Adam Rozencwajg: Oil & Energy Has The Cheapest Valuations In The Entire Commodities Complex?

Introduction

In this section, Jason Berk introduces the guest speaker, Adam Rosenswag, and sets the stage for the discussion.

Introducing Adam Rosenswag

• Jason Berk introduces Adam Rosenswag as a managing partner at a natural resource fund with experience in investment banking.

• The focus of the interview will be on commodities, particularly energy markets.

Oil Market Discussion

In this section, Jason and Adam discuss the current state of the oil market and its future prospects.

Investor Fear Driving Oil Prices

• Investor fear is driving oil prices down due to concerns about a potential recession and its impact on oil demand.

• However, there is no evidence of weakness in any data related to oil demand.

• The cycle in the resources world is cyclical by nature due to capital cycles with money flowing in sanctioning new projects. Too much supply comes online causing prices to fall and everything pours back out again.

Underinvestment in Capital Expenditures

• There has been underinvestment in capex since 2013, with over a trillion dollars estimated back then of underinvestment in capital expenditures.

• This has resulted in a lack of spending on resources and energy projects by around 65%.

• This underinvestment will ultimately drive up oil prices as supply becomes constrained.

Fundamentals Look Good Despite Short-Term Oriented Hedge Funds

• Global oil demand hit record levels recently while global inventories are down.

• The rig count has also fallen significantly both domestically and globally.

• Despite these positive fundamentals, short-term oriented hedge funds are still betting against energy markets.

The Importance of Investment in Oil Production

In this section, the speaker discusses the importance of investment in oil production and how it affects future production.

Investment in Shale vs Conventional Oil

• In 2013-14, a lot of money was going into shale but no money was going into conventional oil.

• Conventional oil has been declining since 2011-12.

• Future production is ultimately determined by how much money is spent.

Inventory Levels as a Predictor of Supply and Demand

• Near-term inventory trends can indicate whether the market is in surplus or deficit.

• Total oil inventories show a substantial deficit, indicating that prices should be around $120 per barrel.

• The market is considering releases from the Strategic Petroleum Reserve (SPR) as a source of supply, which is strange because it's just reclassifying government stockpiles into commercial stockpiles.

Short-Sightedness in the Market

• A ton of extra paper oil futures contracts are being created and going short.

• Eventually, these will have to be covered because oil is a physical market and inventories will decline.

• Cheaper oil production has stopped growing, leaving us with much higher cost oil than 10-20 years ago.

Growth Resting on Narrow Shoulders

In this section, the speaker talks about how growth in global oil demand rests on narrow shoulders due to limited growth in shale production.

Limited Growth in Shale Production

• All other growth in the world has stopped except for shale.

• The Permian Basin in West Texas is the only basin that has shown any growth in the last four years.

• Global oil demand growth is resting on narrow shoulders, with six counties in West Texas representing 100% of total oil supply growth.

Importance of Shale Oil Production

In this section, the speaker discusses the significance of shale oil production in the US and how it has impacted the world energy markets. The speaker also highlights that while shale oil production has been monumental, it is not infinite.

Shale Oil Production in the US

• Shale oil production in the US is as consequential as Saudi Arabia.

• The Permian Basin has been important for shale oil production.

• Production came right back after a fall in prices, leading to a belief that any amount of production could be brought on with almost no rigs.

• Major productivity degradation is being seen in the Permian due to geology.

Peak Production

• Peak production has been reached in two of the three major shale basins.

• The Permian may be close to hitting peak production due to drilling out best areas and being forced into lower quality drilling locations.

• All concern about running out of oil from 15 years ago may come back when shales are no longer a persistent source of growth.

Importance of Developments in Energy Market

In this section, the speaker emphasizes how important developments in energy markets have been over the last decade. They also discuss how American consumers and businesses were gifted with cheaper natural gas and oil compared to other countries but now those days are coming to an end.

Developments in Energy Markets

• Developments in energy markets over the last decade have been significant.

• Cheaper natural gas and oil were gifted to American consumers and businesses compared to other countries but those days are coming to an end.

Future Oil Production Growth

• Similar to 2007, future oil production growth may have to come from deep water offshore wells that are more expensive.

• New production will come online when the cycle is over and prices will fall.

The Future of Shale Industry

In this section, the speaker talks about the rise of China and how it will affect the demand for oil. They also discuss the potential growth areas for shale production in the future.

Potential Growth Areas for Shale Production

• The speaker mentions that they have invested in the shale industry and that deep water offshore is a potential area for growth.

• Other countries such as Russia, China, and Argentina have potential shale plays but there are impediments to their development.

• The Bears off Shale in Russia is a potential area for growth but there are currently sanctions against allowing shale technology into Russia.

• A study conducted by the speaker's team ranked all world shale basins based on geological features that make a good shale basin. Seven out of ten top shales were found to be in the US.

Challenges with Shale Production

• There has been no material development in shale production outside of the US despite predictions made 10 years ago.

• Good shales are concentrated in certain areas such as South Africa with its gold deposits and platinum deposits or Canada with uranium. Similarly, most good shales are located in the US.

• Seismically active areas and mountainous regions can pose challenges to shale production due to lack of permeability and porosity. Fracking is required to create artificial permeability to flow oil and gas.

Overall, this section discusses potential growth areas for shale production while highlighting challenges faced by other countries trying to develop their own shale industries. It also emphasizes that most good shales are located in the US.

Shale Potential in Seismically Active Areas

The speaker discusses the challenges of producing shale commercially in seismically active areas, such as Mexico and the UK. They also mention potential shale deposits in Argentina.

Challenges with Developing Shale Deposits

• Seismic activity can make it difficult to produce shale commercially.

• Broken up areas can result in low commercial production.

• Regulatory issues can also hinder development.

Shale Potential in Argentina

• Argentina has good shale potential, but there are concerns about nationalization of oil assets.

• Getting capital out of the region is also a challenge.

Energy Companies' Valuations

The speaker discusses how cheap energy companies have become and how they offer attractive valuations for investors.

Energy Companies' Cheap Valuations

• Many energy companies are trading at low single-digit multiples and upwards of 20 yields.

• There are many Canadian and US energy companies with seven to ten percent dividend yields.

• Pioneer is a well-run company with top-tier drilling areas in the Permian that offers an indicated gross yield of around seven percent.

Traditional Value Investors Investing in Commodities Producers

• David Einhorn has been adding coal stocks, natural gas stocks, and oil stocks to his holdings.

• Warren Buffett's biggest positions are now all oil companies as well.

The Future of Energy

In this section, the speaker discusses the challenges facing renewable energy and advocates for nuclear power as a solution.

Challenges with Renewables

• Renewables require large projects that are energy-intensive to build.

• Battery technology is not yet advanced enough to support renewables.

• Moving power from one state or county to another is difficult due to limitations in the electrical grid.

Nuclear Power as a Solution

• Nuclear power is highly efficient and generates no CO2 emissions.

• Nuclear power is 3 times more efficient than oil and gas and 10 to 20 times more efficient than wind and solar.

• The lack of investment in nuclear power over the past 15 years has led to supply-side problems across all commodities.

Resource Scarcity and Nationalization

In this section, the speaker discusses resource scarcity and nationalization as potential issues facing key energy elements.

Resource Scarcity

• There are supply-side problems across all commodities due to lack of investment.

• Politicians are not considering the scarcity of key metals like copper, lithium, rare earth elements, nickel, or cobalt when planning for electric vehicles.

Nationalization

• The pendulum is swinging towards resource nationalism.

• Governments may renegotiate royalty taxes or even nationalize resources like lithium ions.

Geopolitical Risk and Resource Nationalism

The speaker discusses the relationship between capital markets, producers, and host countries in the resource space. He notes that there is a codependent relationship between these entities and that geopolitical risk plays a significant role in investment decisions.

Codependent Relationship

• Capital markets, producers, and host countries have a codependent relationship.

• If host countries take too much from producers, capital dries up, making it difficult to build new projects or maintain existing ones.

• Resource nationalism is becoming more real around the world, including in the United States.

• There is talk of strategic stockpiling of certain resources in some countries.

Complications and Challenges

• Trading blocks are emerging around the world due to resource nationalism.

• Things are getting more complicated and less efficient for companies operating in this space.

• Depletion is at work across the board in the gold space.

• Higher interest rates from the FED make it difficult for miners who are not low-cost producers to operate efficiently.

• Miners face higher energy costs, labor costs, and falling grades.

Peak Gold Mining?

The speaker discusses whether we have hit peak gold for gold mining. He notes that while there has been no rush of new major high-grade gold deposits recently, if gold prices move higher globally, many names will do well.

Depletion at Work

• We have not come across any rush of new major high-grade gold deposits recently.

• Depletion is at work across the board in the gold space.

• The grades for key metals like copper and silver are trending downward.

Challenges for Miners

• Unless you're a low-cost producer, higher interest rates from the FED make it difficult to operate efficiently.

• Miners face higher energy costs, labor costs, and falling grades.

Gold Market and Resource Bull Market

In this section, the speaker discusses the potential for a long-term gold bull market and how it relates to a broader resource bull market.

Gold Price and Resource Bull Market

• The speaker believes that both good quality gold mines and bad projects will see higher prices in a strong bull market.

• Historically, every major period of commodity cheapness relative to financial assets has been resolved by commodities moving much higher.

• The trigger that re-rated commodity prices from radically undervalued to ultimately overvalued was a shift in the global monetary order.

• The de-dollarization theme is an example of what might be the catalyst for this new cycle.

Valuation Perspective on Gold

• From a valuation perspective, there's a clear case to be made for much higher goals.

• Although there may be headwinds in the form of rate hike cycles, the speaker believes we're setting up for a very strong bull market.

• It's possible that gold may have trouble breaking out of what's now been a triple top, but this doesn't concern the speaker too much.

Timing and Market Performance

• There's never been a bull market in resources that hasn't had a gold component to it.

• Timing has usually been the question, but they've timed this one fairly well so far.

• Despite having the sharpest rate hike cycle in history in 2020, gold held up pretty well.

Speaker's Position on Gold

• The speaker is not a gold bug and doesn't think that gold is always the solution to everyone's problems all the time.

• However, he thinks that if you look at it objectively from a valuation perspective, there's a very clear case to be made for much higher goals.

Central Banks and Gold

In this section, the speakers discuss how central banks are becoming major buyers of gold due to concerns about the US dollar as a reserve currency. They also talk about how China's problems with its currency and real estate market are driving up demand for gold in mainland China.

Central Banks Buying Gold

• Non-G7 central banks have stopped buying US treasuries due to concerns that their assets could be confiscated by the US government.

• As a result, these central banks have been buying large amounts of gold since mid to late 2022.

• The speakers believe that whatever replaces the US dollar as a reserve currency will likely have a gold component to it.

Gold Demand in Mainland China

• Private sector Chinese demand for gold is expected to continue due to problems with China's currency and real estate market.

• Physical gold is one of the main options for diversifying or protecting oneself from inflation or currency devaluations in mainland China.

Speculation on Gold

In this section, the speakers discuss how speculation on gold could drive up demand even further, but caution that these markets can become overwhelmed with capital if they become too popular.

Potential for Speculation on Gold

• The speakers believe that speculation on gold could take on completely ridiculous proportions as animal spirits come back into the market.

• However, they caution that these markets are small and can become overwhelmed with capital if they become too popular.

Energy and Commodities Investing

The average investor tends to focus on tech stocks and Bitcoin, rather than energy or commodities. These sectors are currently unpopular due to the prevalent feeling of fear in the real asset space. Additionally, there has been a dismantling of institutional knowledge in the industry, with many firms lacking an energy analyst.

Current Sentiment Towards Energy and Commodities

• Energy and commodities are currently unpopular among investors.

• Fear is the prevalent feeling in the real asset space.

• Commodity prices remain as cheap as they have ever been relative to financial assets.

• People are still incredibly bearish towards energy.

Lack of Institutional Knowledge

• There has been a dismantling of institutional knowledge in the industry.

• Most firms don't have an energy analyst.

• Instead of an energy analyst who has been through lean times, many firms now have someone who has been taking away from energy into other industries.

Future Supply Problems

• Politicians tend to focus on windfall profits taxes and drilling bans instead of making investments into new supply.

• Additional supply problems are expected in the long term for energy.

Commodities as an Inflation Hedge

Adam discusses the potential of commodities as a hedge against inflation and how they have historically outperformed stocks, bonds, and real estate during inflationary cycles.

Commodities as an Inflation Hedge

• Commodities are a good way to protect wealth during inflationary periods.

• During past inflationary cycles, commodities have outperformed stocks, bonds, and real estate.

• Longer cycles show that commodities are the best hedge against inflation.

Following Adam's Work

• Garing and Rosen Swag post all their research papers online.

• The website is g-o-r-o-z-e-n.com.

• They write frequently about commodities in their blog articles and newsletter.

Overall, Adam suggests that allocating some wealth to commodities can be a good way to protect against inflation. He also provides resources for those interested in following his work on the topic of commodities.