2 Money supply for the USA and China reflecting the start of the Covid19 Pandemic:

 

M2 supply for the USA and China as of July 2021:

M2 Money supply has grown approx. 13.79% in ~18-months in the US and ~32.32% in China over the same period.

To get a clearer picture of the potential risks attached to Hyperinflation long-term long-range economic data is required to plot money supply against inflation trends to make more meaningful assumptions.  A good proxy would be the use of the data as it pertains to the USA and China given that they compromise the bulk of the global economic output.

The growth percentages will have an effect on inflation for some time.,as they represent steep growth numbers over a short period of time. Safe to say that transitory inflation arguments, which I have been writing a lot about, do not hold water.

Since 2008, Monetary Policy Management and how it intersects with the economy changed a lot with the introduction of Quantitative Easing (QE) and the advancement of Modern Monetary Theory as the two are connected.

QE in its simplest form means:

“quan·ti·ta·tive eas·ing; /ˌkwän(t)əˌtādiv ˈēziNG/

noun

FINANCE

the introduction of new money into the money supply by a central bank”

QE has come modern-day money supply instruments at the wholesale capital market level. It involves the Central Bank purchasing government bonds from investors and banks to exchange the bonds for cash. It has expanded to practices of purchasing bonds other than government bonds. It is another method of injecting liquid cash into the financial system to stem the risk of liquidity risks. QE does not show up directly in the Money Supply. However, as it works its way through to the cash part of the Money Supply, it eventually does get recorded in money supply numbers. One would want to consider what QE looked like before Covid19 and where it is currently.

I am intrigued by the fact that QE bond-buying causes yields to go down (inverse relationship between yield and price: – see Fabozzi’s works on Fixed Income – someones’ works I have come to love, appreciate and digest to its fullest in my postgraduate studies in Investment Management)

This would mean as the bond-buying continues the fair value on the central bank’s balance sheet appreciates. What happens when bond yields rise in reaction to concerns about inflation? The fair value of these bonds do down. as long as previously booked unrealized fair value gains and unrealized fair value losses, on a cumulative basis cancels out, or the economic stimulus ignites new economic growth, the risks of huge net-realized losses are lower. But what if we hit stagflation? Or persistent inflation at higher levels?

One would need to go back to the 1970s and derive how effective policy of the past can be combined with “modern-day money printing” to tame the inflation beast.

QE ran up trillions of dollars since January 2020. The amount of QE is approx. equal the deficit ran up by the Canadian Federal government in 2020 as ~CAD 350 billion of asset purchases through QE was made by the Bank of Canada. The Canadian deficit for 2020/2021 swelled by CAD 314 billion as reported by Reuters

In the USA, the situation is not much better. In 2020 and 2021 combined the total amount spent on asset purchases in QE amounts to ~$4 trillion and the deficits combined for both years amounts to approx. $5.9 trillion.

Hyperinflation is generally seen as a consequence of government ineptitude and fiscal irresponsibility.

It is very evident that Covid19 stimulus spending drove and is still driving deficit spending, thus giving meaning to “a consequence of government ineptitude and fiscal irresponsibility“. The proof in the pudding lies in how fast the QE can be reeled in as a break for likely high inflation? Time will tell I believe.


On, Oct, 25, Bloomberg wrote in “Five Things You Need To Know to Start Your Day”

“Over the weekend, Twitter CEO Jack Dorsey said that hyperinflation is happening and that it’s going to change everything. Of course, nobody really knows what he meant or why he said it. One guess is that he’s long Bitcoin and it’s a good thing to tweet for pumping his bags. Who knows. Also tech types seem to be obsessed with the dollar and monetary policy these days for reasons that aren’t clear.  Obviously the U.S. is seeing inflation these days that’s been higher than in the past, but it’s hardly hyper. But then someone will point out this chart of the so-called money supply (or some variant) as their trump card, and show that yes, there really is hyperinflation happening already.

relates to Five Things You Need to Know to Start Your Day

Fans of Austrian economics, in particular, are fond of this definition of inflation, that it’s not about the price of goods, per se, but the volume of dollars. But anytime I see a chart purporting to show an amount of dollars, my thought is always the same “who cares?”. The only reason we should care about any of this stuff is if prices are rapidly getting more expensive. If suddenly there were a huge increase in dollars everywhere, but prices didn’t move much, it wouldn’t matter. If the price of bread went nuts, it would be very bad. So a chart of the money supply tells us nothing that the inflation chart itself doesn’t. And yes, there’s no denying that inflation itself has been elevated relative to recent history, but again it’s not hyper, and really it’s not that wild if you zoom out even just a little.

relates to Five Things You Need to Know to Start Your Day

The year-on-year change in headline CPI remains nowhere close to what we saw in the 1970s, and there were even times throughout the 80s where the numbers were higher. Speaking of the 70s, on the latest Odd Lots, we spoke with Dan Alpert, a managing partner at Westwood Capital, and the author of a new paper that attempts to debunk the idea that a 70s-style inflationary spiral is coming anytime soon. As he sees it, quantitative ideas about money (such as the one above) have been debunked, and there remains plenty of actual capacity in the economy (domestically and abroad). All the bottlenecks and sources of pressure are in the moving of goods, he says, rather than their actual production.”

Then in another Bloomberg article, Cathay Wood, is of the view that deflationary forces will eclipse supply. Bloomberg writes: Cathie Wood Tells Jack Dorsey Deflationary Forces Will Eclipse Supply-Chain Havoc:

“Deflationary forces will overcome the supply-chain induced price pressures buffeting the world economy, Ark Investment Management LLC founder Cathie Wood said in a tweet after a Jack Dorsey post on hyperinflation. “Three sources of deflation will overcome the supply chain-induced inflation that is wreaking havoc on the global economy,” Wood said in a thread Monday. She was replying to an Oct. 23 post from Twitter Inc. chief executive Dorsey proclaiming hyperinflation “is going to change everything” and is “happening.”

The three sources of deflation Wood flagged are:

    • The impact of technological advances like artificial intelligence.
    • Creative destruction from disruptive innovation pushes down the price of obsolete goods.
    • Cyclical factors due to the pandemic whereby firms ramped up orders to meet reviving demand and will eventually be left with excess supply and unwinding prices after the holiday season.

Enduring supply-chain snarls are stoking inflation expectations and shaking up markets. Higher Treasury yields have led to questions about whether valuations for the kind of technology investments Wood is identified with are too stretched. The flagship Ark Innovation ETF is down 25% from a February peak.”

 

ESG’s shortcomings and the Energy Crisis

This energy crisis has helped expose ESG’s shortcomings, and we’re all paying the price

https://www.theglobeandmail.com/business/commentary/article-this-energy-crisis-has-helped-expose-esgs-shortcomings-and-were-all/

Eugene Van Den Berg, Oct 2021

The Globe and Mail writes:

“About a decade ago, investing on ESG principles went from budding concept to moral crusade. About the same time, it emerged as one of the prime tools to fight climate change. In simple terms, ESG – environmental, social and governance – meant investing responsibly. Grubby, carbon-intensive businesses were, in effect, to be punished unless they moved fast to clean up their acts. If they didn’t, investors and customers of the saintly variety wouldn’t buy their shares or products. Companies that did not wreak planetary destruction in the pursuit of profits were to be rewarded. Out with the “bad,” in with the “good,” even if the latter could never be adequately defined. Were Amazon and Tesla “good” companies because they didn’t dig great gobs of fossil fuels out of the ground? Apparently yes, given their spectacular stock market performances. Never mind that Amazon’s gasoline-powered trucks filled the streets or that Tesla’s global supply chain extended to distinctly ESG-unfriendly cobalt mines in the Democratic Republic of the Congo. What was certain was that oil, gas and coal companies, and most mining companies, suffered the ESG backlash, turning them into market laggards and raising their cost of capital. Their lives were made more miserable by the new ranks of ESG crusaders – among then Mark Carney, Michael Bloomberg, Klaus Schwab (founder of the World Economic Forum) and just about everyone on the United Nations payroll – who promoted the glories and rewards of ESG investing.

So is Green, after all, genuinely Green? What is this facade costing economies?

To pivot to Green, and based on calculating emissions, in Kg per 1USD of economic output, globally (when we talk about emissions intensity and per capita emissions, we ought to consider the other side of the same coin, that being, economic output per capita.

You see, there is a strong correlation in all economies between population growth, economic output, and Green House Gas (GHG) emissions. Because of this relationship, one cannot evaluate the one without the other.

In the image below, that relationship, on a global scale, is reflected. The emissions in Kg per 1 USD economic output has steadily declined since the 2000s. That tells us the world is getting better, leveraging technology to reduce emissions for every 1 USD of economic output being generated.

Relationship between economic output and GHG emissions

Based on the emissions per Kg per 1 USD of economic output, the Paris 2030 emissions target, which is a 30% reduction lower than the 2005 emissions levels, one can calculate the estimated portion of current-day economic output that has to transform to the “green economy” to meet that target. In other words, what part of the global economic production today needs to be “green” to meet Paris 2030?

It comes down to roughly ~$20 trillion of global GDP., or 26% of global annual GDP output.

Derived global GDP that must shift to “green” to meet Paris 2030 targets

This is not the same as the cost of energy transition. In Recent research conducted by The Royal Bank of Canada (RBC), (The $2 Trillion Transition: Canada’s road to Net Zero. RBC estimated the cost of energy transition could amount to ~CAD 2 trillion, the equivalent of approx. a single year’s Canadian GDP output, or roughly ~CAD 60 billion per year. Not a small charge at all.

Net zero as defined by Royal Bank of Canada

RBC writes:

“Canada has a math challenge. When it comes to greenhouse gas emissions, Canadians account for a relatively large share of what the world produces. Although we’ve committed over the decades to cut those emissions, we’ve fallen short. We continue to consume conventional energy to cross our vast land and heat our homes, and allow methane to seep into the atmosphere to feed ourselves and much of the planet.”

RBC is wrong about it’s statement that Canada is a large contributor without mentioning the basis on which such false statement is being made. This, from one of Canada’s largest banks. That statement is based on emissions per capita. My above comments show why, when looking at per capita it is important to consider per capita output too. Why ignoring the part of the equation (economic output) that gives rise to emissions per capita? It creates a strong bias to support a political narrative which is dangerous and will cost Canadians dearly in many ways – more energy crises.

Canada has a small population in comparison; Canada is the 2nd largest landmass in the world, Canada is a freezing place. It will consume more energy as goods must travel long distances between the East and Western parts of Canada. It’s approx. 7,366km. That does not even take transportation distances in the Canadian north into account.

Canada is not a significant contributor to GHG emissions. Canada accounts in aggregate for 1.6%, China accounts for 27%, USA accounts for 15%, India accounts for 7%, Russia accounts for 5%, the UK accounts for 1.1%

Canada’s GHG emissions are low, notwithstanding having high demands for energy for the reasons stated. Those reasons cannot be changed. Canada has the benefit of having a boreal forest that covers a large part of Canada. It’s a natural carbon sink. Russia too has a sizeable boreal forest which, given its attributes, contributes to Russia only making up ~5% of the global GHG emissions total.

Using the same metrics of what the Canadian economy requires to shift financial output to “green,” to meet the 2030 Paris target (reduce emissions to a level that is 30% less than the 2005 emissions level), Canada needs to shift ~USD 1 trillion cumulative economic output between 2021 and 2030 to meet the Paris 2030 targets. That’s the equivalent of approx. 47% of the current annual GDP.

Emissions per Kg per 1 USD economic output – Canada

Stated differently, Canada is to spend ~CAD 60 billion per year to shift ~CAD 115 billion in economic output. Thus the current GDP needs to expand by roughly ~2.8%, to produce the capital required (The CAD 60 billion calculated by RBC) to invest in energy transition efforts.

In other words, the economy needs to grow at approx. 5.8% on an ongoing sustainable basis, year over year for ~10-years to generate the cash to pay for the energy transition. It’s relevant to ask, “how realistic is that given that the fossil fuels industry is the largest contributor to the Canadian economy, but is being marginalized for the past 7 years; Canada is dependant on ~76% of direct trade and exports with the USA. Canada is approx. 10% of the USA in all respects.” – “NOT EASILY DOABLE GIVEN HISTORY!” If Canada cannot diversify its exports and leverage it’s energy to do so; chances are the economy cannot and will not grow at the levels needed to produce the investment capital to make ESG and Net Zero work.

What do we receive in return? The ability to shift CAD 115 billion in economic output to “green”. Spending CAD 60 billion to move CAD 115 billion. It’s an economic ratio of ~52% of what we need to shift to ” green” that we have to spend to go the ~CAD 115.

There are downsides to ESG, the true costs are questionable. RBC suggests it could cost annually ~CAD 40 billion in climate-related disasters if it remains business as usual (BAU). However, just by saying that spending CAD 60 billion to prevent spending CAD 40 billion are wrong for several reasons:

  • The investment into energy transition costs doesn’t produce dollar-for-dollar savings. There is no direct correlation. At best, an indirect correlation that has delayed future disaster cost-savings effects;
  • There are other means to reduce climate disaster costs. Landuses need to be better managed;
  • Humanity does not have proof yet that vast investments will, in fact, generate the targeted emissions education targets.

ESG is coming at a significant cost, a cost that was not foreseen and quantified,

It will take a very long time to reverse the declining investment trend in oil and gas, even if a capital stampede reversal starts now. Oil an has companies are likely “once bitten, twice shy”, ” once marginalused, twice shellfish”. Why should they? It’s more lucrative to ride the wave of tight supply collecting riches.

La Niña may trigger another cold winter, and Russia is not sending enough pipeline gas to Europe. All of these are contributing further to the onset of a commodity supercycle.

RBC further writes:

“This journey will require new approaches to sustainable finance, if we’re to generate the $2 trillion needed to finance the transition. Overall, capital is not in short supply. Investible projects, with reasonable returns, are. What’s needed? An overhaul of industrial regulation and tax policy, and more government backstops, to offset the inherently risky frontier of clean technology, sustainable infrastructure and new consumer products. A lack of consistent and reliable policies continues to impede Canada’s ability to attract the sort of private capital needed to finance the transition.”

If the economy cannot generate ~CAD 2 trillion, lending it through federal government programs will contribute to more debt and deficits. A key catalyst pushing inflation higher over the transition period.

Quite rightly stated by RBC, we need better policies. We need approaches that integrate the path to Net Zero with the transition dependency on fossil fuels while the renewable energy storage, grid demands, and reliability as solved through technology innovations. It’s a dual process, this policy focussing on “Duality.” You honestly don’t need to have a string of Ph.D. letters behind your name to figure this out. All you need is plain old fashioned ” commonsense

Transcript: Jeff Currie Goldman Sachs on the Commodity Supercycle

Transcript: Jeff Currie on the Commodities Supercycle – Bloomberg

Eugene van den Berg, Oct 2021

Source: Bloomberg

Back in January, we spoke with Jeff Currie, the Global Head of Commodities Research at Goldman Sachs. At the time, he was bullish on the commodities complex for several reasons. Since then, of course, we’ve seen several markets go on an absolute tear and to a degree that’s taken even him by surprise. The bad news for commodities consumers? We still haven’t hit max pain. On this episode, we speak again with Jeff about what’s driving prices higher and why he sees stronger price increases over the next several months. Transcripts have been lightly edited for clarity.

Joe Weisenthal:

Hello and welcome to another episode of the Odd Lots podcast. I’m Joe Weisenthal.

Tracy Alloway:
And I’m Tracy Alloway.

Joe:
So Tracy, you see we just got the latest CPI report?

Tracy:
I did indeed. Looks like CPI came in slightly hotter than expected. Like not a huge deviation from the forecast, but of course everyone’s talking about the idea that, well, all of this was supposed to be transitory and yet, you know, here we are almost two years into the global pandemic and it doesn’t seem like any of this is going away.

Joe:
Right. And so, of course, there’s this debate about when transitory means, does it mean pandemic-related or does it mean brief? So we’re starting to split hairs on that. And then there’s also, you know, of course the deviation between headline CPI, which includes energy prices and core, which doesn’t, but the degree to which you could really ever like separate out commodities from the fact that commodities go into everything is kind of impossible. And with the exception of a few things, I mean, we are on a massive commodity/energy bull run.

Tracy:
Yeah. So the crazy thing here is that people were worried about higher inflation even before the commodities market really started going nuts, like just in the past month or so. I mean, I’m looking at some of the energy headlines that have just come over the Bloomberg today and it’s stuff like, you know, European zinc smelters cutting production by as much as 50% because of higher energy costs and, you know, a flood in a major Chinese mine and the Chinese government ending its intervention in the coal market. So basically liberalizing that entire market, which isn’t something that you tend to see that much in China, but is something that is sort of needed given the energy pressures right now. So things have just gotten to a whole new level when it comes to commodities.

Joe:
Yeah. And it’s interesting, you framed that really well. Cause you know, sometimes we do our logistics episodes and one of the themes is the way these sort of pressures compound, right? So something that happens at the port of Los Angeles ends up affecting warehouses, which ends up affecting truckers, which ends up affecting rail at Chicago. And it feels like on the raw commodities front, you see the same thing where it’s like, oh, some energy price spikes. And then the zinc smelters and the fertilizer companies have to pare back production because their production is no longer as profitable. And then that feeds into, you know, some other commodity or something like that. So it feels like there is a similar compounding effect and it’s probably, you know, it seems like a combination of demand, supply obviously. And then there’s sort of like all kinds of idiosyncratic factors, like whether it’s drought or whatever.

Tracy:
Yeah. Well, the other big thing that people are talking about now is how much of this is caused by the transition to clean energy. So this idea that we’ve had years of structural under investment in traditional fossil fuels, and now we’re sort reaping the consequences of all of that. You know, we don’t have enough renewable energy to satisfy demand just now, but we also don’t have enough traditional fuel. So there is just so much going on in the space.

Joe:
Yeah. And that seems particularly salient in Europe where they sort of pretty aggressively phased down nuclear. And now the natural gas bills are soaring. Anyway…

Tracy:
Wait, wait — I’ve just got to say, now some people are talking about reclassifying nuclear as ESG. So something that would fit under the environmental and social and governance-friendly mantle, which is something that, you know, if you suggested that a few years ago, people would’ve gone absolutely nuts. Anyway, go ahead.

Joe:
Anything to fit anything within ESG is probably like its own story. Anyway, we have the perfect guest on, because not only is he probably the best person to talk about commodities period, but we’ve had them on before. We had them on earlier this year actually in January. And he was very bullish on commodities then. So in addition to being very knowledgeable, yes, exactly. In addition to being extremely knowledgeable, he also has the benefit of having been correct, which a lot of people weren’t. And so now we’ll see what’s next. Excited to bring in our guest. We’re going to be speaking again with Jeff Currie. He is the global head of commodities research at Goldman Sachs, a real treat to have on. Jeff, thank you so much for coming back on Odd Lots!

Jeff Currie:
Great. Pleasure to be here again.

Joe:
So it’s been, I guess like nine months since we had you on in January and you were sort of, you called it, you were bullish and you said, this is like a big one that you see a big cycle coming. And obviously if you just look at the BCOM, the Bloomberg Commodities Index or numerous other headline measures, that was right. And so what’s your take on what’s happened? How does what happened compared to what you foresaw?

Jeff:
Yeah, it’s far more bullish than, you know, we could have ever envisioned. Let’s take oil. The deficit that we can measure at the end of last month was running somewhere around 4.5 million barrels per day. That’s nearly 5% of the market is in a deficit. That is such a large hole that OPEC the U.S. administration, nobody’s going to fix this. This is like, you know, the train is off the track and you’re watching it in slow motion. But it’s not just oil. You see it in copper, copper inventories dropping 8%, 10% week after week. These are numbers I have never envisioned or never seen before. You know, and you can think about what is going on here. And I think, you know, it goes back to Tracy’s point about that zinc smelter shutting down in Europe. Problems in one market create problems in the other.

So we think about, you know, first it was coal in China, then it became gas in Europe. Then it became aluminum in China, which then impacts copper elsewhere in the world. And it keeps this chain reaction going and each one of these markets get tighter and tighter. So what is it about oil that makes this deficit so much larger than we could have ever envisioned? It’s because you now have oil being used in lieu of both coal and gas because of the shortages in those markets. So bottom line is, you know, we see a lot of up side risk from these price levels, which are far greater than the price levels we were forecasting when we spoke, you know, nine months ago. So bottom line, the underlying picture is far more bullish than what we had expected nine months ago, but the drivers of it are pretty much in line exactly [with] what we thought just in a much larger degree than what we thought.

Tracy:
Yeah. If I could just press on that on this point. So I remember when you unveiled your bullish commodities thesis, you know, around the start of the new year or the end of 2020, you sort of had like a trifecta of reasons that you thought were going to drive the market. And one was the idea of this redistribution of demand. So basically, you know, people getting stimulus checks and going out and buying new things and buying steak dinners and things like that. And the second one was I think the structural underinvestment in traditional energy like oil, and then the third was this idea of supply chain and stockpiling. So people just sort of trying to build up their own energy independence or resiliency. And I’m curious, just looking back at that framework, is there a particular thing that has surprised you or stood out? Like, is there one leg of that sort of tripod analysis that has really caused the big spike that we’re seeing?

Jeff:
Actually all three are far more important than what we ever envisioned. And I actually want to go with the one that predates Covid. And the one that predates Covid is the underinvestment thesis. The theme that we termed it is the ‘revenge of the old economy.’ Put bluntly, poor returns in the old economy saw capital redirected away from the old economy and towards the new economy, basically taking from the Exxons of the world and given to the Netflixes of the world. And as a result, you starve the old economy of the capital base it needed to grow production and hence the problems we have today. So if it’s trucking in the U.S., which is old economy, chip manufacturers for autos, which is old economy, energy and gas in Europe or coal in China, they’re all the same story.

Now you can argue with the hydrocarbons, as you pointed out that the ESG factor, turbocharges this story. And it clearly has in places like Europe. But I want to emphasize at its core is that these companies have failed to deliver good returns over the last five to 10 years, and investors have had enough. And I like to point out, you know, we got a lot of investors back into the commodity and the old economy space. You know, when we were talking last January, but prices went up to $80 this summer on oil. And I remember it was late August — around August 28th — it was a Friday, oil had collapsed back down to $65. And these investors were going: ‘You lured us back in there. You said the coast was clear. We got in here and we just got completely hammered in terms of the volatility.’ They left. Then oil prices, where are they again? They’re back up to $83? There’s something inherent about the investments in here that make it difficult to attract capital.

It’s not going to be a smooth ride, you know, like it is in tech stocks where you just trend up. Instead, it’s going to be very volatile. So the bottom line, we’re sitting at $83, $84 a barrel oil today. And there’s no evidence of big increases in capex drilling, greenfield capex in metals or new acreage in agriculture. I can keep going down the list. So not only are the C-suites, the corporates, not spending on capex, but the investment dollars in this space is quite low. And as a result, if you get the investors to come back in this space, which we think could happen as we go into year-end, it could catapult the situation on relatively tight fundamentals that I started this discussion with. So I would say that’s the one, I want to point out.

But just quickly on the redistribution story that, that you bring up, the redistribution story is much [more] broad-based around the world than what we initially thought in way, if we think about, you know, in the U.S. when we were talking in January, could we have ever envisioned the $3.5 trillion U.S. human infrastructure fund? Um, absolutely. It was, I mean, this shows you how much larger these redistribution policies have become. Also, you know, the $1.9 trillion recovery act back in, you know, March, then we thought it was going to be $1.1 trillion. You know, it shows you just how much bigger these redistribution policies. China has its common prosperity, green leveling here in the UK. So it’s very — you know, you look at Germany’s government moving left, you know, Latin America’s moved left since we last talked. So bottom line is, you know, the redistribution policies are also bigger than what we thought. And then finally, just point on, you know, about the call. It de-globalization, I think to argue the trucking problem in the U.S. exemplifies the problems around de-globalization is because you have too much stuff being produced locally at home, in the us, which overwhelms the transportation, warehousing trucking, um, rail system, which has helped create some of the problems there. So why don’t we, you can think about United States exemplifies the problems with de-globalization Europe exemplifies the problems with decarbonization with what’s going on and it’s gas crisis. Anyway, that’s long answer to your question about all three.

Joe:
I mean, we want to hit all of these topics more, but let’s go a little bit more into the sort of like decarbonization, ESG stuff, because I think there are a lot of people who are like, ah, we told you so. You politicians had your visions of like a green economy, where we would all like power everything with windmills and solar panels and now look at the price we’re paying and maybe we won’t even be able to heat our homes. But the way you described it is a little bit, like, maybe some of that, but also like politics aside. A lot of these traditional fossil fuel investments were not great period. So how much is it sort of, as you say decarbonization policy that’s contributing to this revenge of the old economy versus decarbonization economics where people just weren’t making the investments because the numbers weren’t good?

Jeff:
Yeah. The, the bottom line is the returns in this sector were abysmal. And I don’t care if it is oil, gas…

Joe:
When you say this sector, you mean, just to be clear?

Jeff:
All fossil fuels. Oil prices were negative last year. You couldn’t create a more hostile environment, you know? So when you look at the investors that I try to get to come back in this space, they’re going, no, I’ve been there. I’ve done that. I know how painful this sector is. And so the way you could argue is ESG — the binding constraint, show me a great company with fantastic returns that’s not getting capital due to ESG. Right now, they don’t get returns because they’ve demonstrated a very difficult environment to generate returns on average. In fact, you know, you look it up, they’ve shrank down to two and a half percent of the S&P 500. To give you an idea, in the late seventies, they were running around 20%. So it’s a big shift here. And I think, you know, I spend time talking to many energy specialists and you get CIOs of these big asset managers on, going: ‘Hey, you know, I’ll listen to him once, but I’ve been there and done that before. And I’m just not that interested.’

And here’s a point when you look at the two thousands, that bull market. Prices spiked in 2003, but it wasn’t until 2006 that the capex began to flow. Why? Because they had a couple of years of really good returns and the investors felt really good about it. But I think, you know, the key point here is first and foremost, it is the revenge of the old economy and poor returns why the sector doesn’t get money. More recently you can say that, you know, it’s likely to be ESG. But I’m going to give you an example in Europe where it clearly is ESG. You know, the courts in Europe, the Hague ruled against Shell, made Shell liable for scope three emissions. That’s what the users of oil create. You know, that’s massive liability.

Yes, they’ll appeal it, but it’s going to be, you know, five, 10 years from now. I think the key point here is that with that kind of liability risk, nobody in their right mind is going to make large scale investments in places like the North Sea again, because they don’t want to be associated with that kind of liability. So it is beginning to bite, but you know, your standard ESG investors, and I do want to say they’ve raised the cost of capital and we’re going to find out — and this is where the ESG really comes into play — is we’re going to find out what price of oil do you need to get capital to flow? I like Scott Sheffield of Pioneer. He said a few weeks ago, he goes I don’t care if the oil price goes to a hundred dollars a barrel, I’m not going to drill. What’s going to make me drill? I need my stock price to double. And we’re going to find out at what price of oil these investors will start to buy these stocks again. You may be right, Joe. It may be that they’re just not going to buy it because of ESG concerns. I tend to think that’s not the case. There is a cost of capital associated with decarbonization and we’re going to find out what that cost is.

Tracy:
Just on the topic of oil. I mean, how much blame can you lay at OPEC for investor unwillingness to put money into stuff like U.S. shale? So, you know, there was always the sense that if shale flooded the market, then OPEC would react in some way and boost their own production and drive a bunch of the shale producers out of business. And then now, even as we see oil prices pressured higher, I mean, OPEC is still being pretty disciplined in terms of production. They haven’t said they’re going to ramp up output by that much. So I guess the question is like, what role does OPEC play in investors’ calculations?

Jeff:
The current OPEC, they got religion. They understand. They’ve been through a lot of pain. They couldn’t have a better business model than what they have today. They’re focused on balancing the market on a near term basis, keeping inventory low, keeping the forward curve in what we call a backwardation. So they’re focused on what they can control, which is the very near term balance. And then they create a credible threat that they will bring on capacity, bring investment on, which keeps the back end of the curve depressed. So they got what we call a backward -dated curve. Spot prices are high, backend prices are low. But to get to that level, to get to this great discipline and I would argue, you know, a great policy structure which makes sense given how much share they control in the market, it was a big policy mistake. And that policy from November 16 till March of 2020 was utterly disastrous and created a lot of problems we have today.

They didn’t, they’re not a monopoly, they’re not like the Federal Reserve where they have a hundred percent market share over the dollar. They don’t have, they have maybe a, you know, put them all together, a 33 to 40% market share over the barrels. And so for their ability to cut back production and maintain prices at $60 to $65 was always invariably unstable. And the investors that got lured into investing in the sector based upon that $60 price had a high probability of having the problems that they ran into in late ‘19 and, you know, 2020. But I do want to say, I think they’ve learned from those mistakes, you know, the new group of energy ministers in particular, I think they understand all of these issues. And so I’d argue they’re doing a fantastic job, they’re really sticking to what they’re supposed to do. And what they’re really good at is managing near-term imbalances in the market and focusing on providing capacity on a longer-term basis, which has left the forward curve in a backwardation, which makes it really difficult for the EMP producers to hedge. Why? Because prices are a huge discount on the back end, relative to where they are on spot.

Joe:
So before we move off of oil, I want to talk about U.S. oil a little bit more. And, you know, I’m thinking back to like 2014, 2015, the good old years, and there was this perception, or there was this characterization of U.S. shale as the swing producer that sort of kept a lid on prices because as soon as prices would rise a little bit, they could quickly ramp up production and that would bring prices down. And part of it was a rates story maybe, part of it was the technology story. What is the status of U.S. production now? And why is it not having that effect of being able to ramp up aggressively and sort of smoothly? I mean, I think there is some increase in the rig counts, but as you said, not that much. So why are we not seeing something greater out of the U.S. as a stabilizing force?

Jeff:
For one back then, the companies were rewarded on volumetric growth, not on return on equity. The investors paid a terrible price for that period. You look at the industry, you know, it destroyed a lot of wealth, like 10 to 20 cents on every single dollar. I think the number is actually closer to 30 cents on every dollar.

Joe:
So basically that aggressive supply response was just a mistake? Like it was just a bad, it was just, in retrospect, it turned out to be a bad approach to business?

Jeff:
Because they were operating at like 105 to 115% of cashflow. So, you know, what they were doing is they were basically growing volumes on the expectation of future returns. But obviously when you grew all those volumes, you would get crushed on the backend in terms of what was being delivered. And so the focus left being a focus on ROE, and instead being a focus on growth. Today, the focus is on ROE. They want to get those returns on equity up. And by the way, the investors who own this company, they want their money back. You know, the OPEC ministers want their money. Everybody wants their money back from the disastrous experience over the course of the last five to seven years. So at this point, you know, you look at why aren’t they drilling because for the first time in nearly a decade, and in fact, you probably have to go back, yeah, you got to go back to ’07, ‘08, that these companies are finally getting free cashflow going up.

They’re not overspending. They have returns moving higher. And so now they’re getting rewarded on return on equity as opposed to growth. And it’s going to be a while. Everybody wants to be made whole, and then they’re going to get the green light to go out and invest. That’s kind of the point. I think Scott Sheffield got it right. The focus here is not on the dollar price of oil, but where is their stock price and their access to capital? Now here comes the whole ESG issue, which means that that hurdle rate is going to be higher and higher before that capital’s going to come in and make that stock price go higher. I tend to think there’s always somebody in the world out there who’s going to buy this, which is why, when you look at the, you know, the investors that do pursue, you know, these ESG strategies, it’s going to be difficult because there’s going to be somebody out there in the world that’s not restricted around these, that’s is going to go out and make these investments, which I think, you know, makes it, you know, it’s not a level playing field right now.

Tracy:
Since you brought up ESG, I guess the obvious question here, the big question is what does all this mean for ESG or green investment? Do we start to see a backlash to green investing and do investors, you know, maybe start pulling out capital or put less capital in or divert some capital to, you know, older fossil fuel energy and things like that?

Jeff:
Well, I have a couple points on that. One divestitures never solved any problem. And when we think about, you know, with ESG in particular, it came about originally because the Europeans were getting frustrated that the Americans and Chinese were not doing anything on the policy side, but the problem why the investors drifted into the policymaker lane is a policy makers weren’t doing their job. And when we think about what job they need to do, they need to create, you know, rules around decarbonization that allow operators to operate around and gives investors the rules of the road in which to invest around. And that’s kind of the problem is that there’s this nether world that’s occurring. And they got these investors just trying to invest in, or policymakers trying to make these investments in things that they don’t really understand. And I think it’s a really risky environment that we’re in. And I think what’s going on in Europe is a testament to the misallocation of capital that can occur in this environment in where you’re [inaudible] markets dictate and policymakers dictate what the rules of the road are and what, you know, investing around those rules of those road.

Tracy:
Hmmm. Just on one of those points there, I mean, the point about the role of the government there is well taken and that’s been of the major criticisms of ESG that they’re trying to fulfill something that should actually be done by governments and through new laws and things like that. But there’s also this sort of foundational debate in ESG about whether or not it should be investors engaging with companies to make them change their behavior. So you care about the environment you’re invested in Exxon or Shell or whoever, and you try to encourage them to change their behavior by actually being invested in having a relationship with the company. Or do you ignore them altogether and invest only in companies that are doing renewable energy that have divested all the old, traditional, dirty stuff, and you try to increase the cost of capital for anyone who is basically in that old energy space. I don’t know what my question is here, but like, I guess it’s, how do you think, like ESG should function? Like what is ESG trying to do?

Jeff:
I think, you know, your Exxon example is spot on. It’s going in there and helping the situation and trying to find the solution is the right answer. It’s the divesture knee jerk reaction that’s the dangerous one. And I want to really distinguish between that. So when we think about, you know, ESG, that, you know, preserves the market signaling, then it’s working great. It’s there where you go, okay, anything that’s hydrocarbon is bad. Let’s shut down the investment. Because bottom line, India should not have three days of coal stocks left right now. Just think about that — three days of coal stocks. And if all of a sudden you had a major disruption India would be out of power in three days, that’s a dangerous place to be for one of the largest, most populous countries in the world.

Joe:
Let’s talk about some of this sort of like ongoing sort of mechanical disruption issues that we’re seeing. And I want to actually focus in on what we’re seeing in China, because it seems to be, there’s a number of moving parts, Tracy and you both talked about that earlier. Overall, what is your take? Let’s start big picture and then maybe zoom in on specific commodities. But overall, what’s your take on sort of like the Chinese energy picture? Cause it seems like very extraordinary and unusual.

Jeff:
Well, you know, it boils down to shuttering of very toxic coal mines. I like to point out what China’s going through today is very similar to what the U.S. did in the seventies when, you know, creation of superfund sites. So it shut these down, these things were very toxic. Then you don’t have the investment in coal globally. And then you have a foreign policy spat between Australia and China. So you put it all together, the access to coal dropped tremendously … By the way, this is all stems from the fact that these supply constraints were there. It took that post-Covid surge in demand that exposed it all across, you know, metals, oil, gas, coal, trucking, you know, whatever, pick your industry. It exposed them all in the old economy.

And it had happened to be particularly acute in coal in China. So then what happened is then they had to replace the lost coal with gas. So they started to hoover up the world’s LNG supplies. Then they started replacing it more recently with oil. Um, and that’s, what’s helped create the big deficit in the oil and the bid in oil. So the bottom line is, you know, you put it together, the situation is dire enough that even our economists have trimmed fourth quarter GDP to being flat with three quarter and taken down first quarter of ‘22. Now there’s investments in coal in Mongolia, and then potential increase in exports of 300,000 tons that many people point to that means this problem goes away next year. It eases the problem. What about further growth rates in GDP and more activity? It just puts more stress on the system.

That’s why we like to argue this thing’s a supercycle, meaning that, and then think about how much stress you put into aluminum, zinc and all these other industries where you’ve had to shut down smelter. So if you want to really think about the chain reaction here, some people kind of simplify the world. It starts in China, coal in China, and then that creates tightness in gas that created the problems in Europe, Europe substitutes into oil, creating the problem in oil. You’ve shut down the (aluminum) smelters, the zinc smelters, you know, so a lot of people say, you know, that the ground zero of those problems really was coal in China. So I do want to say the situation in China is very dire, but it’s just one part of the world that can create a solution to it rather quickly and they’re trying to with investments in Mongolia.

But I want to be careful about restarting a lot of that shuttered coal. For those of us that are Americans and know what a superfund site is in the U.S., restarting these facilities is going to be a lot more difficult, a lot more expensive than I think what people think it will be. So you really got to focus on the new, more cleaner, sophisticated coal, in some of these mines in places like Mongolia. So bottom line, it’s going to be tight over the next three to six months, but once you get that Mongolian coal up and running, the situation should ease, but no way does it solve it.

Joe:
You mentioned it briefly, but you know, when we talk about important global commodities, obviously the first one that comes to mind is probably oil. And I don’t know, maybe natural gas, aluminum prices [are at a] 13-year high in China. And of course, aluminum is used in all kinds of just everyday items. So if we’re thinking about how commodities bleed into sort of normal inflation, that seems like an important one to focus on. Can you walk through a little bit more about the economics of aluminum in China right now, and what you see going on sort of like putting this inexorable upward price pressure there?

Jeff:
Aluminum is a unique commodity, it’s the climate-change paradox. You need it to solve climate change, but it creates a lot of emissions in the production of it. So, you know, it does two of the same. And so when we think about the situation in China right now, if you’re operating on a call it a carbon budget, you know, you’re allotted this amount of carbon production for your economy. One of the most polluting, you know, commodities. In fact, it is the most polluting commodity to produce is aluminum. You’re not going to want to produce it, it’s getting the first thing you shut down. Think about what really is aluminum. It is solid energy. You just take alumina and electricity. You put the two together, and now you’ve got, you know, a solid piece of metal there. So if you’re trying to conserve energy, conserve, you know, how much carbon you’re admitting, the first thing you’re going to pull the lever on is going to be aluminum, which is why you look at, you know, you know, China’s cut 2 million metric tons of capacity, you know, that and about a 50 million metric ton market.

So it’s sizable in terms of what they’ve taken out on top of, you know, that stuff that’s already been taken out elsewhere in the world. So that’s really at the core of what’s driving this. But I do want to go back to the point about cost push inflation, that commodities are being driven by cost push inflation. There is zero evidence of it. It’s always demand pull in the sense that, you know, demand is strong across every single one of these commodities, services and everything else. And it’s demand pulling everything along against the supply constraints that creates the upward pressure on prices. It’s not the input costs accelerating that’s driving up the cost and other parts of the industry, but you think about how did it, you know, aluminum, how does it create tightness in other markets? Because once you lose a supply, let’s think about it, it starts with coal. Tightness in coal.

It’s not that the coal price led to higher aluminum prices. What it was, was a lack of coal led to a shutdown of aluminum smelting and against strong demand that drove up the price of aluminum, which then feeds into more demand for copper as a substitute against aluminum. So, you know, you can think about it as being, you know, the supply chain, you know, working along that way. So it’s not that that the cost of, you know, energy is driving the cost of everything. It’s demand pulling everything along. And when you think about it that way, you know, that’s how you get broad-based inflation because it’s not just isolated. Cause think about it, if it’s isolated in one market, let’s say oil prices, that’s a relative price move. And if you think about, if money supply stays the same, the price of oil goes up. Then the price of everything else has to go down because there’s a net constraint with money supply. But if you think about it, demand is pulling everything along, money supply is growing along with it. Then the price of everything starts to grow as opposed to being a supply shock being relative price moving away.

Tracy:
You touched on this earlier, but what’s the difference between a bull market in commodities versus a supercycle? And like, I, I sometimes get the sense that like commodities experts are very sensitive on this particular topic mostly because I had an argument earlier in the year about whether or not what we were seeing was a commodities boom, or the start of a supercycle. And people got very, very pedantic, but like, what is the difference? And which one are we looking at at the moment?

Jeff:
We’re looking at a commodities supercycle and it goes back to this demand demand story. It needs a structural rise in demand. I can get a bull market in oil driven by a supply shock in Saudi Arabia, but that’s not a supercycle. A supercycle is driven by a structural rise in demand. And why do we have a structural rise in demand? And give me a minute here because I really want to explain this point because I think it’s critical to understanding the difference between physical markets and financial markets. And we think of physical markets like oil or aluminum, they’re what we call volumetric markets. How do you determine if you’re bullish oil? The volume of demand versus the volume of supply. If demand is above supply you’re bullish, no dollars enter into the equation, no growth rates, nothing like that. So physical markets is driven by volume.

Now what are financial markets and GDP, they’re all driven by dollars. How many dollars do you pump into those markets? And it determines whether or not they’re bullish or not. You know, so no volume enters into a financial market. Think about equity. You quote it in billions of dollars, or GDP, you quote it in trillions of dollars. Volume doesn’t enter. So let me summarize. Physical market’s driven by volume ,financial markets and GDP driven by dollars. Now let me ask you the following. What do the world’s rich control? Dollars. They control wealth and income. Can [the] rich create financial inflation? Absolutely. Yes. Can they create GDP? Absolutely. Yes. Can they create physical good inflation? Numerically impossible. There’s not enough of them. It’s a volumetric game. And so only the world’s low income group can create inflation and commodity bull markets. And there is no exception to that. You cannot find me an exception.

Every commodity supercycle is driven by low income groups, as well as every bout of inflation. In fact, you know, let’s start with the seventies. It was LBJ’s war on poverty. The 2000s, when China was admitted to the WTO, it was a gigantic wealth transfer, rich Americans and rich Europeans to low income rural Chinese — 400 million of them. There was your volume, it created inflation in China and a commodity bull market. You know, the inflationary episodes in Latin America tied to populist policy. The list goes down and on. So you come to the conclusion that inflation and commodity bull markets are directly tied to populous policies. And I can’t find an exception to that. So if we argue that we’re in an environment in which there’s, you know, great focus on low income groups and even think about green capex as Joe Biden says green capex creates jobs. As Boris Johnson here in the UK says, he calls it green leveling, spending on green capex to create jobs.

So everywhere we look, even the green capex is focused on lower income groups. And as a result, then we look across the demand levels. You know, gasoline barrels were at an all time high this summer, and I can go across the board, the volumes, just look at the level of demand of durable goods and everything like that. It’s off the charts. So that’s the reason why I think we’re in a commodity supercycle. It’s not because of anything else other than that simple observation that the volumetric demand growth we see right now and going forward is not just a, you know, it’s something that’s hitting all the markets simultaneously. And that’s really what is at the core of a supercycle. So Saudi losing production can create a bull market in oil, but that’s not a supercycle. Was that clear?

Joe:
Yeah, that was fantastic. So I guess like, you know, I know we just have a couple of minutes left here, but, you know, like I said, we talked to you in January. I felt like you nailed the call and then some. We’re in the supercycle as you characterize it. I don’t know commodities, it’s always a cliché, innings, so to speak, but what are we going to be talking about with you in nine months when we rebook you and how much longer is this going to be going for? What’s going to happen in the future. What’s your crystal ball say?

Jeff:
We’re going to be pricing scarcity at that point in time, across oil, metals and everything at that point in time. And when we think about, you know, the transitory nature of these events is that when the system is so strained, like it is right now, it just takes a small little problem to create a big upward movement in price. So you think about what Europe was created by. It was created by the wind quit blowing. The market had to replace that wind power generation with natural gas. And there was no gas there and a small event like the wind quitting blowing, created a massive price spike … Before you’d have to draw something out of the tails to get a problem. Today, you just draw something in the middle of the distribution and you get a problem.

Which means that these transient events are going to be, they’re higher probability and more frequent in nature. So there becomes a persistency to the transitory events. That’s what scarcity pricing is all about. It’s not like you’re going to get a big upward trend in prices, but you’re gonna continue to get, you know, price spikes. So, you know, I think if you brought me back in six months, I think that’s going to be the highest pain point. By the time we look at nine months, you have a much higher probability of the system trying to find solutions to it. So three to six months, I think that’s going to be your max pain point. On oil, we have a $90 target but I want to emphasize lots of upside risks to that. We look out to next year, we’re $11 to $12,000 a ton on copper, but you know, a lot of upside risk to that.

But the real upside risk I’d argue probably happens in that first quarter of next year. Hopefully when we meet nine months from now, we can say, Hey, you know, we see drilling in the U.S. We see, Iran deal has come, you know, there’s a higher probability of getting an Iran deal, the system begins to ease, which is why we see prices moving back into that $80, $85, at the nine month horizon. So if we meet six months from now, I think there’s going to be peak scarcity pricing, and nine months from then to a year, much higher probability that we’ve found some type of, at least, near-term solution.

Joe:
But max pain still coming…

Jeff:
Max pain probably coming in the next next three months, if not sooner.

Joe:
Max pain still coming. Jeff Currie. Thank you so much, always great to chat with you, a real treat. And like I said, we’ll have you in a six or nine months back, and we’ll see if we’re at truly max pain.

Jeff:
Well, thanks for having me.

Tracy:
Thanks Jeff, appreciate it.

Joe:
Take care, Jeff. It’s always a treat talking to Jeff. I just feel like I get like such a big, such a useful, big picture perspective talking to him.

Tracy:
Totally. And I mean, I feel like I’m a little bit biased because, you know, I was a capital markets reporter for a long time, I like writing about things like corporate bonds, but I remember writing a lot about the shale boom in the U.S. as a capital markets story. And I think Jeff did a fantastic job of like drawing that connection once again. You’re not going to get higher oil production and less investors feel comfortable putting money into the company and the company feels comfortable actually putting that money to work in terms of investment and expanding production. And we’re not quite at that point.

Joe:
You know what, I love that point because there is this sort of very clichéd [thing], which I’ve always hated, where like the stock market isn’t the economy. Actually, the stock market is a very important part of the economy. And sometimes maybe it reflects the economy, but sometimes it very much, sometimes it doesn’t reflect the economy, but sometimes it drives the economy. And so when you have a CEO, as he was pointing out, and I want to go find that transcript where he’s like, you know, the determinant now of how much U.S. oil will ramp, it’s actually the stock market itself and the sort of return expectations of investors and having learned the lesson of the sort of like 2010s that pure volume is not a great long-term return on investment is super fascinating to me. It’s like, we’ll drill more when the stock price goes up is sort of like the opposite of how people think like, oh, the stock market is just a mirror to what’s happening in the real economy. And that case is clearly a driver.

Tracy:
Oh, totally. I mean capital markets matter. And this is a really good example of that. The other thing I would say that I really appreciated hearing was his differentiation of, you know, a commodities bull market. The idea of commodities just going up versus a commodity supercycle. And this idea that ultimately a supercycle is something that’s going to come down to physical volume and scale. And so that scale has to come from somewhere and he sort of pinpointed the idea of scale coming from surging demand from the sort of, what did he say, lower income class.

Joe:
Yeah, the redistributionary impulse. For sure.

Tracy:
Which makes a lot of sense, you know, it’s about scale. And so it kind of has to be about consumption from like the biggest proportion of the population as possible.

Joe:
So many interesting points. You know, his point about how normally like, you know, a few days without wind in the UK wouldn’t be a big deal, but this time, because of the tightness of the market, so many comparisons between what’s going on in logistics. Really great getting his perspective on aluminum. Just it is a real treat to talk with Jeff. And again, we got to get them back on it like six or nine months.

Tracy:
Yeah. We’ll make this like every nine months type of event. I think that would be good. Ok, shall we leave it?

Joe:
There? Let’s leave it there.

Momentum Catalyst for the Commodity Supercycle unfolding

Eugene van den Berg, Oct 2021

In another post of the current commodity supercycle unfolding I made reference to commodity supercycles also being supported by accompanying dollar weakness.


What are we looking at and what are we observing:

    • The US Dollar (USD) as measured by the DXY Index vs. the Commodity Research Buro (CRB) Index
    • We compare the start of the commodity supercycle of 2002 to 2011, and more specifically, the behavior of USD weakness and commodity strength shortly after the onset of the supercycle, to the behavior today (far right) of the onset of the current commodity supercycle (that started in April 2020), and more specifically the behavior of USD weakness and commodity strength shortly after the onset of the supercycle;
    • The inverse relationship between USD weakness and commodity strengths was when the last commodity supercycle gained momentum around 2004. We are perhaps not there yet in the current cycle; and
    • The current USD weakness is less inversely correlated with the CRB index. The CRB Index performance at the start of the current commodity supercycle is much more aggressive in relation and is at a steeper inclination compared to the start of the commodity supercycle of 2002 to 2011.

Will the premise hold that a commodity supercycle is also partly driven by USD weakness? What is different this time around?:

    • When the commodity supercycle started in 2002 the world was:
      1. flush in oil to support increased manufacturing and shipping;
      2. Renewable Energy (RE) was mainly talked about with less strongly articulated RE policies; and
      3. China was the main driver of growth experiencing economic growth above ~10% constant double digits. China also became the “world’s factory”
    • The start of the current commodity cycle:
      1. lacks the benefit of sufficient investment in oil and gas;
      2. RE and energy transition is contributing to an energy crisis;
      3. Vast under investment in oil and gas since 2015 driven by climate activism
      4. China’s economy is showing signs of slow growth;
      5. RE and Electronic Vehicle legislated start dates (dates that Internal Combustion Engines end to be sold in countries) driven the energy transition to green with a specific demand for core commodities (lithium, cobalt, copper) and component parts that are required for the manufacturing of microchips. Microchips are experiencing severe supply chain challenges not expected to be resolved before 2023. What does that do to pivoting to selling more EV’s?;
      6. RE core commodities experiencing demand that exceeds supply; and
      7. Covid19 that contributes to labor shortages and shipping backlogs

I believe the fact that many nations, including the USA, which is also the world’s reserve currency nation, are focused on RE development and energy transition, could see the inverse correlation panning out differently from what we observe from previous commodities supercycles. Would this suggest that the impact on inflation for many nations could be more severe, rising commodity prices combined with relatively less weak USD performance?

A disorderly energy transition

Financial Post: Peter Tertzakian: We are witnessing the perils of a disorderly energy transition

 

Eugene Van Den Berg, Oct, 2021

From the article above the Financial Post writes:

“Climate crisis plus energy crisis does not equal a good path to net-zero emissions. Policy wonks at the upcoming COP26 conference in Glasgow later this month will have a tough time with this calculus. It’s been a while since the phrase energy crisis has been thrown around. When I hear it, I have déjà vu to the 1970s. We are witnessing the perils of a disorderly transition, the consequence of mismanaged efforts at decarbonizing the world’s energy systems.

And as with the financial crisis of 2008, which spread around the globe because of systemic risk and contagion, the current energy crisis is spreading from Europe to China to Brazil and soon it will start hurting here at home, North America notwithstanding all the Natural Gas and Oil reserves. the last 7-years in Canada are painted with canceled projects all in the support of the climate agenda. Even though Canada has the world’s 3rd largest oil reserves, it means “squad” because the means to carry it to market for Canada and the world to benefit from has been amputated amid the canceled projects. Even if projects are started now it’s too late and will not be completed in time to fend off any energy crisis. It’s ironic, given that the low Green House Gas (GHG) emissions are being recorded by Canada at ~1.6% of the global total. Another astonishing fact is the quick argument that Canada has a very high emission per capita. I’ll write about that in a separate post safe to say that when we talk an=bout “per capita” both sides of the “per capital” coin are important to grasp. Canada is also painted as having a very high emissions intensity per barrel of oil produced. Nothing is further from the truth as Canada’s record compares favorably to the rest of the world. More about that in another post.

Peter Tertzakian, uses a great analogy, in the above article: ” In business, the word ‘transition’ embodies the premise that people replace old products and processes with new. Sales of the latter grow and the former wane. For example, paper map sales go down when GPS unit sales go up. I didn’t stop buying maps, nor took them out of my glove box, until I was convinced GPS was leading me to the right destination and that there was ubiquitous signal coverage wherever I went. Maps may be a trite analogy to oil, but here is the point: Preserving redundancy through a transition offers continuity of a function, security, and a sense of comfort.

Another way to look at it can be found in history in the late 1800s to early 1950s. The transition from horse and carriage to Internal Combustion Engine (ICE, or car).

When mankind transitioned from horse-to-car it spanned approx. 50-years. The difference then was, making the transition from one reliable source of transport to another cost-effective source of energy to drive transportation. Businesses like blacksmiths went bust only to be replaced by tire shops and dealer repair shops. The transition took place to an energy source in the abundance of supply, reliable, easy to obtain, and cost-effective. No doubt that fossil fuel drove the enhancement of the quality of life for all on planet earth. Fossil fuels play a key role in poverty eradication too evident when comparing the correlation trend between energy consumption, population growth, and poverty eradication.

The transition from fossil fuels to Renewable Energy, and specifically wind- and solar power, aims to capture and tap 100% into the unlimited supply of the sun’s energy and the wind’s power. That’s great, free energy resources, who can say no to that. However, the reality is that although win and sun energy exist in an abundance of supply, the methods in capturing and storing it are the challenges that are tripping up making inroads into this behemoth megalodon transition goal. Wind and sun as of now, contribute approx. 17% and 25% of installed capacity. One can ask a valid question about this. If the climate change agenda has been in effect for ~30-years, why is the effectiveness of its contribution to energy consumption low and seems to remain low? What is preventing these forms of energy to capture compounded market share (of utilization NOT generating capacity)?

The world will still be dependant on fossil fuels for the foreseeable future.

As developed nations race towards ESG utopia ideology and cancel old faithful fossil fuels, other countries like Saudi Arabia and Iran welcome the giving of free gifts in terms of global oil market share. The developed world daily is donating market share to these countries on a silver platter. Imagine the cost for course reversal one day at which point it will be too late and we are likely going to repeat 1973 many times over before we land in ESG utopia. For them, it’s “partying like it’s 1999”, never to be repeated again. This, that right there, plays into concerns of future energy security. I get a feeling and a vision of a “MadMax” landscape where the less ethical controls all the oil when we are long still not quite done with oil and gas. We are following ourselves to ignore “duality” as the basis of transition.

Uranium is joining the commodity surge

 

Day Traders Are Driving Uranium Prices Higher WSJ https://www.wsj.com/articles/day-traders-are-driving-uranium-price-higher-11634637082

Eugene Van Den Berg, Oct 2021

From the above article:

“Enthusiasm from individual traders is reshaping the market for nuclear fuel that generates a tenth of the world’s electricity and sending uranium-linked stocks higher. After languishing for a decade after the Fukushima disaster led Japan and Germany to close nuclear reactors, spot uranium prices have shot up to $47.10 a pound from $32.25 at the start of August. They remain below their peak of $137 in 2007”

With the current energy crisis and previous Renewable Energy (RE) transition plans to make a “quantum leap” in the short-term, no that’s wrong. It’s actually “trying to take a shortcut on a global scale to chase an ideology, the world has “injured” itself in doing so”. As we learn in school solving the math problem does not work so well trying to take shortcuts. We may get to the wrong answer, and still get marks for the steps shown in solving the Algebra equation. Let that sink in then you may appreciate that the race to “prefect ESG” creates problems that are best avoided.

Germany wanted to cut nuclear and replace it with RE wind and solar. It did not quite work out as planned.

Other countries are running flat out a stampede to instantly move from coal-fired plants to RE wind and solar, having disregard that energy transition will have better outcomes when executed in a structured and organised fashion. Transition from coal to Natural Gas and Nuclear whilst, alongside that, the challenges around RE wind and solar intermittency is scienced to perfection, including solving battery storage and fast charge challenges for Electric Vehicles, will ensure smoother long-term outcomes.

To top it all off, as we transition, all should be engaging in planting trees and replace forests being destroyed in a rehabilitation ratio of [1:10]

Inflation surges

Canada Inflation Hits 4.4%, Deepening Central Bank Challenge – Bloomberg.

Eugene Van Den Berg, Oct 2021

As I have predicted earlier in 2021, inflation is going to be with us for some time. 

From the article:

“That’s the highest reading since February 2003, exceeding consensus expectations of 4.3%. Higher food, shelter, and transport prices were the main contributors. The hot inflation readings of the last six months are deepening a communications challenge for Governor Tiff Macklem, who maintains the spike in consumer-price gains will be short-lived. The data also comes as traders in the overnight swaps market bet increasingly against the Bank of Canada’s guidance that policymakers won’t raise interest rates until the second half of next year. Traders are pricing in at least three interest-rate hikes in Canada by the end of 2022, which would bring the policy rate to 1% from the current 0.25%.”

Raising rates from the current level of 0.25% to 1% in approx. one year from now will do very little to tame inflation.

Inflation patterns of the 1970s are evidently combined with the onset of a commodity supercycle I have been writing about regularly since earlier in 2021. A shortage of energy drives this commodity supercycle, demand for Renewable Energy (RE) core commodities to manufacture RE parts (industrial processes uses oil), and on top of that, deficit spending and high levels of debt.

Without productivity improvement, which in Canada has been weak for decades, the inflation spiral will subsist for a longer time. The risk for stagflation is also becoming more to the fore.

Why supply chains matter

https://www.wsj.com/articles/why-is-the-supply-chain-still-so-snarled-we-explain-with-a-hot-tub-11629987531?adobe_mc=TS%3D1634479540%7CMCMID%3D66329940426629611998333562908936619243%7CMCORGID%3DCB68E4BA55144CAA0A4C98A5%40AdobeOrg&wsj_native_webview=androidphone

Eugene Van Den Berg, Oct 2021

The Wallstreet Journal writes about the interconnection of supply chains, which most take for granted as we only see the end product and have a “sort-of idea” of the input materials.

In this article, although the complex procurement system supporting the manufacturing of hot tubs is used to illustrate it, and there are thousands of similar manufacturers in the world, it is an excellent example of the different processes at work to bring a final product to the consumer. The type of process is not limited to only the manufacturing of hot tubs. All products are supported by procurement and supply chains running effectively.

Supply chains are akin to the oxygen flow in your bloodstream. Constraint oxygen causes multiple problems.

Think back to the 1700 and 1800 small towns: one street, a few businesses along the main street. Supplies were sourced locally on the main borders of the city. Think about the general dealer and local horse smith and iron-works depicted in The Little House on the prairies. Live was simple.

Today, sourcing and procurement are complex. It’s driven by globalization and massive integration. The internet, transport modernization, access to information, online transaction processing, communication technology, etc., played a significant role in shifting procurement from local sources, as it was in the 1800s to thousands of miles away on the other side of the globe today

A question I am asking, is how would prolonged supply chain challenges impact working capital and funds flow for businesses? Can it lead to seizing up working capital because of liquidity constraints brought on by delays? What does that do to interim borrowing, capital management, financial restructuring? What does it do to the recognition of liabilities stemming from pending order fulfillment? All these aspects in their own right causes are crowding out effects, and they all share a single dominator, “unforeseen delay.”.

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