"The End of Abundant Energy: Shale Production and Hubbert's Peak"

[Previously from Goehring & Rozencwajg: "Why Won't Energy Companies Drill?", Q2 (2022) Natural Resource Market Commentary, "The Distortions of Cheap Energy" and Goehring & Rozencwajg and Horizon Kinetics on Commodities.]

Highlights from Goehring & Rozencwajg's fourth quarter 2022 Natural Resource Market Commentary, "The End of Abundant Energy: Shale Production and Hubbert's Peak".

• Few of us properly appreciate the importance of the shales. Not only were they the only source of incremental growth over the past decade, but they were also tremendous in absolute terms. Between 2010 and 2020, US shale oil production grew by 7.6 mm b/d, while natural gas liquids (nearly all from shale) increased by 4.0 m b/d. Total liquid production from the US shales grew by 11.6 mm b/d – more than Saudi Arabia’s production of 10.5 m b/d.
• Shale gas production grew an incredible 65 bcf/d over the same period. When converted to barrels of oil equivalent, shale gas added another 10.8 m boe/d – equivalent to a second Saudi Arabia.
• In recent years, Goehring & Rozencwajg has become convinced that shale production growth will slow and eventually turn negative. So far, the data has confirmed our thesis. If current trends continue and the shales do indeed plateau and roll over, global oil markets will have lost their only source of growth. Many of the resource depletion theories of the 2000s will likely return as critical issues in the 2020s. Investors would be wise to study them now.
• The development of shale oil spelled the end of public interest in Peak Oil. Like Professor Hall, many openly dismissed and even ridiculed Hubbert’s work., US production bottomed at 4 mm b/d in 2008 and, driven entirely by the shales, has grown since to become the largest oil producer in the world.
• While Hubbert’s predictions look ridiculous when considering total US liquids production, focusing only on conventional crude production suggests Peak Oil is alive and well. Last year, the US produced 3 m b/d of conventional crude oil – 7 m b/d or 70% below the peak reached 52 years ago. In other words, the shales bailed out total US production but did nothing to change the forces underpinning Peak Oil and depletion. On a global basis, conventional oil production (total production ex shale and Canadian oil sands) has exhibited no growth in 17 years.
• E&P companies successfully determined over time the “sweet spots” of the basins, where attributes such as thermal maturity, thickness, permeability, porosity, and organic content were ideal. In 2014, we estimate 45% of all drilling occurred within Tier 1 areas, whereas by 2018, it had surged to over 65%. If the industry were getting better at drilling wells, then previously low-productivity drilling locations would be converted into high-productivity locations, allowing production to continue to surge. Instead, we determined the industry was “high-grading” or drilling its best wells first. Our neural network told us that companies were drilling their best top-tier locations in all their basins. If our neural network was correct, we argued in 2019 that per well productivity would peak and begin to fall as tier 1 prospects dwindled, leaving the industry to either drill many less productive wells or, if not, see their production decline.
• Given the shale’s prodigious production growth, almost everyone believed they were limitless. Analysts talked about chronic oversupply without once thinking about the underlying geological constraints. Although the shales are extremely large, we determined they behaved precisely like traditional (albeit enormous) fields. We concluded that shale basins exhibited Hubbert-style production profiles: they ramped up, plateaued, peaked, and declined. The two earliest shale basins, the Barnett and Fayetteville, peaked between 2011 and 2014 and have both since declined by 70%.
• Interestingly, the Permian has been the only basin to grow drilling activity since the end of 2019. In the Bakken and Eagle Ford, activity remains 10% below pre-COVID levels, whereas, in the Permian, activity is 5% above late-2019 levels. The answer is the superior inventory of remaining Tier 1 locations. Unfortunately, this superior inventory is being drawn down. We estimate that closer to 45% of all Tier 1 Permian locations have been drilled. The Permian is quickly approaching the same level of development as the Bakken and Eagle Ford in 2019. Our models tell us the results will be similar: Permian production will peak, plateau, and decline much sooner than anyone expects.
• All five companies in our super-major survey increased capital spending and production in 4Q2022. Spending grew 22% compared with 2Q2022 from $11.1 bn to $13.6 bn. Year-over-year, super-major capital spending is up 25%. Increased spending was driven by Chevron (up 37%), Exxon (up 28%), and Shell (up 22%). BP and Total grew their spending much less: 10% and 5%, respectively.
• Crude demand has proved far more resilient than most analysts have expected for nearly two decades. For example, economic activity slowed following the 1980 oil price spike, and demand fell almost 10%. It took nearly ten years for demand to surpass the 1980 peak. On the other hand, economic activity plummeted following the 2008 price spike and the global financial crisis. Instead of falling by 10% (or even more), crude demand fell by only 1.5%, surpassing the 2007 peak in 2010. The difference was that in 1980, OECD countries made up 68% of global oil demand, whereas by 2010 it was only half. Emerging markets have a much different price elasticity and demand profile than developed countries: consumption is far more resilient. More recently, during COVID, energy analysts argued vociferously that global demand would never again regain 2019 levels. Less than three years later, the International Energy Agency (IEA) expects 2023 demand will be 1.4 m b/d greater than in 2019.
  

Goehring & Rozencwajg - Q2 Natural Resource Market Commentary

[Previously from Goehring & Rozencwajg: "The Distortions of Cheap Energy" and Goehring & Rozencwajg and Horizon Kinetics on Commodities.]

Highlights from Goehring & Rozencwajg's second quarter 2022 Natural Resource Market Commentary, "Why Resources During a Recession":

• Both energy and materials are considered extremely economically sensitive. Oil has pulled back almost 30% from its June high of $120 per barrel, and Dr. Copper, the metal with a PhD in economics, suggests a global recession is looming. Natural resource investors went from asking, “Have I missed it?” to “How can we possibly allocate money to resources if we are heading into a recession?” in a matter of weeks. These worries are not unfounded. During the Global Financial Crisis (GFC), natural resource stocks collapsed. Materials and Energy were two of the worst four sectors in the S&P 500 (along with Real Estate and Financials), falling 60% from May 2008 to March 2009. As recession fears took hold a few months ago, traders fell back on the same tactic. As the market sold off from June 8th to July 12th, materials and energy were once again amongst the hardest hit sectors, falling 15-25% in only a month. We strongly discourage investors from using recessionary fears as a reason to sell commodities. Commodity markets today bear no resemblance to 2008. Investors using the 2008 GFC playbook risk selling commodities right at the bottom, missing the huge potential returns embedded in these markets over the coming decade. When investing in natural resource equities, the commodity capital cycle is far more important than the broad economic cycle.
• The key insight here is that the commodity capital cycle may or may not correspond with the broader business cycle (i.e., expansion and recession). Heading into the GFC, the two cycles were in near-perfect alignment. Commodity prices were extremely high relative to the stock market in early 2008. Energy and materials made up 20% of the S&P 500 – a 30-year high. Natural resource capital spending had accelerated. Driven by high prices, insatiable Chinese demand, and endless analyst calls for a commodity “super-cycle,” energy and mining capital spending in the S&P 500 surged four-fold between 2000 and 2008 from $80 bn to an all-time high of $330 bn per year. When the recession arrived, the commodity sector was hit hard. Energy stocks fell by 50% while mining stocks fell 65%, gold stocks fell 25%, and agriculture related equities fell 40%. Natural resource equities rebounded in 2009 and into 2010, but then entered a decade-long bear market. The capital spending surge during the bull market of the middle-2000s ultimately resulted in new production of almost everything: iron ore, coal, copper, shale gas, and oil. The GFC represented a rare alignment of a bearish commodity capital spending cycle and a bearish broader business cycle. It is no wonder that investors are skeptical of natural resource investments given the experiences of the GFC. However, we think focusing solely on one episode risks missing the point. As it relates to natural resources, the GFC was an anomaly: for most of the past 120 years, the commodity cycle and the business cycle have not been in sync at all. In fact, throughout the twentieth century, resource equities have actually been good investments during most recessions.
• In this context, the GFC was indeed a unique episode in which the commodity capital cycle and the business cycle were in sync. After several years of strong performance capital had rushed in and new projects abound. As a result, prices fell sharply during the GFC, recovered somewhat, and then entered a 10-year structural bear market. Today conditions couldn’t be more different than those preceding the GFC. Commodities and natural resource equities have never been cheaper and more out of favor relative to financial assets. In 2020, energy and materials made up less than 2% of the S&P 500 compared with 20% in 2008. Because of the 2010-2020 commodity bear market, capital spending for almost all extractive industries has been severely curtailed. For example, in the energy industries, capital spending in the S&P 500 has fallen from $320 bn per year to less than $100 bn today and, as you will read in the “Incredible Shrinking Super Majors,” what capital remains is not being spent efficiently.

"Why Won't Energy Companies Drill?"

[Previously from Goehring & Rozencwajg: Q2 (2022) Natural Resource Market Commentary, "The Distortions of Cheap Energy" and Goehring & Rozencwajg and Horizon Kinetics on Commodities.]

Highlights from Goehring & Rozencwajg's third quarter 2022 Natural Resource Market Commentary, "Why Won't Energy Companies Drill?":

• Following Russia’s invasion of Ukraine, oil prices broke through $100 per barrel for the first time since 2014. Most analysts predicted that triple-digit oil prices – the highest in nearly a decade – would produce a strong response in drilling activity. However, thus far, that response has been muted. Even now, after six months with oil prices greater than $85 per barrel, the US oil-directed rig count remains at 533 – nearly 40% below the 2018 levels despite oil prices having nearly doubled.
• [A] tight relationship has historically existed between oil prices and drilling activity. Between 2008 and 2018, the oil price alone explained 70% of the variation in drilling activity. Since 2020 however, this relationship has broken down. The industry should be turning 1,000 rigs; instead, they are stuck stubbornly at 533.
• We estimate that a company with high-quality Permian acreage can generate $38 mm in undiscounted cash flow from a well given $80 WTI, compared with $8 mm in drilling and completion costs. Given more than half of a well’s cash flow is generated in its first two years, the IRR at today’s oil prices is well over 200%. Given these extremely attractive single-well economics, why are the companies not drilling more?
• By keeping activity low, oil companies are simply responding to the signals sent from their three significant constituencies, all emphatically telling them not to drill. These constituencies are policymakers, investors, and their internal strategy teams.
• Low valuations encourage companies to favor returning capital to shareholders over increasing drilling, despite strong single-well returns. Here’s why: The E&P sector trades at 0.8x its net-debt adjusted PV-10 per share. For those to whom this is unfamiliar, the SEC requires energy companies to publish their PV-10 value (or standard measure) annually in their 10-K. The companies must list their proven reserves and estimate the discounted cash flows using a given oil and gas price. Removing net debt and dividing by the share count yields the so-called “net-debt adjusted PV-10 value per share,” which we will refer to as NAV per share going forward. In the past, investors capitalized an energy company at a multiple of NAV, reflecting the future development potential not yet reflected in their proved reserve figure. The trick was to determine the appropriate multiple given the company’s assets.
• We cannot recall a time when the entire industry traded for less than its NAV, and these extremely low valuations have tipped the scales away from drilling and toward dividends and share repurchases. Consider a hypothetical E&P company trading at 0.8x its net-debt adjusted PV-10 per share. Our hypothetical company has $1 bn of PV-10, 10 mm shares, and $200 mm of net debt. The company’s CEO can choose between spending $100 mm on new drilling or buying back stock. Assuming they can find and develop energy reserves for $15 per barrel of oil equivalent (boe), the company will book 6.7 mm boe of newly proved developed reserves for the $100 mm investment. At $80 crude and $5 gas, we estimate this investment would generate ~$130 mm in new PV-10. However, because the market capitalizes the company at only 0.8x NAV, the ending stock price would be virtually unchanged. On the other hand, if the company bought back $100 mm of its stock, its share count would fall by nearly 20%. Adjusting for net debt and dividing by the new lower share count implies the stock would rise by over 5% -- more than by drilling new wells. Therefore, the CEO that choses to return money to shareholders will enjoy a higher stock price and still have his best wells left undrilled. Under these conditions, no rational executive would rush to increase activity. Even though each well drilled would generate an IRR of nearly 80% in our example, the company is better off deferring development. The companies’ extremely low valuations explain this paradox. To summarize Edward Chancellor in “Capital Returns,” high multiples value growth and reward investment, while low multiples discount growth and encourage discipline.
• We call this analysis a company’s “signal to drill,” and we believe it explains the industry’s reluctance to increase activity. Looking company by company, we estimate over 50% of the remaining undeveloped reserves in the US are in the hands of companies for whom it is better to return capital than to drill. Those companies with a clear “signal to drill” are growing production by 8%, while those without are shrinking by 4%. Pioneer Natural Resources (PXD) is an example of the former. PXD trades at a 100% premium to their NAV, and the company is growing production by almost 20%. In the latter category, Laredo Petroleum trades at a 70% discount to NAV, and its production is declining by 7%.
• In 2018, the industry had a much clearer signal to drill despite lower prices. Oil averaged $51 per barrel in 2017 – 40% lower than today; however, we estimate the industry was valued at 4x NAV compared with 0.8x today. Using the same parameters as in the example above, drilling increases the stock price by 7%, whereas buying back stock at very high valuations would decrease the price by 10%. Even though a single well’s IRR is much better today than it was in late 2017, the difference in valuations back then pushed oil companies to drill. If oil companies traded at 3x NAV, everyone would have a positive “signal to drill,” and a considerable drilling boom would be underway. These same companies today are being told to defer drilling and development because of depressed valuations.
• The last group signaling energy companies to keep development muted are their strategy teams: petroleum engineers, rig crews, and project managers. The reason is resource depletion. We have long argued that Eagle Ford and Bakken producers have drilled out most of their best wells, so production would likely plateau and decline. Over the past years, several companies have gotten into serious trouble by running out of high-quality inventory. As recently as 2017, Oasis Petroleum, a sizeable Bakken driller, claimed they retained 20 years of top-quality Tier 1 drilling locations. However, only a few months later, they tacitly acknowledged they were running out by closing a high-priced Permian acquisition to exit the Bakken and forestall future production declines. The strategy did not work, and Oasis declared bankruptcy in September 2020.
• When you think about the challenges now being faced by the industry in these terms, you can easily see why oil company executives would keep the pace of development subdued. On the one hand, you could increase activity, risk attracting the ire of policymakers, have your stock price go down, and deplete your irreplaceable asset. On the other hand, you could return capital to shareholders, stay under the radar of policymakers, have the market reward your capital discipline, and keep your Tier 1 assets for a later time when the market will better value them.
• In past cycles, the “signal to drill” has often been determined by the oil and gas price. When oil prices fell from $100 to $27 between 2014 and 2016, the industry laid down rigs because they could not generate a return on drilling. As prices recovered in 2016 and into 2018, the rig count rebounded by 600 rigs. Because of record low valuations, this is the first time we can recall where the “signal to drill” is driven by valuation instead of oil price. As a result, higher prices have not incentivized increased activity. Until investors allocate capital to the
  space and valuation improves, we expect drilling activity to remain subdued and oil shale supply disappointments to continue.
• [W]e believe OPEC’s current output, at 29.9 mm b/d, represents its maximum capacity. Not only is OPEC pumping less than 2 mm b/d below their quota, but we believe Saudi Arabia’s current production (~ 11mm b/d) is putting strain on their fields and is unsustainable -- a subject we have covered in the past. With any contrarian thesis, we lay out roadmaps that try and predict what we should expect to see if we are heading in the right direction. In 2019, when Saudi Aramco released its first reserve report in nearly 50 years, we predicted their production could not exceed 10.5 m b/d for any sustainable period without incurring material field damage. As a “mile marker,” we stated that anytime Aramco pumped above 10.5 m b/d, they would quickly announce an unexpected production cut. These “surprise” curtailments occurred in 2019, 2020, and again today. In today’s example, weak oil demand has given the Saudis cover to slow production once again. We continue to believe the real reason they slowed production is field exhaustion.
• Assuming our models are correct and the Saudis cannot pump more than 10.5 mm b/d, OPEC pumping capacity is much lower than stated. Nearly every other OPEC member cannot achieve their quotas, and the 1.5 m b/d of unused Iranian capacity remains sanctioned. Since Iranians are now providing weapons to Russia, the probability of the US lifting its sanctions is quite remote. Considering these, we believe OPEC’s pumping capacity is only 31 m b/d and not the commonly stated (and accepted) 34 m b/d. With demand now pushed up against total pumping capability, the only thing keeping inventories from continuing their multi-year plunge has been the 1.5 mm b/d of coordinated releases from US, European, and Japanese strategic petroleum reserves. The world has become addicted to SPR sales to keep global markets balanced and prices from soaring. The Biden administration has stated that SPR sales will continue into December, but they cannot go on forever. As of today, the US SPR has already fallen by 32% and, at current rates, will be entirely depleted within 17 months.
• Although the continued growth in gas supply combined with the loss of Freeport LNG demand has pushed out our thesis concerning the convergence of US and international gas prices, we still have great confidence this will occur at some point in 2023. It appears the Marcellus is in the process of rolling over, which is very much in line with our models. Those same models suggest we will see a significant slowdown in the Hayneville’s growth very soon. The Haynesville rig count has doubled since the 2020 COVID-related bottom but has stagnated over the last 10 months.

A correspondent writes in to share a link,

I think it's pointing to why everyone shorting energy according to the "recession playbook" is going to be blown out. Energy was in a nearly decade-long retreat and then was finally clubbed to death in 2020. Equities have recovered, but are still at a discount. Managers shorting XLE according to the usual recession rules are committing the recency bias error. They are missing the fact that energy stocks were clubbed in 2020, and only came off historic lows in 2021. They are looking at 2022 in isolation and thinking "sell energy," as if it's 2008, 1998, or 1980 and energy is going to return to 2020/2021 prices without realizing how impossibly cheap 2020/2021 valuations were. or that energy companies have been deleveraging like mad the last 12 months. Equities have even more earnings power now than they did last year. 

We pointed this out on Twitter:

It appears that many investors think that shorting energy is a smart way of hedging recession risk in their “software eating the world” tech portfolios. The top 800 hedge funds are long "tech" and short energy, still, a full two years after tech versus energy peaked.

"Hubbert's Peak is Finally Here"

We really like Goehring & Rozencwajg's quarterly commentaries on energy and natural resources. Here are a few highlights from their second quarter commentary titled "Hubbert's Peak is Finally Here":

• The most crucial development in global oil markets is depletion in the Permian basin. We first warned about this in 2018, predicting the Permian would peak in 2025. In retrospect, our analysis was too conservative. We now believe the basin could peak within the next twelve months. The implications will be as profound as when United States oil production peaked in 1970, starting a chain of events ultimately sending prices up five-fold over ten years. If we are correct, this could not come at a worse time for oil markets: inventories are tight, production in the rest of the world is declining, and investors are incredibly complacent.
• The trends first outlined in our 1Q22 essay, “The Gas Crisis is Coming to America,” are still all in place; the exceptionally warm weather has simply pushed them out. Even with warm weather, 100% of the storage surplus occurring over the last eight months can be attributed to the fire at the Freeport LNG facility in June last year, which took offline two bcf/d of export capacity. Freeport is again operational, and with the Marcellus gas fields plateauing and six bcf of additional LNG capacity coming on stream in 2024, we believe North American natural gas convergence with international prices could happen much faster than anyone expects.
• Given its “pariah” status, no industry has been more capital starved than coal over the last ten years. As the structural deficit in global natural gas comes to the fore, coal prices should again become price leaders as this decade progresses. We have just started an enormous commodity bull market, similar to the commodity bull markets of 1929-1941, 1968-1980, and 1999-2011. In each of those bull markets, coal equities were the best-performing sector from trough to peak. Given underlying fundamentals, depressed valuations, and a complete lack of institutional interest, we believe coal equities could again become the best-performing equity group when this bull market is over.

Goehring & Rozencwajg manage a mutual fund (GRHIX/GRHAX) with a little over $200 million in assets. The fund owns oil and gas E&Ps (32%), uranium miners (15%), gold miners (13%), copper miners (12%), agricultural companies (12%), coal producers (6%), offshore services (6%), and other oil services (4%). The biggest position is in Range Resources (7%), followed by Cameco (uranium; 4.4%) and Pioneer (E&P; 4%).

If you look at our Shale Treadmill scatterplot, Range Resources is almost all (98%) natural gas and had 39% year-over-year capex growth (Q1 2022 to Q1 2023) resulting in a 3.5% increase in total BOEs produced. Pioneer is evenly split between oil and gas and their y/y capex was down 8% yet BOEs were up 7% - a very favorable result.

It is surprising that G&R do not seem to own any royalty companies (or coal or metals royalties), nor any Canadian oil or deepwater oil producers. They are very bullish on commodities and energy prices but they have a very different approach to constructing their portfolio.

Goehring & Rozencwajg: "The Distortions of Cheap Energy"

We have posted excerpts from Goehring & Rozencwajg in the Links. Here are some excerpts from their Q4 letter, "The Distortions of Cheap Energy":

 

We estimate the US E&P companies will only spend $45 bn in 2022 – up from the COVID low of $30 but far below even 2019’s depressed level. The last time oil averaged $90 was 2014, a year in which E&P capital spending totaled $140 bn – nearly four times higher than we expect this year. The market needs more supply, but the normal clearing mechanism is being blocked by ESG pressures. Engine No. 1 secured three Exxon board seats in May 2021, despite owning a mere 0.02% of the shares outstanding. The fund waged a public campaign urging Exxon to slash upstream capital investment. Fearing similar shareholder activism, most energy companies have diverted spending away from production and focused instead either on returning capital to shareholders or on funding renewable projects.

These activist investors believe traditional energy will soon be eclipsed by renewables, both in terms of economic returns and carbon emissions. They talk relentlessly about renewable power’s declining costs and how someday renewables will compete with hydrocarbons in energy efficiency. They argue that this time really is different because of electric vehicles and that oil demand, after 160 years of relentless advances, will decline. They warn about the risk of hydrocarbon assets being “stranded as demand falters and investments made in long lived hydrocarbon asset such as oil sands will never be recovered. These activists argue that energy companies must stop spending on their upstream immediately or risk impairing their capital and instead must spend on renewable energy investments that will ultimately yield higher returns. They believe they are acting rationally in the face of changing technology, but what they really are doing is preventing the carefully choreographed energy capital spending cycle from taking place.

--

It is no coincidence that the proliferation of renewable energy occurred during a decade of abundant cheap energy and abundant cheap capital. As both resources become scarcer and more expensive, the inherent limitation of renewable energy (i.e., its significantly worse EROEI) will come to the fore. Our view is extremely out-of-consensus. In fact, most investors believe low energy prices have severely discouraged the adoption of renewable energy. When we ask what impact rising energy prices will have on renewables, the vast majority argue that higher energy prices will help renewables by making them more cost competitive. Most investors are under the impression that much higher energy prices will push renewables “into the money”--- that is renewables will become competitive for the first time versus higher priced hydrocarbons. This completely ignores the fact that energy itself makes up the single largest cost component for both wind and solar. Instead of making renewable energy more cost competitive, higher energy prices will simply drive up the costs. Renewables today remain “out of the money” and higher energy prices will never be able to push renewables “into the money.”

--

EROEI is not some abstract academic concept; it has huge impacts on a country’s economy and its ability to grow. Germany, after the Fukushima nuclear accident, decided to close all of its nuclear power plants. Nuclear power plants have the highest EROEI of any energy source (100 : 1) and nuclear power supplied almost 25% of Germany’s electricity. Much of the nuclear generated power was replace with renewables with EROEI’s of only 3 : 1. To any observer, there should be no mystery about why German electricity prices have surged by over four-fold in the last two years and why Germany is at the center of Europe’s energy crisis—it’s what happens when you replace an energy source with incredibly high efficiency with an energy source embedded with low efficiency.

--

Whether you look at absolute prices, the backwardation, producer stock prices or inventory levels, all the normal market signals are screaming for more oil. This in turn requires more upstream capital spending. Unfortunately, ESG pressures are serving as a block, preventing capital from entering the oil market and preventing it from balancing. There is little relief in sight. Capital spending at the 100 largest energy companies in the S&P 500 topped out at $228 bn in 2014 and had already fallen by a third to $155 bn in 2019. The COVID-19 pandemic drove capital spending budgets lower by another 40% in a single year to $91 bn in 2020. With oil prices nearing $100 per barrel, energy capital spending is only expected to reach $98 bn in 2022 and $110 bn in 2023 – half the levels in 2014 the last time oil was above $90 per barrel.

--

Many of our clients want to know about oil demand destruction. They want to know what oil price will impair global economic activity. This is a very difficult question to answer, but both history and theory can point us in the right direction. We have done a lot of work on the history of energy. Throughout most of human history, energy was provided by biomass with an EROEI of 10:1. This relatively low energy efficiency did not leave any surplus energy for growth. Neither GDP nor population grew until commercial coal deposits were developed in the seventeenth century (please see our video here to learn more). If an EROEI of 10:1 resulted in de minimis economic growth, what can we use this 10:1 number to infer about how high oil prices can go today? An EROEI of 10:1 means that 10% of all energy goes to sustain the energy supply. If energy is a good proxy for general economic activity, then an economy should stagnate once 10% of its GDP goes towards producing (and by extension consuming) energy. Evidence backs this up. Many academic studies suggest an economy will fall into recession once energy takes up 10% of total GDP – an empirical result that agrees with our theory.

In 2008, energy prices were approximately 10% of GDP right before the global financial crisis. If oil represents about half of all energy consumed, this means an economy will stall when oil represent about 5% of GDP. In 2008, the US consumed 18.8 m b/d. At $120 per barrel that equated to $823 bn or 5.6% of the $14.7 tr US GDP. The economy fell into recession shortly thereafter. In 2012-14, oil consumption never exceeded 3.5% of US GDP and prices stayed between $90 and $100 per barrel with no impact on either demand or economic activity. Today, oil represents less than 3.3% of US GDP and would have to rise to $140 per barrel before approaching the critical 5% threshold.

We have mentioned in the past that we have settled on long-life Canadian oil majors and royalty trusts for our energy investments. Some key concerns that informed this:

• Avoiding (or benefiting) from escalating production costs, which other E&Ps will have.
  
• Avoiding reinvestment risk / principal agent conflict with managements, which seems to be the key reason that the E&P sector fails to build value over time.
  

Oil sands are almost royalty-like, in the sense that (a) the capital costs are front loaded, unlike drilling wells, so they should benefit more from inflation than an E&P and (b) they have decades of sands to mine, so you avoid the forced reinvestment at inopportune times.

Tuesday Night Links

• Other information missing from the story that seems essential to charting Vanderbilt's rise: what he paid for various business assets and how he financed them, what he earned from them and what he paid in taxes, when he controlled an asset and when he was a minority partner, etc. Especially, we should like to know his leverage over time and how he was able to benefit from the various money panics that occurred repeatedly throughout his business career. One thing is for certain, he seemed to always be a buyer in such scenarios, never a seller, and he seemed comfortable being in control of his investments and making and enforcing operating policy, rather than being a mere financial speculator such as a partner like Daniel Drew might. [The TX Taipan]
• NRP generated $72 million of free cash flow in the first quarter of 2024 and $312 million of free cash flow over the last twelve months," said Craig Nunez, NRP's president and chief operating officer. "NRP has generated more free cash flow over the last two years than during any comparable period in the history of the Partnership. This performance has allowed us to make considerable progress toward our goal of eliminating all our financial obligations. The sum of debt and preferred equity outstanding is down to approximately $260 million, the Partnership is warrant free, and our financial position is solid and improving. [Natural Resource Partners L.P.]
• As readers of my older posts know, I always find the small European washing machines a bit hard to decipher, especially when written in Czech. A little Google translation led me to discover that the Gorenje machine doubles as a dryer. The wash cycle was two hours and the dry cycle was three in this very energy-conscious continent. [Curated Carlos]
  
• Berkshire itself is so large and diversified now that the businesses that dominate its operations hardly get a devotee of Buffett’s investment approach excited. The insurance operations, the energy assets, and the railroad - which get the lion’s share of the attention - do not the resemble the Gross Profit Royalties of old. [Larry Jamieson]
• With most manufacturing processes, even those using precision methods to produce interchangeable parts, there is a fair degree of tolerance in the process. If a part is a fraction of a millimeter too long or too short, it will still fit. If the impurity content of a metal is a tiny bit too high, the metal can still be used. If a process runs slightly too fast or too slow, the output is still usable. In semiconductor manufacturing, allowable tolerances are whittled away to almost nothing. Making transistors a few nanometers across requires processes that are hundreds of thousands of times more accurate than conventional manufacturing. The tiniest rogue particle can short out a connection and destroy an entire chip. A few atoms in the wrong place can cause a process step to fail. Imperceptibly small amounts of impurities can irreparably damage materials. [Construction Physics]
  
• While helium is the second most abundant element in the universe, it is relatively spare on earth: produced as a by-product of nuclear decay of heavy elements in the Earth’s crust, it accumulates in the same geological deposits as natural gas. However, only a few such natural gas deposits have sufficient amounts of helium to make it economically viable for separation, purification, and supply. [Silicon Semiconductor]
• With the introduction of Ivanhoe Electric’s Typhoon survey, hard-rock geologists can, for the first time, image mineral deposits several thousand meters below the surface. Unsurprisingly, 80% of all copper mine supply comes from deposits discovered within 200 meters of the surface – that is how deep the geologists could “see.” With Typhoon, that has changed. We know that copper porphyries exist at depths greater than 200 m, as several have been discovered by accident. However, the industry has never been able to explore for  these large ore bodies efficiently from the surface. [Goehring & Rozencwajg]
• To illustrate: our electronic medical records which doctors are forced to spend a significant amount of each day entering data into collect an absolutely massive amount of medical data. Yet—despite countless pleas to, we almost never mine that data to determine what constitutes the best medical practice (e.g., which drug produces a better outcome for a condition or which pharmaceuticals are more likely to harm than help a patient). This would be very easy to do, numerous people (including an acquaintance of mine) have tried to do this but got shut down (e.g., the government scrapped a system that in 2010, showed 2.6% of recipients of vaccines had an injury within 30 days of vaccination). I in turn, would argue that suggests the data in those records greatly threatens the pharmaceutical industry (which is why I was so supportive of RFK Jr’s VP nominee’s call to make that data available to everyone). [Midwestern Doctor]
• One of the things I do around the edge of the portfolio is mess with the energy weight. Some of this is old habits — most of my option trading career was being active in oil and gas. But I also see energy as fundamental to the concept of inflation and inflation is the largest tax on investment returns. I actually see the core of our portfolio not as means of getting rich — it’s just preserve purchasing power as best we can without incurring major drawdowns so we can sleep well at night. Because sleeping well = health. And so long as we are healthy, I’m confident our human abilities will provide prosperity. I’m trying to sterilize the impact of the random number generator and rely on idio — in life terms. These days I have a small overweight to oil. This is something I’m in and out on with horizons of about 1 year. It’s purely on vibes. I bought XLE in late 2020 after the oil crash and when Tina told me that you couldn’t even touch the Brent call skew in the early part of the Ukraine invasion I sold the position (and in a “old degen habits die hard” moment told her to buy wheat calls if the skew was still stale — iirc that was timestamped on a whatsapp screenshot on twitter). [Moontower]

Friday Night Links

• Back in October of last year, I had the pleasure of discussing the “generational opportunity in energy stocks” with Leigh Goehring. At the time, he made a very compelling investment case for the energy sector and in just the five months since then it has nearly doubled in value. Leigh and his firm still believe energy offers compelling value but to truly appreciate it, it helps to also understand the related bubble in both renewables and electric vehicles. In this conversation, Leigh’s partner Adam Rozencwajg shares his views on the mania in these so-called green energy stocks, outlining why renewables and EVs are not the panacea for climate change investors believe them to be and why, ironically, the best way to profit from the transition to green energy may be in the very stocks ESG investors are shunning today. [Felder]
• The “big market delusion” is when all firms in an evolving industry rise together, although as competitors ultimately some will win and some will lose. The electric vehicle industry, with its astronomical growth in market-cap over the 12 months ending January 31, 2021, is a prime example of a big market delusion. In the highly competitive and capital-intensive auto industry, the January 2021 valuations of electric vehicle manufacturers are simply not sustainable over the long term. [Research Affiliates]
• Allowed ROE’s for electric and gas utilities have trended downwards for years with declining interest rates. At YE20, allowed ROE’s nationally are roughly 9.4%, although there are large variations from state to state. Importantly, there is larger than average gap between allowed ROE’s and the 10YR UST (8.46% as of YE20) compared to the historical average of 6%. [Enlightened Capital]
• ENB currently trades at 17.1x 2021 EPS and 14.6x 2022 EPS. Additionally, the company trades at 11.6x 2021 EV/EBITDA and 10.6x 2022 EBITDA. Given ENB’s strong and improving DCF generation, ENB represents an attractive investment trading at an 8% FCF yield with 5-7% annual DCF growth expected over the next 5 years. There is also a massive disconnect between prospective returns on ENB’s bonds and ENB equity. You can earn a 2% return purchasing an unsecured ENB bond maturing in 2029, a 3.4% return on an unsecured ENB bond maturing in 2049, or 13-15% for ENB’s equity. A 10+% equity risk premium for a stable company is unjustified in my opinion. [Enlightened Capital]
  
• Give me your busted compounders, your energy stocks, Your huddled microcaps yearning to breathe free, The wretched financials of your teeming shore. Send these, the ETF castoffs, tempest-tost to me, I lift my lamp beside the value investor door! [Nate Tobik]
• A given means of production, combined with a resource base, will throw off some amount of surplus.  That surplus is divided among the p0pulation based entirely on their power. Sometimes that power comes from scarcity, often managed scarcity as in the Medieval Guild system, or un-managed scarcity during the first decades of a technological change (hello programmers), but most often it comes out of the barrel of a gun; from the point of a spear, or from the edge of a sword. [Ian Welsh]
  
• The “Coalition of the Ascendant” prophecy isn’t happening. Democrats barely won the 2020 election. They have less power in the state legislatures. Joe has a thinner majority in Congress than Barack Obama. It has gotten so bad that Democrats have to use budget reconciliation to pass a bill that has the support of 70% of the public to give people free money. They don’t have the juice to even do popular things like raise the minimum wage because of their cultural toxicity to White working class voters in rural states. What is Joe going to do now after signing the COVID bill? Is he going to wage a “War on Terror” against “domestic extremism” and the “insurgency” which only exists on CNN and MSNBC? What happens if he peaks after signing the COVID bill and the rest of his agenda just flatlines in the Seante? [Occidental Dissent]
  
• What has happened to Denmark? Once renowned as a liberal, tolerant, open-minded society with respect for human rights and a strong and humane welfare state, we have now become the first country in Europe to revoke residence permits for Syrian refugees. Last week, Danish authorities ruled that the security situation around Damascus has improved, despite evidence of dire living conditions and continued persecution by Bashar al-Assad’s regime. As a result, they stripped 94 refugees of their right to stay in the country. Another recently introduced proposal would move all asylum applicants outside Denmark. [link]
• Among the many traits the peoples of our two countries have in common, none is stronger than our mutual abhorrence of war. Almost unique among the major world powers, we have never been at war with each other. And no nation in the history of battle ever suffered more than the Soviet Union suffered in the course of the Second World War. At least 20 million lost their lives. Countless millions of homes and farms were burned or sacked. A third of the nation's territory, including nearly two thirds of its industrial base, was turned into a wasteland--a loss equivalent to the devastation of this country east of Chicago. [JFK]
• Dr. Seuss was one of the most effective propagandists advocating for war and internationalist foreign policies committing American troops and treasure abroad. An enemy of the original “America First” conservative populist movement, Dr. Seuss was not just an advocate for America’s early entry into WWII, but for a permanent internationalist foreign policy posture after WWII, and for the re-education of people worldwide into the ideals of American democracy. Dr. Seuss was the pen name of Theodor Seuss Geisel, son of an evangelical Lutheran family in Massachusetts who adopted radical leftist politics in his youth and honed his craft as a persuasive artist, first as a well-paid ad man for the oil industry, and then as the premier cartoonist for PM. [Chronicles]
  
• Beginning in 1899, Packard built luxury cars for kings, princes, bank presidents and movie stars. In the 1920s, its cars cost five-hundred-thousand dollars each, in 2021 dollars. The 1929 stock market made the high-luxury market too small for Packard to survive by building ultra-luxury cars. So it entered the Buick-Oldsmobile-Pontiac-Lincoln market with cars no more impressive than Buick-Oldsmobile-Pontiac-Lincoln cars. The competition in a market segment packed with competitors was too intense for Packard. It stopped building cars in 1958. Tesla is repeating the Packard experience. It is going from a low-competition market to a high-competition market, building un-needed cars in a market packed with cars that have better build quality. [CBS]
  
• The industries with the worst trailing 10 year returns (all negative) are: metals and mining, oil, gas & consumable fuels, and energy equipment & services. If this theory is right, there should be mean reversion for them. The rising profits will attract people who will pay higher multiples - double counting. Meanwhile, the sectors that have been enjoying high profits and good times will have been over-investing. The NASDAQ earnings peak is already in the rear view mirror. [CBS]
• I am bullish on reopening, especially when you combine it with a money-printing stimulus bill that is so gigantic I am wondering whether it might feel like an abrupt currency devaluation this summer. The challenge is to find investments that aren't already pricing-in the reopening. Things like airlines and cruise ships are very obvious to retail, and they have never been my favorite investments anyway. I prefer to find things that are royalty businesses or some kind of real asset (e.g. real estate) rather than a low-margin "spread" business that could just as easily be challenged by higher input costs associated with the shock of the reopening. [CBS]
• Having reported evidence that the brain required arachidonic and docosahexaenoic acid specifically, for its growth, structure and function in 1972, our work has focused first on testing the evidence, the specificity and the requirement. Attention is now directed on establishing  (i) the biological reason for the uniqueness of docosahexaenoic acid in neural signaling systems which stretched unchanged over the 500- 600 million years of evolution and  (ii) the application of this knowledge to the prevention and treatment of neurodevelopmental disorders. [Michael Crawford]
• In humans, the therapeutic window for lithium treatment of bipolar disorder lies between 0.5 and 1 mM in serum, whereas concentrations of 1.5 mM and above severely increase the risk of tissue damage (Malhi and Tanious, 2011). Previous work in Drosophila suggests that the dose range at which we observed lifespan extension (0.5–25 mM) translates to Drosophila tissue concentrations below 0.5 mM (Dokucu et al., 2005). As previously reported for C. elegans and Drosophila (McColl et al., 2008, Zhu et al., 2015), concentrations above 50 mM were highly toxic. Drug interventions to promote healthy lifespan are less likely to have side effects if started late in life (Castillo-Quan et al., 2015). Only a handful of drugs approved by the US Food and Drug Administration, namely rapamycin, metformin, and the Ras inhibitor trametinib, induce lifespan extension when commenced at later ages in model organisms (Harrison et al., 2009, Cabreiro et al., 2013, Martin-Montalvo et al., 2013, Slack et al., 2015). We found that lithium extends lifespan when first administered in mid-late life. In humans, long-term treatment with lithium for psychiatric disorders is associated with progressive and permanent renal damage (Malhi and Tanious, 2011). We showed that short treatment periods in Drosophila, 15 days during early adulthood, are sufficient to prolong life. Taken together, our data suggest that when testing lithium as a pro-longevity drug in mammals, lower doses than those used in psychiatric disorders are likely to be sufficient, and other strategies such as alternate-day dosing or transient treatment periods (either early or late in life), may be sufficient to reduce undesirable side effects and maximize the potential health benefits. [link]
• For example, there has been a 1000-fold increase in the consumption of soybean oil in the United States during the 20th century and, as a result, the per capita consumption of its primary unsaturated fatty acid component, linoleic acid (LA, C18:2), has increased from less than 1% to approximately 7.4% of energy intake. Soybean (SO) and other oils high in LA have been shown by us and others to be obesogenic and diabetogenic in rodent systems, and we have shown that a diet enriched in SO similar to the American diet causes a global dysregulation of hundreds of genes in the liver compared to an isocaloric coconut oil (CO) diet. [link]
• Arete (Greek: ἀρετή) is a concept in ancient Greek thought that, in its most basic sense, refers to "excellence" of any kind. The term may also mean "moral virtue". In its earliest appearance in Greek, this notion of excellence was ultimately bound up with the notion of the fulfillment of purpose or function: the act of living up to one's full potential. The term from Homeric times onwards is not gender specific. Homer applies the term to both the Greek and Trojan heroes as well as major female figures, such as Penelope, the wife of the Greek hero Odysseus. In the Homeric poems, Arete is frequently associated with bravery, but more often with effectiveness. The person of Arete is of the highest effectiveness; they use all their faculties—strength, bravery, and wit—to achieve real results. In the Homeric world, then, Arete involves all of the abilities and potentialities available to humans. [Wiki]
  

Thursday Night Links

• We are still in the opening innings of the reversal in value versus growth, but today was a big drawdown for growth investors. Do you even hear any of them questioning themselves? From what I can see, they are blaming macro factors and not considering the strategic factor bet. [CBS] 
  
• This is a good paper from commodities investor Goehring & Rozencwajg. One point it makes is that while the unit economics of drilling for oil are attractive right now, the economics of spending that same sum on buying back stock are even more appealing. Low multiples are both a tax on capital expenditure (each incremental dollar of capex produces less market value than it otherwise would) and a subsidy to buybacks (if the stock is trading at a discount to its fair valuation, buybacks make it cheaper). A very off-the-wall policy proposal for fixing this would be to expand the strategic petroleum reserve's mandate, and allow it to not just buy physical oil but to buy huge amounts of stock in oil companies, too. The SPR is a special kind of investor with an unusual utility function: their mandate is cheap oil (at least at times when it's expensive), and one way to indirectly produce it is to ensure that the substitute good of oil-related equities isn't so competitively cheap. In the event that oil prices rise, owning those equities is a hedge against refilling the SPR on less advantageous terms. And if oil stocks underperform, it also means the SPR doesn't need as much money. The current value of the SPR is about $30bn, but it's been worth upwards of $100bn in the past, and $100bn is enough to buy 10% of every company in the S&P 500 energy index, which would probably have a market impact. T. Boone Pickens once joked that the cheapest place to drill for oil was on the floor of the New York Stock Exchange. If that's the case, organizations committed to a stable and cheap supply of oil should adjust incentives accordingly. [The Diff]
• The hardest part of traversing Nevada was undoubtedly the desolation. Back east we often had a town for breakfast, lunch, and dinner, with plenty of places to hide from the sun and wind. In Nevada, we were forced to ride huge chunks of milage just to reach the next town. Coupled with the 2-4 1,500ft mountain passes per ride, we were in rough shape by the end of this section. We typically road between 60-85 miles between towns, so we had to haul more water weight than usual, which only made the climbs tougher. During this section, I was very much in “biking mode.” That vision in my head that encourages me to stop and create photos was all but silent, replaced by the desire for cold chocolate milk and shelter. Continuous pedaling was the only way to convert this daydream to reality. [Chris Hytha]
  
• I believe spike protein toxicity is the most universal reaction to the vaccines. Whereas autoimmunity is not a typical response to them, circulating spike protein is the universal response. The most likely mechanisms of spike protein toxicity are in acting as a pore-forming toxin, increasing the production of breakdown-resistant clots, and binding to ACE2 receptors to drive increases in hypertension. Spike protein toxicity and autoimmunity are not mutually exclusive, but the causation starts with the spike protein. Spike protein toxicity will cause tissue damage, and tissue damage often causes autoimmunity. [Chris Masterjohn]
• Actual working business applications of blockchain were really, really hard to find. Plenty of blockchain products were on offer, characterized as “polished”, “robust”, “production-ready”, and “regulator-approved”. But if you looked hard at their customer stories, it got pretty vaporous pretty fast. The throughput of proof-of-waste blockchains was just as bad as we thought. In practice, the technology is a database. Everyone who did anything had some sort of a database structure mapped over the actual blockchain, with the usual B-trees and so on. It wasn’t obvious how anything would be different if there were something other than a blockchain behind the B-trees. The Australian Stock Exchange was betting the farm on blockchain, which seemed to prove this was no joke. A huge, almost incomprehensible, volume of venture capital was flowing into the sector, and that money was localized in the Finance sector, specifically in Manhattan. AWS was already making a lot of money off blockchain. All these venture-financed companies had to build out infrastructure, and most of them were all-in on cloud, either AWS or GCP (don’t think Azure got much of that biz). So there was a serious flow of cash from VC firms into AWS. [Tim Bray] 
• The Great War is my favorite to study, both because I like dumb stuff, and it was the dumbest war ever, and because it was the dawn of the modern world. Everything about modern life can trace its origins to the era of 1914-1919; all the bad, all the good, all the stupid and what little cleverness there is all comes from that time. Other than the invention of antibiotics, we really haven’t appreciably advanced beyond that era: something we can’t see now because we have iphones and the internet, but something future historians will consider as obvious as the fact that the Dark Ages started with the sack of Rome. Just as Western Civilization staggered and faded after the fall of Rome, Western Civilization has never really recovered from the shock of the Great War. Cultures which endured and developed over a thousand years were wiped out, never to return again. Western culture, abstract thought and artistic development: nothing important has developed since 1919; we’re still reeling from the shock. If you want to understand the present: contemporary history started in 1914. The battleship isn’t a bad place to nose around and figure out where we are and how we got there. [Scott Locklin]
  
• PM USA has entered into a JV with a subsidiary of JT, Japan Tobacco International (JTI), for the U.S. marketing and commercialization of HTS products. HTS products are defined in the JV as products that include both (i) a tobacco heating device intended to heat the consumable without combusting and (ii) a consumable that meets the definition of a cigarette under the U.S. Federal Cigarette Labeling and Advertising Act. JT is a leading international tobacco company and currently sells Ploom HTS products in four countries. JT launched its most recent HTS device, Ploom X, in Japan last year and since its introduction, JT has doubled its share of the Japanese HTS segment. The JV is structured to exist in perpetuity and establishes Horizon Innovations LLC (Horizon), which is responsible for the U.S. commercialization of current and future HTS products owned by either party. The parties expect to combine their scientific and regulatory expertise to jointly prepare U.S. Food and Drug Administration (FDA) filings for the latest version of Ploom HTS products, which are not currently commercialized. The parties currently expect to submit pre-market tobacco product applications (PMTA) for these products in the first half of 2025. [Altria]
• IQOS HTU volume growth has eclipsed declines in combustible shipments, leading to net shipment volume growth on both a reported and pro forma basis. This demonstrates that IQOS is not just cannibalizing PMI’s legacy volumes but the market as a whole. The company has also updated its FY pro forma outlook to include +2-3% shipment volume growth, up from its previous July outlook of +1.5-2.5%. Along with this, the company continues to exercise favorable pricing. In Q3 2022, combustible product pro forma adjusted net revenues increased by 4.1% on an organic basis due to pricing variance of +4.9%. [Devin LaSarre]
• David Brooks’ Bobos In Paradise is an uneven book. The first sixth is a daring historical thesis that touches on every aspect of 20th-century America. The next five-sixths are the late-90s equivalent of “millennials just want avocado toast!” I’ll review the first sixth here, then see if I can muster enough enthusiasm to get to the rest later. The daring thesis: a 1950s change in Harvard admissions policy destroyed one American aristocracy and created another. Everything else is downstream of the aristocracy, so this changed the whole character of the US. [Scott Alexander]
• The Federal Deposit Insurance Corp. is becoming concerned about mounting unrealized losses in U.S. banks' bond portfolios and the possibility that those losses will have to be realized, according to the regulator's acting chairman. "Right now, our banks have strong liquidity, so they shouldn't have to dispose of those assets," Martin Gruenberg said at a Nov. 30 Senate Banking Committee hearing. "But as the market evolves and banks may have to dispose of those assets, there are substantial unrealized losses that could impact our institutions." Gruenberg, who has been nominated for the permanent chair position, labeled the increase in unrealized losses as a "very substantial" overhang for banks that could soon become "problematic." [S&P Global]
• Thanks to their brilliant success, this little resort community, which will be familiar to some readers as the setting for the 1998 movie The Truman Show, is a landmark in postwar urban design. In two weighty volumes—Visions of Seaside (2013) and the new Reflections on Seaside (2021)—planner-architect Dhiru Thadani provides a highly informative overview of the planning and evolution of the town and its influence on architecture and urban design. The books are composed of short commentaries and reminiscences by professionals involved with or influenced by Seaside’s creation. Each contains a fine essay by the former dean of Yale’s architecture school, Robert A.M. Stern, putting Seaside in historical context. Each volume also includes an instructive look at the spiritual and ethical lessons to be learned from Seaside by Notre Dame architecture professor Philip Bess. For the general reader, however, the books’ most attractive feature will likely be their copious illustrations. [Claremont]

End of Quarter Links

• We now know the incredible growth of shale oil (and shale gas), and the resultant downward pressure it put on oil and gas prices, fooled investors into thinking they could divert huge amounts of capital into unproductive renewable projects without any consequences. What are those consequences and how painful are they going to be? We are only now beginning to find out. In a normal cycle, falling inventory levels, rising prices, and improved profitability would have attracted capital back into the industry by now. Instead, ESG commitments made over the past several years are keeping capital from reentering the oil and gas industry, making the production problems much worse. Oil prices are at 15-year highs and natural gas in Europe and Asia are setting new records and yet E&P capital spending is still down 50% from the peak with shale spending down 60%. Despite record free cash flow, companies prefer to return capital through dividends and share buybacks rather than drill new wells. Several E&P executives were brought before Congress last fall and criticized for not doing more to curtail their fossil fuel production. These same companies were called to Washington again in April and asked why they were not producing more. Unfortunately, the impact of many years of anti-fossil fuel rhetoric cannot be undone overnight. Another major issue facing the energy industry is that, although the shale resource is extremely large, it is ultimately finite just like any other conventional field. Like a conventional resource, a shale basin ramps up early in its life then plateaus and ultimately declines. We were among the first to intensely study the concept of shale depletion as early as 2019 and we concluded their best days were likely past. This was an incredibly important conclusion given the US shale basins represented nearly 90% of all non-OPEC+ growth between 2010 and 2019. In our Q4 2019 letter, we laid out our research and predicted that shale growth would begin to falter, causing the global crude market to slip into deficit. So far this is exactly what has happened. [Goehring & Rozencwajg]
  
• ExxonMobil’s chief executive predicted a resurgence of investment in fossil fuel production as he blamed soaring oil and gas prices on pressure to move to cleaner energy at a time of relentless demand. Darren Woods, the head of the biggest western oil and gas supermajor, said efforts to reduce emissions by cutting production before addressing consumption had left the world struggling to meet energy needs, pointing to an “optimistic view” about how quickly the energy transition can happen. Governments had not only failed to deal “with the demand side of the equation” but also did not recognise “that you need a fairly robust set of alternative solutions if you’re going to reliably and affordably meet the needs of people”, Woods told the Financial Times. [FT]
• I knew these were time-wasting sites, but I didn’t realize that scrolling through short-form content like this could actually disrupt my attention span so deeply that I wouldn’t be able to sustain my concentration on books anymore. I didn’t realize that I was training my brain to glance and skim, reading only a few sentences or watching a short clip before shifting focus to the next snippet. [link]
• A federal appeals court on Friday granted Juul Labs Inc. a temporary stay of the Food and Drug Administration’s order for the vaping company to pull its e-cigarettes off the U.S. market. A panel of judges from the U.S. Court of Appeals for the D.C. Circuit on Friday afternoon granted Juul’s request to delay the FDA’s ban, according to court documents. The temporary stay gives the court time to hear arguments and wasn’t a ruling on the merits of the case, the judges wrote. In addition to fighting the FDA’s order, Juul has been working with its legal advisers on options that include a possible bankruptcy filing if the company is unable to get relief from the government’s ban, according to people familiar with the matter. The company’s counsel, Kirkland & Ellis is advising on the contingency plans, the people said. [WSJ]
• The way Ginni Thomas recalled it, she and her husband, Supreme Court Justice Clarence Thomas, were driving through upstate New York, by Lake George, when the red check engine light flickered on the dash of their 40-foot 1992 Prevost Marathon conversion coach. As they buzzed along Interstate 87, “The red light came on and the engine went down and it stopped. And Clarence pulled over to the side,” she said of the associate Supreme Court justice and proud RV driver. “I was like ‘uh-oh’ and was getting ready for a long time sitting on the side of the road,” she added. [Washington Examiner]
  
• We estimate that at the end of May, the Federal Reserve had an unrecognized mark-to-market loss of about $540 billion on its $8.8 trillion portfolio of Treasury bonds and mortgage securities. This loss, which will only get larger as interest rates increase, is more than 13 times the Federal Reserve System’s consolidated capital of $41 billion. Unlike regulated financial institutions, no matter how big the losses it may face, the Federal Reserve will not fail. It can continue to print money even if it is deeply insolvent. But, according to the Federal Reserve Act, Fed losses should impact its shareholders, who are the commercial bank members of the 12 district Federal Reserve banks. [The Hill]
• Douglas wrote the decision in Griswold v. Connecticut (1965) in stating that a constitutional right to privacy forbids state contraception bans because "specific guarantees in the Bill of Rights have penumbras, formed by emanations from those guarantees that help give them life and substance." That went too far for Hugo Black, who dissented in Griswold despite having been allies with Douglas. Justice Clarence Thomas would years later hang a sign in his chambers reading, "Please don't emanate in the penumbras." [William O Douglas]
• Supreme Court Justices tend to lecture at this expensive summer school for lawyers during the Salzburg Opera Festival in Austria. I don’t remember how they are compensated? Money? Opera tickets? There will be a rush of decisions released around now because the festival starts on July 18. [iSteve]
• The three-story Sears store at the Mall of America closed years ago, but a dispute lingers over whether the bankrupt retailer can transfer its original lease — just $10 a year — to Sears' former CEO. Now the U.S. Supreme Court will have a say. Bloomberg reports that the Supreme Court on Monday said it would consider an effort by Mall of America to appeal a bankruptcy court's 2019 approval of a transfer of the Sears lease to Transform Holdco, a company controlled by former Sears CEO Eddie Lampert, who bought Sears out of bankruptcy. The Bloomington megamall had appealed that decision, arguing that Transform Holdco plans to sublease the 200,000-square-foot space rather than occupy the store itself — all while paying just $10 yearly rent. [link]
• Trump’s next step was radical and brilliant: the creation of a new category of federal employment. It was called Schedule F. Employees of the federal government classified as Schedule F would have been subject to control by the elected president and other representatives. Who are they? They are those who met the following criteria: "Positions of a confidential, policy-determining, policy-making, or policy-advocating character not normally subject to change as a result of a Presidential transition shall be listed in Schedule F. In appointing an individual to a position in Schedule F, each agency shall follow the principle of veteran preference as far as administratively feasible." Schedule F employees would be fired. “You’re fired” was the slogan that made Trump TV famous. With this order, he would be in a position to do the same to the federal bureaucracy. [Brownstone Institute]
• I think urbanism is a Very Online movement, as nobody I've met IRL gives a shit about walkability, density, etc. Even the most progressive people I know would love to live on a five acre lot if they could afford it and have zero interest in riding a bicycle on the street. Walkability in a U.S. context kind of sucks. It just means that the most dysfunctional and antisocial elements of society have easy access to you and your property and you're constantly rubbing elbows with them whenever you go out. Nobody wants that. Auto dependency is a feature of the burbs, not a bug. The residents don't want it to be easy for randos to just stumble through their enclave. That said, I think people do like to walk, bike, ride golf carts, etc around their enclave. For anything utilitarian though, they don't find it a burden to use a car or truck, and if they do, they think it's worth it in exchange for the space. [High Desert Rider]
• These days most people desire an open concept kitchen incorporated into a family style great room. But this home simply didn’t lend itself to that kind of floor plan. The kitchen was boxed in by stairs on one side and the bath on another. Only a radical addition that enlarged the house off the back would work and that wasn’t in the budget. What we have instead is an updated version of a 1950s kitchen that functions well and looks good. The heavy duty stove was a splurge, but it’s part of the marketing strategy for the property. That one item probably does more to attract quality tenants than anything else. [Granola Shotgun]
• Las Vegas is a great place to poke around and examine these themes. This part of Nevada receives 4 inches (10 cm) of rain per year. To put that into perspective, the national average is 38 inches (96 cm.) The dominant soil is a sedimentary rock that’s a combination of heavy clay, gravel, sand and calcium carbonate called hardpan or caliche. It’s basically a naturally occurring form of concrete and quite possibly the worst material you could imagine if you were interested in growing anything. The high temperature in Las Vegas is 125 F (51 C) and the low is 8 degrees (– 13 C). Without modern machinery and a national network keeping this place supplied with essentials there’s no way the current population of 2,200,000 people could survive in this environment. Las Vegas is basically a space colony. [Granola Shotgun]
• Russia is a sad case that I am ambivalent about. Russia has aspects of anti-fragility because it already collapsed to a low order of complexity, and because it is net long and benefits from higher energy and commodity prices. It is just dumb luck that Russia has so much natural gas. If the communists could have sold it all in one slug to the west at any point, they would have. But they couldn't and these resources have now conferred an anti-fragility on Russia. Unfortunately from an investment perspective, Russia does not have a tradition of harmonious minority ownership of corporations. We will watch and see whether ownership in Russian public companies eventually translates into meaningful economic interest, but right now it doesn't. I propose a long-term short of the BRICs. Only a very ebullient social mood - and overpriced U.S. securities to match - has caused investors to be interested in abstract (imaginary) claims on BRIC businesses. The BRIC ETF BKF has a dividend yield of less than two percent. One of the funny things about buy and hold investors is that they choose to ignore some very unpleasant discontinuities in stock index time series. For example, once during the past century you would have lost all of your investment in Chinese companies in a confiscation. How do you account for that? Are you getting paid for that risk with a two percent yield? [CBS]
• Obviously there are lots of risk. Maybe the energy curve collapses. Maybe CHK is flat out lying to you and plans to light all of that cash flow on fire. Maybe the ground opens up and swallows all of CHK’s assets. Who knows? But there is a massive mismatch between the energy strip and the price energy companies’ stocks are trading at, and the companies are gushing so much cash that the market is going to be proven right or dramatically wrong on pricing these companies below the strip very quickly. [Yet Another Value Blog]
• The capital, operation and maintenance cost of two power systems, the need to operate at lower efficiencies, the extra stop/starts, grid balancing, spinning, the use of less efficient turbines and the need to buy gas on the spot market at times of high demand all add costs to the operation of the grid. Those costs will increase as you add more intermittent power sources to the grid, but they are never shown in the published costs of wind and solar power. Those extra costs are the reason why countries with high installed wind and solar capacity tend to have high electricity prices, and why your electricity bill will always go up when so-called “low cost” wind and solar are added to the grid. Higher installed wind and solar capacity correlate with higher prices. [jaberwock’s Newsletter]
  

Sunday Night Links

• Figure 2 shows the rolling 12-month performance of the Long-Term Reversal factor in the US. This compares the returns of the best- and worst-performing stocks of the previous five years, excluding returns to 1-year Momentum, and thus isolating the extent to which longer-term trends are changing. A high reading means that a reversal is underway and previous losers are performing strongly. Conversely, a low reading means that previous trends are continuing. While we are not yet at all-time highs for the factor, investors have experienced the biggest overall swing in the data set. In the space of a year (highlighted in Figure 2), the dominance once enjoyed by mega-cap tech and Growth stocks has almost entirely reversed, with previous losers approaching the outperformance they enjoyed when the tech bubble burst in 2001. [Man Institute]
• Once the fertility transition to controlled fertility occurs in a population, its fertility generally continues to decline until it is below replacement. The benefits of the new pattern are increased material wealth per person, a reduction in disease, starvation, and genocide, and upward social mobility. The main drawback is the onset of a dysgenic phase that may end civilization as we know it. [Sarah Perry]
• For example, natural resource equities did well during the Great Depression between 1929 and 1943 – a period typically associated with extreme deflation. The stock market crash of 1929 saw the S&P 500 fall over 80% by 1932. Gold meanwhile remained flat until 1934 when President Roosevelt raised its price from $20.67 to $35 per ounce. Natural resource related equities (other than gold stocks) fell too but they rebounded much more quickly. Between 1929 and 1943, the US had experienced more than a full decade of deflation with the CPI falling by 5% in aggregate. In 1943, the S&P 500 still remained some 60% below its 1929 peak. Over that period, the price of gold rose by 70% while oil stocks advanced 30%, mining stocks rose 12% and agricultural stocks advanced 45%. The decade normally associated with economic depression and deflation was actually very good for natural resource investments – both on an absolute and a relative basis. [Goehring & Rozencwajg]
  
• In an era when a small number of people lived past sixty-five, society could easily support them for the very few years they survived beyond that point. Now that citizens are routinely living two decades longer, it is simply not mathematically possible, let alone politically feasible, to expect each worker to support 0.67 retirees, no matter how many coconuts, dollar bills, stock certificates, or Krugerrands they save up in the meantime. It is also not reasonable to expect productive younger individuals to support large numbers of healthy older non-workers. As Arnott and Casscells succinctly conclude, what we have is not a savings crisis, but rather a demographic crisis. We will not be rescued by increased voluntary or enforced savings. The idea of investing Social Security funds in stocks, so fondly embraced by right-wing think tanks, is a prescription for capital-market instability. [William J. Bernstein]
• I pulled up a recent case. U.S. App. No. 16/824,815 focusing on a vehicle heads-up display owned by Visteon.  A third party (James D. Busch) submitted his own published patent application (US Pub. No. 20180217429) as prior art and included a 30-page “concise description of relevance.”   At that point, the examiner issued an anticipation rejection and the patentee abandoned.  Note here that Busch is both a prolific inventor and a patent attorney.  He has an interesting article suggesting that patentees may want to use 3rd party submissions in order to seed forward citations of your patent. [Dennis Crouch]
• U.S. distillate demand in 2021 has been running at about 5% above pre-pandemic levels, putting inventories at 15% less than the five-year moving average, according to U.S. Energy Information Administration data. U.S. East Coast stockpiles are at their lowest since April 2020. When inventories are low, refiners generally respond by ramping up output. However, global refining capacity shrank by more than 2 million barrels per day during the pandemic, while U.S. refining capacity last year fell 4.5% to 18.1 million barrels per day, according to federal data. U.S. refiners are still running plants at lower rates than the five-year average to avoid producing too much jet fuel, where demand still lags 2019 levels. "We actually don't see a clear path in the near future to be able to restock diesel inventories," said Gary Simmons, chief commercial officer at Valero, during the company's earnings call last week. [Laura Sanicola]
• The site Know Your Meme has an amazingly detailed history of the term wordcel. Apparently it was coined on 4chan’s /pol/ message board, and the Twitter user roon just popularized it. It’s an interesting phenomenon that /pol/, which is WAY outside the Overton Window, has such a short pipeline into semi-mainstream political discourse. All of the smarter-than-average, very online pundits and anons operate in a milieu in which their lives can be wrecked if they say something politically incorrect. And yet, all of these people are now intimately familiar with tons of hatefacts and dissident right arguments; they’re exposed to them constantly in the recesses of Twitter and comment sections. This was not true twenty years ago, and it is true now despite the post-2016 bannings. Today I also noticed Andreessen, a big-time Silicon Valley name, follows and retweets Zero HP Lovecraft, who is basically a full-blown Alt Right account. This situation doesn’t seem sustainable. I have no idea what will happen, but the mainstream’s hold may be more tenuous than we realize. [Sailer]
  

Goehring & Rozencwajg and Horizon Kinetics on Commodities

Highlights from Goehring & Rozencwajg's first quarter 2022 Natural Resource Market Commentary: "The Gas Crisis is Coming to America":

• Asian and European natural gas prices stand at $35 per mmbtu, versus $8.20 per mmbtu here in the United States. Given the underlying fundamentals that have now developed in US gas markets, we believe prices are about to surge and converge with international prices within the next six months. The natural gas market outside of North America has been in an extreme shortage since the end of last summer. Prices first broke $35 per mmbtu last October, plateaued, and then surged again in December, surpassing $50 per mmbtu – equivalent to $300 per barrel oil.
• Our models suggest the decades-long protection from international price swings, enjoyed by the North American gas market, is about to change. Slower-than-expected shale growth will push the US market into structural deficit for the first time in 15 years. Almost immediately following the shift, US prices will converge with global gas prices. Given today’s $35 per mmbtu international gas prices, prices could surge by almost four-fold.
• In just six short years, the US has become the world’s largest LNG exporter. Six export facilities currently operate and a seventh, Calcasieu Pass, will add an additional 1.7 bcf/d of capacity, bringing total US LNG export capacity to 13 bcf/d, surpassing both Qatar and Australia, formerly the world’s two largest LNG exporters. Even though it is now integrated into the global gas market via LNG, US prices remain disconnected from global prices. Why? Surging shale production has far exceeded LNG export demand. The US natural gas market has remained in structural surplus even with surging LNG exports. That is all about to change. Slowing shale production will cause the US to flip from structural surplus to structural deficit.
• The moment the US gas market swings from even marginal surplus to marginal deficit (i.e., when US demand plus LNG exports exceeds production and imported supply), something shocking will take place: almost immediately, US prices will converge with global prices.
• Most investors can only extrapolate a trend. In this case, the trend has been near endless growth from the shale gas basins. The idea that gas supply could falter and as a result that US gas prices could nearly instantly rise four-fold is completely off any investors’ radar. And yet, this is exactly what our models are telling us could happen within the next six months. 
• As you can see, commodities and financial equities have both traded in long cycles that are usually inversely related. Over the last 130 years, there have been four times when commodity markets became radically undervalued versus the stock market: 1929, the late 1960s, the late 1990s, and today. After each period of radical undervaluation, commodities entered into large bull markets and then proceeded to become radically overvalued. If you had invested in commodities or commodity related equities in any of these three previous periods, the returns on both an absolute and related returns basis were huge.
• These three periods couldn’t have been more different: the 1930s were a period of deflation and global depression; the 1970s were a period of severe inflation and worries over currency debasement; and the 2000s were a little bit of everything including a stock market collapse, a global financial panic, and an oil price spike not seen since the 1970s.
• These three great commodity buying opportunities were all characterized not only by cheap commodity prices, but by the recurrence of four other events. First, prior to each commodity buying opportunity was a decades-long commodity bear market that produced price declines so severe that capital spending in many extractive industries was impaired. Second, each period was characterized by excessive monetary creation. Third, all three periods saw intense financial speculation. And fourth, each period saw a major shift in global monetary regimes. All four conditions are once again present today and, in many instances, they are far greater in magnitude than in any of the previous three cycles.
• The deflationary trend of the last 40 years is now over. A new inflationary trend is in place and will last longer and carry on farther than anyone expects. Huge changes in investment flows are about to take place with large implications. Although inflation-sensitive assets have already begun to radically outperform bonds and the general stock market, investors’ interests in these assets remains subdued.
• We remain wildly bullish on North American natural gas and we continue to recommend large exposure to natural gas focused E&P companies. Even after their big runs in 2021 and into the first quarter of 2022, natural gas related equites are priced extremely cheap. In no way do these stocks incorporate $4.00 per mmbtu gas, let alone today’s $8 price.
• Internally, we have discussed what we should expect to see as the world runs out of spare pumping capacity. Although extremely challenging and uncertain, we find it valuable to lay out a roadmap with mile makers that we should expect to pass if our premise is correct. We agreed that if we are in fact running out of spare capacity, we should see a series of large releases from strategic petroleum reserves. On March 31st 2022, President Biden announced he would release a record 1 m b/d for six months from the SPR. Other countries followed suit and agreed to release another 1 m b/d for at least two months. Historically, SPR releases have been unsuccessful in reducing oil prices and instead are an indication that the physical crude market is exceptionally tight. The larger the release, the tighter the market. The recent announcement from the US and the rest of the International Energy Agency (IEA) member countries is by far the largest coordinated SPR release in history and we believe confirms our thesis that the oil market has fundamentally changed.
• In a normal cycle, falling inventory levels, rising prices, and improved profitability would have attracted capital back into the industry by now. Instead, ESG commitments made over the past several years are keeping capital from reentering the oil and gas industry, making the production problems much worse. Oil prices are at 15-year highs and natural gas in Europe and Asia are setting new records and yet E&P capital spending is still down 50% from the peak with shale spending down 60%. Despite record free cash flow, companies prefer to return capital through dividends and share buybacks rather than drill new wells.
• One question we are often asked is whether high prices will curtail demand and potentially push the world into recession. The topic of demand destruction is extremely interesting and in a future letter we will likely dedicate a whole essay to the subject. Using the relationship of oil expenditures to GDP helps us put the current situation in proper context. The last two major oil tops occurred in 1980 when oil rallied from $3 to $36 per barrel and in 2008 when oil rallied from $11 to $145 per barrel. In 1980, the US consumed 17 m b/d which amounted to $225 bn per year on GDP of $2.9 trillion. In other words, nearly 8% of US GDP was spent on oil. On a global basis, oil demand averaged 61 m b/d, amounting to $800 bn on GDP of $11 trillion, or 7.2%. In 2007, the US consumed 19 m b/d, amounting to $1 tr on GDP of $14.5 tr, or 6.9%. Globally, we consumed 86 m b/d, amounting to $4.5 tr or 7.8% of $58 tr in global GDP. At present, the US consumes 20 m b/d, amounting to $730 bn at $100 per barrel crude. With GDP running at $21 tr, oil expenditures amount to 3.5% -- less than half the prior two peaks. Globally, demand ran at 97.5 m b/d last year (although we believe this is higher), amounting to $3.4 tr or only 4% of global GDP – again only slightly more than half the prior two peaks. Oil prices likely contributed to slowing economic growth in 1980 and 2008, however we are not yet at the same levels of expenditures. Were oil to reach $170 per barrel, expenditures as a percentage of GDP would reach 6-7%, more consistent with previous market tops.
• The current energy crisis will not be solved until capital comes back into the industry in significant quantities. Normally high commodity prices and improved profitability help attract capital, but ESG pressures are keeping that from happening. E&P capital budgets are indeed up 25% compared with the 2021 lows, however they remain 60% below trendline. Moreover, we are hearing that most of the increase is not the result of increased activity but rather represents cost inflation as bottlenecks have now developed in key equipment, steel, and labor. Energy related IPOs and secondary offerings totaled a mere $1.8 bn over the past six months, 80% below the $10 bn average between 2010 and 2017 and 90% below the $22 bn peak in 2016.
• Capital remains unavailable even though oil and gas prices are high and even energy hostile politicians are now calling for more upstream investment. Investor interest in the energy sectors also continues to be extremely low. Between January 2021 and today, the XOP (the largest ETF of E&P stocks) has advanced by 120% and yet, over that period, the shares outstanding have actually decreased--investors have actually redeemed shares on balance.

Highlights from Horizon Kinetics' Q1 roundtable discussion: 

• The oil service industry, for eight years, that’s from 2014 to now, has been through the greatest depression in its history. And that includes the post-1980 environment, until now the greatest depression ever. And all you can say right now is it’s a little bit better than it was in the second quarter of 2020. It’s not a lot better. It’s a little bit better, from their unique point of view. They don’t make any money to speak of. So, we’re going to get price increases, and that’s going to happen because they don’t have the money to buy new equipment. This is a capital-intensive business. So far, they’re cannibalizing old equipment, but they’re about at the end of that process right now. Therefore, when some energy company states that it is going to spend X billion dollars in capital expenditures, the unfortunate thing is that, in short order, that money, whether it’s $1 billion, or $2 billion, or $3 billion, or $4 billion, is not going to buy what it bought last year. It’s the same money but it will buy less, and that’s going to constrain production.
• [W]e all talk about oil as if it’s homogeneous, but it’s not homogeneous. Refineries are configured for different types of oil, heavy oil, light oil. Those names refer to what’s called API gravities. API stands for American Petroleum Institute. There are certain kinds of oil that are just better for extracting asphalt and diesel fuel, and there are certain oils that are better for getting gasoline out of it. It has to do with the length and the strength of the hydrocarbon chain. What this means is that if you run a refinery and you’re configured to run on heavy oil, you can get that from Russia, you can get it from Canada, or you can get it from Venezuela. Those are the main sources. If, because of sanctions, or whatever the reason happens to be, you lose the Russian oil, it’s not as if oil from Texas can replace that supply you lost, because your refinery isn’t configured to run on light oil. You’d have to totally rebuild your refinery.
• One other thing I’ll just mention in passing is that it’s very hard for institutional investors to make energy investments, since they took the pledge to divest themselves of energy. That’s another factor. Therefore, the energy companies will not be spending a lot of money to gear up to produce oil when the major institutions, the financiers of the world, have said they’re going to be divesting. So, that’s not going to happen, either.
• We’ve been accustomed to 40 years, basically, of one cycle, the whole cycle that we covered in the last quarterly review. Declining interest rates, declining tax rates, all these trends—it’s all come to an end. Not just an end, it’s actually changing. But people haven’t wrapped their heads around that yet. It felt normal, because there was 40 years of it. If you’re 50 or even 60 years old, in terms of being conscious about economics, that’s all you knew.
  
• [C]ommodities have been in a recession/depression for 40 or 41 years, other than the occasional few months exceptions to that. Not a recession, but a depression. And for those decades, return on capital for commodity companies was very low, while for businesses globally the return on capital was very high. Technology is a good example, whether it’s Microsoft or Apple or what have you. Accordingly, for 40 years, capital has been gravitating away from the commodities—really the extractive industries.
• One other dynamic is very important. As if this depression in commodity prices, the competition from the collapsed communist states, the withdrawal of asset allocation capital from these industries, wasn’t bad enough, there’s been the impact of the ESG movement for the last five or six years at least. For the ESG movement, since anything extractive is going to emit some type of greenhouse gas, these companies basically all had to take the pledge to reduce greenhouse gases by three percent a year. But you can’t increase production and decrease greenhouse gases. It doesn’t work that way. So, none of them is in a rush to increase production of anything whatsoever.
• Another category of presumed inflation beneficiaries are the consumer products businesses, for which there is stable demand, because they’re perceived to be able to raise their prices. But two challenges they faced historically, like in the 1970s, is that you can have cut-rate, no-name brands arising in supermarkets, for instance, for all sorts of high-margin staples like cereal, and peanut butter, and jams, and frozen dinners. At the same time, their input costs go up, too, so their margins contract. That happened to the big consumer products companies. And of course, if that happens, their P/Es contract.
• Virtually all the oil produced in the United States is light crude oil. Yet, many of the refineries in the United States process heavy oil, as opposed to light oil. The reason for this is that heavy oil is preferable for products such as asphalt, fuel oil, and petrochemical feedstocks. Thus, a shortage of one type of oil cannot be replaced by a different type of oil. In other words, increased U.S. production cannot replace Russian production. Russian production must be replaced with something comparable to Canadian heavy oil. However, to supply refineries located in the United States, pipelines must be built. Apart from Canada, in the Americas, the two biggest sources of heavy oil are California and Venezuela. California will probably not permit meaningful increases in heavy oil production. Actually, it may not permit any increases in any type of oil production. Therefore, Venezuela becomes the next choice. That’s the reason why the government is turning to Venezuela for oil. It’s not merely to replace a given quantity of oil. It’s that the type of oil produced in Venezuela is the type of oil needed for the refineries that currently use Russian oil, because of the way in which they’re configured.